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RDEN > SEC Filings for RDEN > Form 10-K on 12-Aug-2013All Recent SEC Filings

Show all filings for ELIZABETH ARDEN INC

Form 10-K for ELIZABETH ARDEN INC


12-Aug-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with the consolidated financial statements and the accompanying notes which appear elsewhere in this document.

Overview

We are a global prestige beauty products company with an extensive portfolio of
prestige fragrance, skin care and cosmetics brands. Our extensive product
portfolio includes the following:



Elizabeth Arden Brand    The Elizabeth Arden skin care brands: Visible Difference,
                         Ceramide, Prevage, and Eight Hour Cream, Elizabeth Arden branded
                         lipstick, foundation and other color cosmetics products, and the
                         Elizabeth Arden fragrances: Red Door, Elizabeth Arden 5th
                         Avenue, Elizabeth Arden Green Tea and UNTOLD

Celebrity Fragrances     The fragrance brands of Britney Spears, Elizabeth Taylor, Mariah
                         Carey, Taylor Swift, Justin Bieber, Nicki Minaj and Usher

Lifestyle Fragrances     Curve, Giorgio Beverly Hills, PS Fine Cologne and White
                         Shoulders

Designer Fragrances      Juicy Couture, Alfred Sung, BCBGMAXAZRIA, Ed Hardy, Geoffrey
                         Beene, Halston, John Varvatos, Lucky, Rocawear and True Religion

In addition to our owned and licensed fragrance brands, we distribute approximately 250 additional prestige fragrance brands, primarily in the United States, through distribution agreements and other purchasing arrangements. In August 2011, we amended our long-term license agreement with Liz Claiborne, Inc. and certain of its affiliates and acquired all of the U.S. and international trademarks for the Curve fragrance brands as well as trademarks for certain other smaller fragrance brands. The amendment established a lower effective royalty rate for the remaining licensed fragrance brands, including Juicy Couture and Lucky Brand fragrances, reduced the future minimum guaranteed royalties for the term of the license, and required a pre-payment of royalties for the remainder of calendar 2011. We paid Liz Claiborne, Inc. and its affiliates $58.4 million in cash in connection with this transaction. We capitalized $43.9 million of the $58.4 million cash paid as exclusive brand trademarks and the balance was recorded as a prepaid asset associated with the settlement of royalties for the remainder of calendar year 2011 and the buy-down of future royalties for 2012 and beyond.

In May 2012, we acquired the global licenses and certain related assets, including inventory, for the Ed Hardy, True Religion and BCBGMAXAZRIA fragrance brands from New Wave Fragrances, LLC. Prior to the acquisition, we had been acting as a distributor of the Ed Hardy and True Religion fragrances to certain mid-tier and mass retailers in the North America. The total cost of the acquisition was $60.1 million, including amounts paid for inventory of $19.8 million, of which $58.1 million was paid in cash and $2 million was retained by us and was scheduled to be paid in the third quarter of fiscal 2013, subject to the settlement of certain post-closing adjustments. The full $2 million of the purchase price that we retained was offset by post-closing adjustments and was not paid to New Wave Fragrances, LLC. This transaction was accounted for as a business combination. See Note 11 to the Notes to Consolidated Financial Statements for further information on the acquisition and allocation of the purchase price.

In June 2012, we also acquired the global licenses and certain assets related to the Justin Bieber and Nicki Minaj fragrance brands, including inventory of the Justin Bieber fragrances, from Give Back Brands LLC. In connection with the acquisition, we paid Give Back Brands LLC $26.5 million, including $3.6 million for inventory. In addition, we have issued to Give Back Brands LLC a subordinated note in the principal amount of $28 million, payable upon the achievement of specified net sales targets for the acquired brands over the three-year period from July 1, 2012 through June 30, 2015. Based on results for the six months ended December 31, 2012, conditions for payment of the first $5 million installment were satisfied, and such installment was paid during the third quarter of fiscal 2013. In addition, based on the results for fiscal 2013, conditions for payment of the second $5 million installment have been satisfied and such installment is payable during the first quarter of fiscal 2014. This transaction was accounted for as a business combination. See Note 11 to the Notes to Consolidated Financial Statements for further information on the acquisition and allocation of the purchase price.

For ease of reference in this Form 10-K, the acquisitions from New Wave Fragrances LLC and Give Back Brands LLC are referred to herein on a collective basis as the 2012 acquisitions.

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In fiscal 2013, we invested a total of $7.6 million, including transaction costs, for a minority investment in Elizabeth Arden Salon Holdings, LLC, an unrelated entity whose subsidiaries operate the Elizabeth Arden Red Door Spas and the Mario Tricoci Hair Salons. The investment was made with the intent of accelerating the growth of the spa business in parallel with the growth of the Elizabeth Arden brand and the Elizabeth Arden brand repositioning. The investment, which is in the form of a collateralized convertible note bearing interest at 2%, has been accounted for using the cost method and at June 30, 2013, is included in other assets on our consolidated balance sheet. We expect to invest an additional $2.1 million in fiscal 2014.

Our business strategy is currently focused on two important initiatives: the global repositioning of the Elizabeth Arden brand and expanding the market penetration of our prestige fragrance portfolio in international markets, especially in the large European fragrance market, as well as growing markets such as Brazil and Russia. We also intend to continue to increase net sales, operating margins and earnings by continuing to expand the prestige fragrance category at mass retail customers in North America and continuing to improve working capital efficiency and return on invested capital. We believe that our focus on organic growth opportunities for our existing brands, new licensing opportunities and acquisitions, and new product innovation will assist us in achieving these goals.

We are in the process of a comprehensive brand repositioning for the Elizabeth Arden brand, which is designed to honor the heritage of the brand while modernizing the brand's presentation and increasing its relevance among target consumers. The brand repositioning includes a revised product assortment, improved product formulations, package redesign, counter redesign, new advertising and marketing vehicles, and enhanced beauty advisor support. The initial roll-out was limited to a number of flagship retail doors. During fiscal 2013, we introduced our new product assortment to our prestige retail customers and replaced most of such flagship retail counters with new counters. We also extended elements of the new advertising, marketing and beauty advisor programs beyond our global flagship retail doors to the next tier of approximately 200 retail doors globally. To date, we have incurred pre-tax costs and expenses of $23.1 million in connection with the brand repositioning. In fiscal 2014, we expect to incur $11 million to $16 million in additional costs and expenses in connection with the continued roll-out of the Elizabeth Arden brand repositioning and to exit unprofitable retail doors in certain markets. The specific facts and circumstances of the continued roll- out of the repositioning will impact the timing and amount of any such costs and expenses as well as capital expenditures.

In fiscal 2013, we recorded pre-tax costs and expenses of $23.1 million in connection with the brand repositioning, including $13.1 million for non-recurring product changeover costs and expenses and $10.0 million for product discontinuation charges. The non-recurring product changeover costs and expenses related to the shipping of new product assortment to retailers to replace the older products. The product discontinuation charges resulted from our strategic decision, based on our current evaluation of market demand and the status of the Elizabeth Arden brand repositioning, not to incur the additional costs associated with using existing raw materials and other components related to our older Elizabeth Arden skin care and color cosmetic products to manufacture additional finished goods inventory of such products. This strategic decision was made in order to accelerate the execution of the Elizabeth Arden brand repositioning, which should enable systematic improvement in our gross margins in future periods.

In fiscal 2014, we expect to incur approximately $5 million in restructuring related costs. These one-time restructuring costs include amounts for sales positions as well as other staff positions across various business units that are being eliminated to drive expense savings and additional operating efficiencies. We are also implementing the last phase of an Oracle global enterprise system, which includes an upgrade to certain of our information systems relating to our global supply chain and logistics functions. This is intended to further increase business efficiencies throughout our Company to improve our cash flow, operating margins and profitability.

During fiscal 2013, we introduced several new Elizabeth Arden products including the new Visible Difference entry-level skin care regimen, Prevage Anti-aging + Intensive Repair Daily Serum, Prevage Clinical Lash + Brow Enhancing Serum, several new Ceramide skin care products, and a new Red Door fragrance, Red Door Aura. We also launched new products for several of our fragrance brands, including Pink Friday Nicki Minaj, Wonderstruck Enchanted, our second fragrance for Taylor Swift, Justin Beiber's Girlfriend and Ed Hardy's Skull & Roses.

In fiscal 2014, we plan to launch several new products across the Elizabeth Arden skin care, color and fragrance categories including Prevage Anti-aging Intensive Eye Serum and Prevage Anti-aging Treatment Booster Cleanser, a Ceramide Boosting 5- Minute Facial and a new Ceramide line, Flawless Future, Beautiful Color Lipstick, Flawless Finish Liquid Mineral Foundation and a new fragrance, UNTOLD. We also plan to launch several fragrances including Justin Bieber The Key, Taylor by Taylor Swift, our second fragrance for Nicki Minaj, BCBGMAXAZRIA Bon Genreand a new Britney Spears Fantasy fragrance.

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In fiscal 2013, our gross margins were 240 basis points below our fiscal 2012 gross margins, including the negative impact of 270 basis points for costs associated with the Elizabeth Arden brand repositioning and the 2012 acquisitions of the licenses for Justin Bieber, Nicki Minaj, Ed Hardy, BCBGMAXAZRIA and True Religion fragrance brands. This 270 basis point gross margin impact in the year ended June 30, 2013 represented an increase of 230 basis points over the 40 basis point impact of these costs in the year ended June 30, 2012. As we complete the integration of the 2012 acquisitions and implement the key drivers of our success from the repositioning for the Elizabeth Arden brand across a larger segment of the business, we expect to begin to see systematic improvement in our gross margin during the second half of fiscal 2014. We continue to focus on (i) expanding gross margins through increased focus on product mix, improved pricing and reduced sales dilution,
(ii) improving our sales and operations planning processes and our supply chain and logistics efficiency and, (iii) leveraging our overhead structure by increasing sales of our International segment.

We manage our business by evaluating net sales, gross margins, EBITDA (as defined in Note 11 under Item 6 "Selected Financial Data"), EBITDA margin, segment profit and working capital utilization (including monitoring our levels of inventory, accounts receivable, operating cash flow and return on invested capital). We encounter a variety of challenges that may affect our business and should be considered as described in Item 1A "Risk Factors" and in the section "Management's Discussion and Analysis of Financial Condition and Results of Operations - Forward-Looking Information and Factors That May Affect Future Results."

Critical Accounting Policies and Estimates

The preparation of our consolidated financial statements in conformity with U.S. generally accepted accounting principles requires us to make estimates and assumptions that affect the amounts of assets, liabilities, revenues and expenses reported in those consolidated financial statements. We base our estimates on historical experience and other factors that we believe are most likely to occur. Changes in facts and circumstances may result in revised estimates, which are recorded in the period in which they become known. Actual results could differ from those estimates. If these changes result in a material impact to the consolidated financial statements, their impact is disclosed in "Management's Discussion and Analysis of Financial Condition and Results of Operations" and/or in the "Notes to the Consolidated Financial Statements." The disclosures below also note situations in which it is reasonably likely that future financial results could be affected by changes in these estimates and assumptions. The term "reasonably likely" refers to an occurrence that is more than remote but less than probable in the judgment of management.

Our most critical accounting policies and estimates are described in detail below. See Note 1 to the Notes to Consolidated Financial Statements - "General Information and Summary of Significant Accounting Policies," for a discussion of these and other accounting policies.

Accounting for Acquisitions and Intangible Assets. Under the accounting for business combinations, consideration paid in an acquisition is allocated to the underlying assets and liabilities, based on their respective estimated fair values. The excess of the consideration paid at the acquisition date over the fair values of the identifiable assets acquired or liabilities assumed is recorded as goodwill.

The judgments made in determining the estimated fair value and expected useful lives assigned to each class of assets and liabilities acquired can significantly affect net income. For example, different classes of assets will have useful lives that differ, and the useful life of property, plant, and equipment acquired will differ substantially from the useful life of brand licenses and trademarks. Consequently, to the extent a longer-lived asset is ascribed greater value under the purchase method than a shorter-lived asset, net income in a given period may be higher.

Determining the fair value of certain assets and liabilities acquired is judgmental in nature and often involves the use of significant estimates and assumptions. One area that requires more judgment is determining the fair value and useful lives of intangible assets. Because the fair value and the estimated useful life of an intangible asset is a subjective estimate, it is reasonably likely that circumstances may cause the estimate to change. For example, if we discontinue or experience a decline in the profitability of one or more of our brands, the value of the intangible assets associated with those brands or their useful lives may decline, or, certain intangible assets such as the Elizabeth Arden brand trademarks, may no longer be classified as an indefinite-lived asset, which could result in additional charges to net income.

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During the quarter ended June 30, 2012, we adopted the updated guidance to Topic 350, Intangibles-Goodwill and Other, issued by Financial Accounting Standards Board ("FASB") in September 2011, which simplifies how an entity assesses goodwill for impairment and allows an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment assessment. An entity is no longer required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. Should a goodwill impairment assessment be necessary, there is a two step process for assessing impairment of goodwill. The first step used to identify potential impairment compares the fair value of a reporting unit with its carrying amount, including goodwill. The second step, if necessary, measures the amount of the impairment by comparing the estimated fair value of the goodwill and intangible assets to their respective carrying values. If an impairment is identified, the carrying value of the asset is adjusted to estimated fair value. See Note 1 to the Notes to Consolidated Financial Statements.

In July 2012, the FASB issued another update to Codification Topic 350, Intangibles-Goodwill and Other: Testing Indefinite-Lived Intangible Assets for Impairment. This update simplifies the guidance for testing impairment of indefinite-lived intangible assets other than goodwill. Examples of intangible assets subject to the guidance include indefinite-lived trademarks, licenses, and distribution rights. The amendments allow a company the option to first assess qualitative factors to determine whether it is necessary to perform the quantitative impairment test. A company electing to perform a qualitative assessment is no longer required to calculate the fair value of an indefinite-lived intangible asset unless the company determines, based on such qualitative assessment, that it is "more likely than not" that the asset is impaired. The changes to Codification Topic 350 will be effective for us beginning July 1, 2013, with early adoption permitted. We did not adopt the updated guidance in Topic 350 for our annual impairment test of indefinite-lived intangible assets other than goodwill performed during the quarter ended June 30, 2013. Adoption of the updated guidance is not expected to have a material impact on our consolidated financial statements or disclosures.

Our intangible assets consist of exclusive brand licenses, trademarks, patents and other intellectual property, customer relationships and lists, non-compete agreements and goodwill. The value of these assets is exposed to future adverse changes if we experience declines in operating results or experience significant negative industry or economic trends. We have determined that the Elizabeth Arden trademarks have indefinite useful lives as cash flows from the use of the trademarks are expected to be generated indefinitely. Goodwill and intangible assets with indefinite lives such as our Elizabeth Arden trademarks, are not amortized, but rather assessed for impairment at least annually. We typically perform our annual impairment assessment during the fourth quarter of our fiscal year or more frequently if events or changes in circumstances indicate the carrying value of goodwill may not fully be recoverable.

During the quarter ended June 30, 2013, we completed our annual impairment assessment of the Elizabeth Arden trademarks, with the assistance of a third party valuation firm. In assessing the fair value of these trademarks, we considered the income approach. Under the income approach, the fair value is based on the present value of estimated future cash flows. The analysis and assessments of these assets and goodwill indicated that no impairment adjustment was required as the estimated fair value exceeded the recorded carrying value. A hypothetical 10% decrease to the fair value of our Elizabeth Arden trademarks or a hypothetical 1% increase in the discount rate used to estimate fair value would not result in an impairment of our Elizabeth Arden trademarks. During the quarter ended June 30, 2013, we also completed our annual impairment assessment of goodwill using the qualitative assessment under the updated guidance to Topic
350. The analysis indicated that no impairment adjustment was required. A hypothetical 10% decrease in the fair value of our North America reporting unit would not result in an impairment of our goodwill.

Due to the ongoing uncertainty in capital market conditions, we will continue to monitor and evaluate the expected future cash flows of our reporting units and the long-term trends of our market capitalization for the purposes of assessing the carrying value of our goodwill and indefinite-lived Elizabeth Arden trademarks, other trademarks and intangible assets. If market and economic conditions deteriorate, this could increase the likelihood of future material non-cash impairment charges to our results of operations related to our goodwill, indefinite-lived Elizabeth Arden trademarks, or other trademarks and intangible assets.

Depreciation and Amortization. Depreciation and amortization is provided over the estimated useful lives of the assets using the straight line method. Periodically, we review the lives assigned to our long-lived assets and adjust the lives, as circumstances dictate. Because estimated useful life is a subjective estimate, it is reasonably likely that circumstances may cause the estimate to change. For example, if we experience significant declines in net sales in certain channels of distribution, it could affect the estimated useful life of certain of our long-lived assets, such as counters or trade fixtures, which could result in additional charges to net income.

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Long-Lived Assets. We review for the impairment of long-lived assets to be held and used whenever events or changes in circumstances indicate that the carrying amount of such assets may not be fully recoverable. Measurement of an impairment loss is based on the fair value of the asset compared to its carrying value. An impairment loss is recognized to the extent the carrying amount of the asset exceeds its estimated fair value. Because the fair value is a subjective estimate, it is reasonably likely that circumstances may cause the estimate to change. The same circumstances that could affect the estimated useful life of a long-lived asset, as discussed above, could cause us to change our estimate of the fair value of that asset, which could result in additional charges to net income. We did not record any adjustments to our long-lived assets in fiscal 2013, 2012 or 2011. Long-lived assets to be disposed of are reported at the lower of carrying amount or fair value less costs to sell.

Revenue Recognition. Sales are recognized when title and risk of loss transfers to the customer, the sales price is fixed or determinable and collectability of the resulting receivable is probable. Sales are recorded net of estimated returns, markdowns and other allowances. The provision for sales returns and markdowns represents management's estimate of future returns and markdowns based on historical experience and considering current external factors and market conditions.

Allowances for Sales Returns and Markdowns. As is customary in the prestige beauty business, we grant certain of our customers (primarily North American department stores and specialty beauty stores), subject to our authorization and approval, the right to either return product for credit against amounts previously billed or to receive a markdown allowance. Upon sale to such customers, we record a provision for product returns and markdowns estimated based on our level of sales, historical and projected experience with product returns and markdowns in each of our business segments and with respect to each of our product types, current economic trends and changes in customer demand and customer mix. We make detailed estimates at the segment, product and customer level, which are then aggregated to arrive at a consolidated provision for product returns and markdowns and are reviewed periodically as facts and circumstances warrant. Such provisions and markdown allowances are recorded as a reduction of net sales. Because there is considerable judgment used in evaluating the allowance for returns and markdowns, it is reasonably likely that actual experience will differ from our estimates. If, for example, customer demand for our products is lower than estimated or a proportionately greater amount of sales is made to department stores and/or specialty beauty stores, additional provisions for returns or markdowns may be required resulting in a charge to income in the period in which the determination was made. Similarly, if customer demand for our products is higher than estimated, a reduction of our provision for returns or markdowns may be required resulting in an increase to income in the period in which the determination was made. As a percentage of gross sales, our returns and markdowns were 8.6%, 7.3% and 8.3% for the fiscal years ending June 30, 2013, 2012 and 2011, respectively. A hypothetical 5% change in the value of our allowance for sales returns and markdowns as of June 30, 2013 would result in a $1.2 million change to net income.

Allowances for Doubtful Accounts Receivable. We maintain allowances for doubtful accounts to cover uncollectible accounts receivable, and we evaluate our accounts receivable to determine if they will ultimately be collected. This evaluation includes significant judgments and estimates, including an analysis of receivables aging and a customer-by-customer review for large accounts. It is reasonably likely that actual experience will differ from our estimates, which may result in an increase or decrease in the allowance for doubtful accounts. If, for example, the financial condition of our customers deteriorates resulting in an impairment of their ability to pay, additional allowances may be required, resulting in a charge to income in the period in which the determination was made. A hypothetical 5% change in the value of our allowance for doubtful accounts receivable as of June 30, 2013 would result in a $0.1 million change to net income.

Provisions for Inventory Obsolescence. We record a provision for estimated obsolescence and shrinkage of inventory. Our estimates consider the cost of inventory, forecasted demand, the estimated market value, the shelf life of the inventory and our historical experience. Because of the subjective nature of this estimate, it is reasonably likely that circumstances may cause the estimate to change. If, for example, demand for our products declines, or if we decide to discontinue certain products, we may need to increase our provision for inventory obsolescence which would result in additional charges to net income. A hypothetical 5% change in the value of our provision for inventory obsolescence as of June 30, 2013 would result in a $1.4 million change to net income.

Hedge Contracts. We have designated each qualifying foreign currency contract we have entered into as a cash flow hedge. Unrealized gains or losses, net of taxes, associated with these contracts are included in accumulated other comprehensive income on the balance sheet. Gains and losses will only be recognized in earnings in the period in which the forecasted transaction affects earnings or the transactions are no longer probable of occurring. Changes to fair value of any contracts deemed to be ineffective would be recognized in earnings immediately.

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Share-Based Compensation. All share-based payments to employees, including the grants of employee stock options, are recognized in the consolidated financial . . .

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