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Elizabeth Arden, Inc. (NASDAQ:RDEN)

Q2 2010 Earnings Call

January 27, 2010 4:30 p.m. ET

Executives

Scott Beattie - Chairman & CEO

Joel Ronkin - EVP North America Fragrances

Steve Smith - EVP & CFO

Marcey Becker - SVP of Finance and Business Development

Analysts

Joe Altobello - CIBC World Markets

Arnie Ursaner - CJS Securities

Alice Longley - Buckingham Research

Bill Chappell - SunTrust

Jason Gere - RBC Capital Markets

Presentation

Operator

Greetings and welcome to the Elizabeth Arden second quarter fiscal 2010 results conference call. At this time all participant are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder this conference is being recorded. It is now my pleasure to introduce your host, Ms. Allison Malkin with ICR. Thank you Ms. Malkin, you may begin.

Allison Malkin

Thank you. Good afternoon. Thank you for joining us. Before we being, I would like to remind you that some of the comments made on the call adhere prepared remarks and 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 10K filed with the SEC. If non-GAAP financial information is provided on this call you can find a reconciliation of the non-GAAP information to the most comparable GAAP financial measure in our press release.

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

Scott Beattie

Thank you very much Allison and welcome everyone to our second quarter conference call. Joining me today is Joel Ronkin, our Executive Vice President of North American Fragrances, Steve Smith, our Executive VP and Chief Financial Officer and Marcey Becker our Senior Vice President of Finance and Business Development. In terms of the agenda today, I will provide an overview of Q2 operating performance and as specially a review of our international business as a summary of our Key corporate initiatives and priorities.

Joel Ronkin will provide an overview of our North American business unit, as well as fragrance brand performance and the performance of our high business through the Christmas season. Joel's business to remind everyone represents approximately two thirds of our total business and the international business is approximately one third of our total business.

Steve will provide a detailed review of our key financial metrics, as well as a status update on our JD Edwards Oracle Enterprise implementation and an update on our global efficiency reengineering initiative. Following Steve’s presentation I will provide a brief overview of some of our longer-term strategic objectives and then we will open it up to questions from everyone.

Just in terms of an overview our second quarter performance. Our performance is generally in line with our expectations. Our U.S. mass business continued to perform better than the U.S. department store channel, as consumers focused on value. And our U.S. mass retailers tended to be more aggressive in terms of inventory investment, particularly some of our mass volume retailers which Joel will go into in more detail.

Overall, North American retailers continue to be very cautious in terms of inventory investment. And we have forecasted a very modest improvement in replenishment for the second half of fiscal 2010.

The good news is that I think global retailers are generally finished destocking. It seems that we hit bottom sometime in the late summer, early fall depending on the retailer and the geography around the world and that inventory replenishment and restocking seems to be a function of retail sell-through and the individual performance of that retailer. In terms of our international business which represents as I said about a third of our total business, sales were up 6% for the second quarter. This growth is primarily driven by our Asia Pacific business which was up 13% in constant dollars and travel retail which was up 32% in constant dollars which is a travel retail and distributor business.

Some of this growth was of very weak comps from last year Q2. As you recall we saw very weak distributor demand particularly last year as a results of the strong dollar and the credit crisis that severally impacted many of the foreign distributors. Europe was quite weak during the second quarter, was down 4% in constant dollars and it was driven by a continued weak environment in Spain, Italy and the U.K.

Some of the weakness however was driven by ourselves. We actually reduced the proportion of promotional gift sets and price discounts to help improve our gross margins on the business particularly our gross margins in our fragrance business and improved long-term profitability. Late in the quarter, we started to see improvement in the U.K particularly and are hopeful that the U.K. and the rest of Europe will continue to show modest improvement during the second half of this year. Obviously, with any kind of modest improvement in top line growth within the improved gross margin that will help to accelerate profitability in Europe.

In terms of the Elizabeth Arden brand, the brand showed strong recovery globally during the second quarter. The U.S. department store business which Joel will talk in more detail is up 23% with strong retail trends better than the category. The Elizabeth Arden brand in our international markets was up 4.3% in constant dollars and 12.5% in with currency included. And that again that was driven by our Asia Pacific business particularly in skin care and our travel retail and distributor business in both skin care and color.

Looking forward to the second half as I stated in previous conference calls, the improvements that we're seeing that are being driven by our global reengineering initiative, first manifest and stepped themselves in improved cash flow, reduced inventory levels and as a result improved return on invested capital, and then as by those improvements get cycle through the inventory gets sold and the improvement in gross margins get, the improvement in these initiatives get cycle through our P&L will continue to see improvement in gross margins, EBITDA margins and profitability.

I'm extremely pleased with our current position as it relates to these financial metrics, and Steve will go through these in more detail, but our inventory been down 32% versus last year, the gross margin in cash flow is well ahead of our guidance and as a result we are extremely confident that as we move forward, we will continue to see quarter-over-quarter improvement in all of these metrics for several quarters to come.

In addition, we expect that sales will modestly accelerate during the second half of this fiscal year which will help drive improvement in our business. What that all means is that assuming that we continue to experience a slow, steady recovery in the global economy, we expect to deliver methodical systematic improvement in our business and profitability over the next several quarters and in to 2011 fiscal year.

As I mentioned, before I hand it over to Joel, spend a little bit of time before questions to talk about a couple of key initiatives that our management team is working on to help drive long-term top line organic growth in our business. Joel?

Joel Ronkin

Thank you, Scott. I'm going to comment first on the performance of the North American Fragrances group for the quarter, including our new launches and our key brands and then I'm also going to discuss our Elizabeth Arden U.S. prestige department store business as well as our e-commerce business. And then finally I will comment as usual on the outlook for the remainder of the fiscal year.

As Scott mentioned, the North American Fragrances group comprises about 60% to 65% of our overall net sales. It includes the department store fragrance business in the U.S. which is that part of the U.S. department store business where we sell all of our non-Arden branded fragrances. It also includes our mass business, our e-commerce business and our businesses in Canada and Puerto Rico.

For the second quarter, our net sales were up 6% and our operating profit increased by 11% as we saw strong gross margin expansion of 200 basis points.

Turning first to the mass channel, net sales for mass business were up about 7%, with operating profit of 9% for the quarter. We showed strong gross margin improvement on improved sales mix and some modest targeted price increases. Retail sales of our prestige fragrances in the mass channel were up for the quarter about 2% to 3% with trends varying significantly from retailer to retailer within the category whether you are talking about chain drug, mass volume retailers or club stores.

We were pleased that we continued to gain market share in this channel and we increased our share from 58.5% a year ago to 60% this year. Mass volume retailers generally had stronger retail sales of other retailers. This was in part due to the rollout of an open sell format at Wal-Mart. As we discussed on our last call, during October and November, Wal-Mart implemented its keeper program. You may recall that I mentioned that keepers are clear acrylic boxes placed around the product which are then unlocked to checkout and they are allowed to most stores to move to an open sell format making a much easier shopping experience for fragrance consumers.

We and Wal-Mart are very pleased with the results of this program to-date and they are tracking slightly higher than we expected. We are also very pleased to announce that as a result of all of our efforts at Wal-Mart during the past year, Elizabeth Arden recently was awarded the Supplier of Excellence Award for the second quarter by Wal-Mart. This is a real testament to our supply chain, our sales, our marketing and our category management teams and it really underscores the results the organization has achieved from all of these various sales, merchandising and account management initiatives.

Now amplifying on Scott's earlier comments on inventory, the inventory to stocking theme which is been recurring for the last few quarters, it -- we saw when you look at the retail sales, you might think because retail sales were a bit lower than shipment that this trend is moderating, and while it is moderating and there is a bit less destocking going on, if retailers are continuing to be careful with respect to inventory levels.

In some accounts the gap between shipment and retail sales is improving and inventory levels are getting closer to historical averages, while on other accounts what we call weeks on hand of inventory have actually declined over the quarter. So it really is a mix bag. Overall, our holiday promotions in the mass channel performed well. Our selling was up very slightly as was our retail sales, resulting in overall flat sell-through. Sell-through in the mass channel would have actually been up year-over-year except we were impacted by the big storm that hit the weekend before Christmas. It impacted particularly the Northeast and the Midwest retailers.

Turning now to the Prestige channel, as we mentioned on our last conference call, retail trends in U.S. department stores as well as actually in department stores in Canada and Puerto Rico have been challenging. For the month of December, NPD reported that overall retail sales for fragrances dropped 7% which actually was an improvement over prior trends as retail sales for the whole year were actually down 10%. Now our sales were generally in line with the overall market trend. One of the fundamental changes that we saw in the category in department stores this year was that the retail sales volume for new launches dropped considerably. In fact, down 26% from July through December of this year, of this past year and 24% for the entire calendar year as consumers seemed to focus on the classic brands.

Now one exception to this trend was the reception of our Couture Couture brand which we launched into wider prestige distribution in late November. We are pleased to report that for the month of December, Couture Couture ranked number one among all new launches in department stores and number five among all fragrance bar brands. This really was a strong showing and in a minute I’ll discuss this brand house in more detail.

Now some of our other department store launches did, however, suffer from the same week new launch trends that the entire category did. Overall, though, prestige net sales for the second quarter were up 6% compared to last year, driven by the strong Couture Couture sales I mentioned before. Operating profit for the quarter expanded strongly off a pretty small base last year and gross margins rose 370 basis points due to the sales mix which included in a much larger percentage of high margin basic items.

Now, regarding brand performance, as I mentioned, our launch of Couture Couture has been successful thus far and we continue to support this brand heavily. We actually have many programs and events focused around the Valentine's Day holiday. At the same time, Viva la Juicy introduced in August 2008, continue to perform very strongly and actually ranked number three on the fragrance bar for all of the fall season and the original Juicy Couture brand ranked number 11 over the same period. This led to an increase in sales for the Juicy house of 31% at retail in U.S. department stores this fiscal year. Also, we saw some of the same trends outside the U.S. where the Juicy franchise continues to expand and year-to-date sales of Juicy fragrances have nearly doubled.

Turning now to White Diamonds our all important brand, it continue to form well like it typically does over the holiday season, maintaining its market share and prestige. White Diamonds prestige national holiday set increased rank at the fragrance bar from number seven last year to number five this year. While, in the mass channel, White Diamonds once again ranked number one, outpacing the number two brand which also is our own brand by more than three to one. So, clearly White Diamonds continues to be a stellar performer for us and clearly Christmas continues to be Taylor time.

Now, we are also very excited to be welcoming a new limited edition fragrance Violet Eyes to the Taylor brand family and put in the prestige channel this spring.

Turning to the Britney Spears franchise. The performance was exceptional this past quarter. On a global basis, our shipment of Britney brands were up 30% in the second quarter of this year as compared to last year with virtually all of our markets recording increases in shipments.

As we mentioned on our last call, we actually launched Circus Fantasy this fall in somewhat limited distribution, capitalizing on the popularity of Britney's Circus themed tour. While the new launch did helped Britney sales, shipments of the Original Fantasy and curious brands also increased compared to last year. In fact, retail sales of Fantasy in our mass business were up year-over-year and it gained a ranking point from number six to number five in that channel for the year.

Now, turning to our Elizabeth Arden prestige department store business which is comprised of our Elizabeth Arden branded skin care, color and fragrances products that we sell to U.S. prestige department stores and comprises about 4% of our total sales. We saw strengthening trends in Q2 with sales up 23% for the quarter versus prior year due to significantly less discounting and successful innovation, this includes the Elizabeth Arden pretty fragrance, mineral makeup and PREVAGE as well as some inventory replenishment after some significant destocking.

In addition, the Elizabeth Arden brand has gained important additional distribution in the West Coast of the United States very recently. We are expecting a launch of prestige day moisturizer and the relaunch of the prestige base serum this spring to accelerate our global performance and also accelerate the performance of the PREVAGE line in particular.

Now just a brief mention, our e-commerce business may still be relatively small but really is an incredibly dynamic business experiencing tremendous growth. Shipments were up 94% in the second quarter, over a 100% year-to-date and we posted a profit this year versus losses last year. Our e-commerce team has done a great job attracting visits and converting customers with all the metrics getting better. Visits were up 24%, conversions up 85% and first-time purchasers which is a very important statistic for us was up a startling 327%. We see continued strong growth moving forward for the business and see this as an important channel of moving forward.

Now, turning to the outlook for the second half, we expect to see a continuation of the retail trends we saw at the end of the calendar at 2009 year. And our sales guidance incorporates these trends. We expect the prestige business to continue to be challenged though we are hopeful that comparisons will get a bit easier because last year's numbers do incorporate a significant decline. In the mass channel we expect the retail sales trends of Prestige fragrances will continue to be better than those seen in department stores though they likely will be uneven from retailer to retailer which is what we have seen in the first half.

Retailers in all channels are continuing to focus on inventory levels and we expect that to continue and as Scott mentioned earlier we have taken a cautious attitude until there are clear signs of a consumer recovery.

In addition in some cases the retailers are managing the order cycle to delay bring in products until it is needed. Which we believe could impact the quarterly timing of orders from Mother's and Father's Day, pushing some orders in to our fiscal fourth quarter. And with that I will now turn it to the Chief Financial Officer, Steve Smith.

Steve Smith

Thank you, Joel. I will discuss our working capital, balance sheet and operating results for the second fiscal quarter as well as some comments regarding the third fiscal quarter and the remainder of our fiscal year.

First and foremost, I want to highlight the momentum we are seeing in our supply chain and logistics areas with our global reengineering initiative. While I will provide some more color in my remarks, we expect that for the remainder of fiscal 2010 and as we look to fiscal 2011 for each quarter on a comparable year-over-year basis we will realize, reduced capital invested in inventory, increased gross margins and a higher operating cash flow and reduced leverage. As a result of our improved earnings and significant inventory reductions, year-to-date cash flow from operations increased to $77 million from a use of cash of $2.1 million at the same period last year.

Regarding inventories, we ended December with one third less inventory as compared to December last year. This brought inventories down by $126 million to $265 million and this is also a decrease of $89 million from our seasonal peak levels in September. We anticipate additional inventory reductions of another $5 million to $15 million by the end of this fiscal year. The lower inventories reflect a leaner supply chain process, resulting from our global reengineering initiatives and there is no issue with respect to having sufficient inventories to meet customer demand.

DSOs continue to track favorable to our expectations. Our DSOs did increase two days from the prior period but that is because of a shift in holiday orders, in to November from October this past year with certain of our accounts, the cash was received in early January. Total net debt of $257 million was $84 million lower at the end of December as compared to December of 2008. Currently our credit line is $96 million lower than it was at this time last year. With reductions in inventory, we achieved to date and as the bulk of our cash flow is generated in the first half of our fiscal year we now expect operating cash flows for the full year to range between $70 million to $75 million, increased from our previous range of $50 million to $60 million.

Additionally, regarding our operating cash flow, we do not expect to be a significant cash tax payer in the U.S. for the next few years which will help further drive our operating cash flow improvement. The second quarter we realized gross margins of 44.3%, which is a 270 basis point improvement over last year's adjusted gross margins. The 44.3% includes 30 basis points of depreciation expense which we are now classifying in the cost of goods. This is also the approximate basis point impact; this week class has on the historical prior year period.

The improvement is due to favorable sales mix as Joel mentioned, as a higher percentage of sales were of higher margin owned and licensed brands as compared to the brands we distribute, favorable currency impacts and operational efficiencies due to the global efficiency reengineering initiatives including sourcing, supply chain, freight and distribution savings. Given our results so far this year, we are confident in our ability to deliver on the upper end of our gross margin improvement objectives of 200 to 250 basis points and we expect to continue to consistently improve our gross margins for each comparable quarter for the remainder of this fiscal year and into 2011.

With respect to SG&A expense, excluding transition expenses in the prior year, SG&A expense as a percentage of net sales for the quarter increased by 120 basis points to 33.1%. Advertising and promotional expenses increased by 9.3%, or $7 million, compared to the second quarter of last year. This reflected higher brand support which is two third to the increase and royalties. As a percentage of net sales these expenses increased by 60 basis point from 20.4% to 21%.

Our administrative and overhead expenses increased also by 60 basis point for the quarter from 11.5% to 12.1% primarily as the prior year included reversals of incentive compensation grants that weren't likely to vest. Despite these reversals in the prior year on a year-to-date basis, administrative and overhead expenses continue to track lower than the prior year. They were lower by $1.3 million and this is a 30 basis point decline, and as a percentage of net sales have declined to 14.1%.

Capital expenditures year-to-date were $17.8 million. In total we expect CapEx for the year to be between $30 million to $35 million of which $13 million is for the oracle financial accounting and order processing project and related IT expenditures. For fiscal 2011 we expect that CapEx will return to historical levels of $20 million to $25 million.

I would like to provide a quick update on the project implementation. As we have previously discussed the accounts payable and general ledger modules went live last summer. We've completed the migration to a shared services model in North America and Europe on time and on budget and without any delay in our information delivery.

The second phase order to cash processing is scheduled to go live in the spring. A robust systems testing phase is in process and we continue to track to our overall implementation time table and project costs. We completed the migration of our order to cash employees to a shared services model, thereby consolidating 12 locations down to 2. This implementation in addition to supporting a shared service model and reducing administrative expenses, our functions I should say, will unify the company to a single business process and systems infrastructure and enable us to better leverage our operations and simplify our transactional processing and will provide enhanced management reporting to drive the long-term strategy.

This quarter we incurred $2 million of restructuring and other charges primarily related to our reengineering initiative for a total of approximately $11.2 million since the project was announced in May of 2008. The year-to-date costs incurred approximates $4 million. The costs continue to be on plan and we still expect that the total cost of the multiyear project will be within the $12 million to $14 million range originally provided.

Regarding the remainder of this fiscal year, our view of the second half has not changed. The third fiscal quarter in particular is a seasonally slow quarter as we stated in our press release, while some mass retailers have begun to increase investment in inventory this is not widespread across most retailers and they continue to be conservative with respect to inventory.

Currency is expected to impact the full year results by approximately 2%. Our earnings guidance for the third quarter reflects higher advertising and promotional spend as compared to the third quarter of the prior year where we significantly reduced spend given the economic environment. Additionally we expect higher depreciation expense this year due to the oracle financial and order processing system, which will more than offset savings from interest expenses. And with that I will turn it back to Scott.

Scott Beattie

Thanks very much, Steve. Hopefully as Steve has gone through an update of our global reengineering initiative and the key metrics that are showing traction in terms of improvement, investors feel confident as we do that we have a systematic improvement in terms of our business model and our cash flows, gross margin, EBITDA margins and return on invested capital. I'm very confident that the changes we've made over the last two to three years in terms of improving our business processes are now starting to show dramatic improvement in terms of the performance of our business.

Now, is the opportunity as we look forward to start accelerating organic growth of our brand portfolio on an international basis and that's what I would like to address now the key initiatives that we have over the next -- that we started as a management team and will help grow organic growth of our business internationally for the next several years.

The first one I would like to talk about is the expansion of our fragrance business in Europe. You step back for a second and you look at the global fragrance market and as of 2008 the total retail sales of the global fragrance market is about $40 billion. And the ten year growth rate has been between 5% and 6%. If you look at the U.S. market, it represents about $6 billion and has essentially been flat from a growth point of view for the last ten years. So it represents approximately 16% of the total global fragrance market.

If you -- in terms of our business we currently have approximately 20% market share across all channels of distribution in fragrances in the U.S. and are the second largest player. I would suggest that we have the best business model of any fragrance company in the U.S. market. We have a strong market share in the prestige channel and we dominate in terms of market share in the mass channel which is growing much more quickly in aggregate. But it is still the U.S. only represents 16% of the total global marketplace.

If you look at Europe, Western Europe is a $14 billion market. And Eastern Europe is a $4.4 billion market. So Western and Eastern Europe combined represent approximately 50% of the total market in fragrances. And they have been growing at approximately 2% to 3% over the last ten years with Eastern Europe growing faster than that. Our market share in Europe is less than 1%. And so obviously we have underpenetrated the European market. We've recognized this and as a result we have put a task force together that reports directly to me that consists of Baird West and Mauricio Garcia, two of our senior commercial affiliate managers in Europe as well as Ron Rolleston who out of New York who runs our global fragrance portfolio and (inaudible) our head of finance in Geneva. And what we have done by matching our commercial team with our brand team and our finance team is really focused on mapping our brand portfolio by market and by retailer and to better penetrate the existing brands that we have in those markets and by retailer in those markets.

We started this process last summer and we are making quite significant progress. This is a top priority as we move forward, particularly as we enter fiscal 2011. We see a great opportunity to increase our market share. We recognize that not all of our brands will resonate with European customers but we certainly believe that some where between our 20% market share that we have in the U.S. and the 1% market share that we have in Europe is a tremendous opportunity given the size of the market's almost five times as large.

Second initiative related to talk about is just the continued development of the Elizabeth Arden brand globally. The -- already mentioned when I went through the review of the performance in the second quarter of the Elizabeth Arden brand, the growth is really coming from international. Particularly our skin care and color business in Asia and many of the -- of our franchises within travel retailer and distribution. So our objective over the next five years is to increase the proportion of our business to international to approximately 50% of our total business. This will result in a very strong profitability growth as well as given that we reengineered our business platform through our global reengineering initiative it will allow us to leverage the profitability and scalability of this improved business model.

Related to this I would like to make a couple of management appointment announcements. The first one is Pierre Pirard the Senior Vice President of Supply Chain. He joined us two years ago from Johnson & Johnson and he has been the leader driving the global reengineering initiative as it relates to supply chain. His team and -- Pierre and his team have driven tremendous improvement in the sales and ops planning processes, the transformation to a turnkey contract manufacturing model and the reengineering of our business processes.

In addition to overseeing the supply chain operations, Pierre will now oversee our innovation, organization and our global logistics organization and will become a reporting officer of the company.

I'm also pleased to announce that Kathy Widmer, a very experienced consumer brand marketer also from Johnson & Johnson has joined us as Chief Marketing Officer. Kathy's mandate is to help us leverage the strength of our product innovation and product development expertise, particularly in fragrances and the very substantial global brand awareness of the EA brand on a more global basis. Similar to the reengineering of our business processes through the global reengineering initiatives, that will provide a -- which has provided a global scalable business model, Kathy will bring the global brand management business processes to our organization to help us drive the profitable brand growth internationally. Kathy will also become a reporting officer of the company. Thank you very much and we would like to open it up to questions.

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen we will now be conducting a question-and-answer session. (Operator Instructions). Our first question comes from the line of Bill Chappell with SunTrust. Please go ahead.

Bill Chappell - SunTrust

Good afternoon.

[Multiple Speakers]

Afternoon.

Bill Chappell

I guess, don't want to take away from a strong quarter and the raising of guidance but it seems like at this point inventories are so low both in the channel and on your balance sheet, you know, at some point something has to give and isn't typically this month and next month the time where you would see some restocking really kick in? Is your caution you are just not seeing that or it is just too early to really call for the restock?

Scott Beattie

I think as Joel mentioned, it's been very inconsistent retailer-to-retailer and on channel-to-channel from distribution and globally. And, as a result of that, it is much more difficult to project how much restocking of inventory will drive revenue growth in the second -- or the third and fourth quarters. And I think at this time really means that it is probably not reasonable for us to be overly ambitious in terms of the -- what we see in terms of consumer demand recovery. I think we are looking at it quarter-to-quarter and as we see an improvement quarter-to-quarter we will adjust our guidance and -- appropriately.

Scott Beattie

Got it. If I'm looking at also the SG&A again, it was a solid bottom line number but the SG&A being higher year-over-year as a percentage and expected to be that way in the next quarter, is that part of the international spin and infrastructure spin you are talking about or is there some other big launch that I'm missing? Or kind of help me with that.

Scott Beattie

As Steve mentioned we are anniversarying, the third quarter last year we really stripped most of the spend out of our P&L just given that financial crisis that we were experiencing. And so we are rebuilding some of that. As well as Joel mentioned, we are continuing to invest behind the Juicy Couture franchise and specifically the Couture Couture business in the third quarter. We had an initial contain launch with Nordstrom and Bloomingdales late summer and then we expanded it to other prestige department store retailers in the United States in November and then we are expanding that launch and investing behind it in the third quarter as well. And then the final contributor is that we had stripped out most of our incentive comp the last year and some of that is being filled back in to the P&L for this year.

Bill Chappell

Okay and then just one final or final two. On gross margin, just trying to understand, I mean is most of this just what you had expected or are we seeing a pull-through of some of the benefits that were expected in 2011 happening in 2010 or do you still see a pretty big margin improvement in 2011? And also, Steve, maybe any idea what now full year D&A should be for fiscal year 2010?

Steve Smith

Well in terms of our question on gross margin, the improvements we're seeing for this fiscal year is what we expected and we continue to expect to see further improvements as we move into 2011. It is not a pull forward so to speak of '11 savings into this year. So we will continue to see this the next several quarters. Our D&A number for the year.

Marcey Becker

Is up a 1.5 million.

Steve Smith

It's about a 1.5 million for the year from last year.

Bill Chappell

Okay, great. Thanks so much.

Operator

Thank you. Our next question comes from Joe Altobello with Oppenheimer. Please go ahead.

Joe Altobello

Thanks, good afternoon. First question I guess just going back to Europe for a second. Do you guys feel like you have the brand portfolio to really make a big push there?

Scott Beattie

Well, as I said, not all of our brands resonate well within all markets in Europe. But what we have done in our -- and our task force has done is really mapped our brands by geography and by customer and what we've seen is particularly the U.K. and Germany which are both strong fragrance markets and actually both strong celebrity fragrance markets and the U.K. which is also a very similar market to the U.S., our brands map pretty well. When you get to markets like France it is more difficult obviously where it is more of a French luxury goods business and with, it the home of luxury designers and our portfolio doesn't map as well in France as it does in other markets. So, and what we are finding is the Juicy brand is although it is still building in terms of its awareness is building quickly and there is opportunity there as well. So, we are very confident that as I said, certainly have a much bigger business than the 1% market share than we currently have.

Joe Altobello

Okay. So basically there are pockets of opportunity in different regions?

Scott Beattie

Absolutely. And significant opportunities.

Joe Altobello

And just going back to the spending -- the spending behind that, it is my understanding and correct me if I'm wrong, Scott, but you guys already have a lot of that built out now so a lot of the infrastructure is already there?

Scott Beattie

Yes.

Joe Altobello

Okay. I guess moving to, gross margin and I have sort of, asked you this question a number of different ways in the past conference calls and I guess I will ask it a little more bluntly. Once this global reengineering program is in place what is a real steady say gross margin for this business, three or four years out obviously?

Scott Beattie

I don't think we are in -- I mean we have a very structured methodical plan over through to 2014 that I'm very confident in and we are tracking at or ahead of that plan. But at this point I really don't want to put a particular number on it because then that really drives so much other implications in terms of forward guidance and so on. I think we provided very clear annual guidance in terms of what we have done. Steve and I both emphasized that quarter -- we expect not only for the remainder of this year but next fiscal year we will see consistent improvement in gross margin and EBITDA margins as a result of the improvement flowing through to -- from this initiative. We are very confident of that. But I -- I just don't want to get too far ahead of ourselves.

Joe Altobello

Fair enough. And lastly, if I could, you mentioned that the U.K. business seemed to pick up a little bit late in the quarter. The fact that you called it out would imply at least to me that did continue into the March quarter, is that fair to say?

Scott Beattie

You know, I have got to be honest with you, I don't have an update in this quarter in that particular market but I do think that, we are seeing an improvement. In fact, some of the initiatives we have with our European fragrance task force are starting to show traction in the U.K. We have a very established affiliated, our largest market in international. The Arden brand is very strong there. We have a good organization, it is being led by good, very high quality general manager, Barrett West and we expect to see traction there.

Joe Altobello

Okay. Great, thank you.

Operator

Thank you. Our next question is from the line of Arnie Ursaner with CGS Securities.

Arnie Ursaner - CJS Securities

Good afternoon. First question is does your guidance include or exclude the one time charges occurred this quarter?

Marcey Becker

It excludes them. Our guidance always excludes the charges.

Arnie Ursaner - CJS Securities

And selling and sell-through basically would you view them as in balance right now?

Steve Smith

I think it would be fair to say, Arnie that it depends by you have to look at each retailer. Before it was that sell-through was much greater than sell-in. Now there are some accounts where it actually went a little bit the other way last quarter. But for the most part -- I would say they are in balance overall but again, very mixed.

Arnie Ursaner - CJS Securities

Okay. You had talked before about 200 to 250 basis points of gross margin improvement, you were much better than that this quarter. Should we assume that the 200 to 250 is still the range and if so, what will be pulling that gross margin in the next few quarters?

Scott Beattie

I think we are probably -- and this sort of relates to I think Bill Chappell's point as well. I think we are a little bit ahead of where we expected to be on gross margin and hopefully we will -- the majority of that will sustain through the rest of this year. So we will start at a higher base as we go into next year.

Arnie Ursaner - CJS Securities

Okay. And Scott on your last conference call you indicated or reiterated a previous goal of double digit operating margins while everyone focuses on gross margin, I think it’s a lot more important to focus on operating margin where you may spend some of it in discretionary items. You talked about a goal with double-digit operating margins entering fiscal year 2011 but you didn't want to comment on that until you saw how the holiday season went. Now, that it is behind us, what is your view of what you expect to have entering 2011 for operating margins?

Scott Beattie

Well, I don't think we are at a point yet that we usually provide that. We usually provide that kind of guidance in August when we provide our yearly guidance for 2011.

Arnie Ursaner - CJS Securities

But again you had spoken about the fact you thought you would be in a good position to speak about it now.

Scott Beattie

Well Arnie as I mentioned earlier, the SG&A number is really being normalized this year. There's a couple of things that, we stripped out a lot of SG&A, as many companies did, this time last year. And we are putting some of that back, including some incentive comp and spend against the brand portfolio, which is important. The other influencing factor that we talked about in August is that we didn't want to pull back our innovation and launch calendar of new brands either within Arden or within our fragrance portfolio so we have a disproportionate amount of SG&A supporting new launches in an environment where we haven't seen a rebuild of a lot of the volume of existing brands.

And I think what you have heard from Steve and Joel and myself is that until we get more confident, more consistent replenishment globally across all of our retailers and our brands in inventory it is much more difficult to project the double digit EBITDA margins.

Arnie Ursaner - CJS Securities

Okay.

Unidentified Company Representative

One thing to keep in mind, Arnie, also about inventory right now is our retailers are just about to go into their end of their fiscal year so it is hard to figure out what exactly -- they are very light on inventory and its hard to see what they're going to do when February 1st kicks in.

Operator

Thanks. Our next question is from the line of Jason Gere with RBC Capital market. Please go ahead.

Jason Gere - RBC Capital Markets

Thanks, good afternoon. I was just wondering about clearly you guys are generating a lot of cash and raised the guidance here and you have been able to take on debts. I was wondering about the other uses of cash. Well it sounds like -- even with some of the hires that you mentioned before, our global marketing ups there, really a bigger push towards the global portfolio. So can you talk about the opportunities now to make other acquisitions, especially with the little feel kind of anniversaried at this point?

Scott Beattie

Well we don't comment on things like acquisitions. I mean clearly we have a lot of liquidity on our balance sheet. It is a great place to be and as Steve mentioned, we will continue to see, some improvement in operating cash flow for the remainder of this year and as we go into next year. And, in terms -- as we stated before, we typically just pay down our operating line. We have a share buyback program that we might consider. We also might consider buying back some of our bonds. And we might also consider potential acquisitions that fit in terms of our strategic growth plan.

Jason Gere

Okay. Great. And then just secondly, when you look at the mass business, can you just comment on -- and I know everybody focuses on Wal-Mart and how well the initiatives are going there -- but I know you had some hires in, for the CVS business as well as target and I was wondering if you could talk about those opportunities here, what type of best practices do these hirings bring and what is the potential opportunities for these channels going forward?

Joel Ronkin

I think it would be fair to say there is great opportunity with all of the key mass retail accounts, Target and CVS included. We are right in the midst of working on some significant merchandising efforts with (inaudible) and the retailers a number of our key retailers to really reinvent the prestige fragrance category at these accounts. I think I mentioned on prior calls that all of our key mass retailers see a huge opportunity in growing this business as consumers continue to shop more and more for prestige fragrances in their store and also they have better foot traffic overall. So we certainly should benefit from that. And so while we are interested in growing our share and we like that we are growing our share in the mass channel it is just as important or more important given our large share to grow the entire category and those are the initiatives that we are working on not just with Wal-Mart but with others including the Targets and Walgreen's of the world. So that is where we are at and I think you are going to see over the next six months to a year a lot of concepts rolling out in the stores and hopefully those will begin to become meaningful increases to our results.

Jason Gere

Great, thank you.

Operator

(Operator Instructions). Our next question is from the line offal list Alice Longley with Buckingham Research. Please go ahead.

Alice Longley - Buckingham Research

Hi, good afternoon. I guess some numbers about mass. I think I got the numbers right that your shipments into mass were up 7% and you think that your fragrances were up 2% to 3% at retail. Can you tell me how much the category itself was up at retail or down?

Steve Smith

The category is basically flat.

Alice Longley

Okay. And you also said that operating profits for mass were up 9% I think. When you talk about operating profits, is that number all end, would it compare to the operating profits that I look at for the company overall?

Steve Smith

Yes.

Alice Longley

And is North America overall, it is 66% of sales, is that like 75% of profits?

Steve Smith

May even be a little bit more.

Alice Longley

Okay. So the point is that your big strategy now is to increase international up to 50% of sales within five years. Do you think that you will be able to get your margins up to a comparable level so that five years from now international profits are 50% of the company or is that too aggressive?

Scott Beattie

That is probably too aggressive. I mean the -- the U.S. market is a very efficient market to service. When you get into international it is a very fragmented geography. Basically the rest of the world and made up of a lot of smaller markets and smaller retailers and so you lose some of the efficiency that you would have in the U.S. But we -- the advantage meaning -- I mean in international is as we reengineered our global business platform the leveragability of that platform is much more significant and as you add volume to that it really accelerates profitability. And so, beyond the fact that it is a great opportunity to build our brand portfolio and more of the growth in the beauty category is coming from the international markets, it also enhances our profitability as an organization disproportionately, if you will.

Alice Longley

Alright. Then back to mass here. You're saying that it is mixed as to whether retailers are building inventory back or not. Is some of the inventory destocking we got last year retailers sort of permanently cutting out SKUs because we hear a lot about their cutting SKUs so instead of just cutting back on the numbers of each SKU they carry, are they eliminating SKUs and might not restore those?

Steve Smith

There has always been elimination of SKUs in a normal business but no, we are not seeing.

Alice Longley

That is not happening more than normally?

Steve Smith

No.

Scott Beattie

And its not a -- there is a substitution of SKUs, not an elimination. In terms of the amount of shelf space they are dedicating to the prestige fragrance category, that hasn't changed and that is not what is driving it, Alice. As Joel said, there is a lot of substitution. Brands that get moved out and new brands brought in all the time. But the shelf space for the most part across retail is pretty stable.

Alice Longley

Okay. And when you said that the prestige fragrance category in mass was flat at retail, was that just prestige?

Scott Beattie

Yes.

Alice Longley

So if I were to include the non-prestige fragrances, how much -- what did the category do in the December quarter?

Joel Ronkin

It was down. Because I know mass fragrances were down. I don't know if we have that number handy.

Alice Longley

So like down 2% to 3%, would that be reasonable?

Scott Beattie

We have to get that number -- why don't we get the number and Marcey can provide it to you.

Alice Longley

Okay.

Scott Beattie

But I think what you have to -- I mean the -- I think Joel went through, Alice, here is that there was very inconsistent performance across all of the different retailers. Some retailers had very strong performance. Others didn't. And so when you net it all out, that is, it was about flat. But there are definitely some winners and losers in this.

Joel Ronkin

And we performed better than the category.

Alice Longley

That's clear.

Joel Ronkin

And Alice, just to clarify, operating margins, there are certain costs we do not allocate to the reporting segments.

Alice Longley

Oh, okay.

Joel Ronkin

That are kept at corporate, depreciation interest and then there is some other corporate type expenses all laid out in the 10-Q and filings with the SEC.

Alice Longley

All right, and you are projecting I guess 250 basis points of gross margin expansion this year. Is there some way of dividing how much of that is mix shifting to own fragrances and how much of it is profitability improvement? And the reason I ask is because that going to the own fragrances comes along with higher SG&A.

Scott Beattie

I think to go through that we need to spend a little bit more time and do the analysis. We don't have that handy right here. So, we can follow-up with Marcey on some of that.

Alice Longley

Okay. And I will ask one other question that goes back to the numbers. I think you said something about offshore being up 6% in the second quarter but I look at the numbers and I think it is up 4% and that includes currency benefits. What is the difference between those numbers?

Scott Beattie

I don't know where you are getting your number. Our international business was up 6%.

Alice Longley

Off your press release.

Scott Beattie

That is our total business was up 6.

Alice Longley

Total international.

Marcey Becker

Was up 6%.

Alice Longley

It's okay. Its -- anyway, how much of that was foreign exchange?

Marcey Becker

For the total company it is 300 basis points.

Alice Longley

Okay. I'll talk to Marcey later, thanks.

Operator

Thank you. There are no further questions in queue at this time. I will turn the floor back over to management for any closing comments.

Scott Beattie

Thank you for joining us on the Q2 conference call.

Operator

Ladies and gentlemen it concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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Source: Elizabeth Arden, Inc. Q2 2010 Earnings Call Transcript
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