A.T. Cross Company Q3 2008 Earnings Call Transcript

| About: Costa Inc. (ATX)

A.T. Cross Company (NASDAQ:ATX)

Q3 2008 Earnings Call

October 22, 2008 5:00 pm ET

Executives

Laurie Chute – Investor Relations

David Whalen – President, Chief Executive Officer, Director

Kevin Mahoney – Chief Financial Officer

Analysts

Patrick Flavin - Flavin, Blake & Co

Operator

Good day, everyone, and welcome to the AT Cross Company third quarter fiscal 2008 earnings results conference call. As a reminder, today’s call is being recorded. At this time, all participants have been placed in a listen only mode and the floor will be opened for your questions following the presentation.

It is now my pleasure to turn the floor over to Ms. Laurie Chute of Integrated Corporate Relations. Please go ahead ma’am.

Laurie Chute

Thank you, Paul. Before we begin, I would like to take a moment to read the Safe Harbor Statement. Statements contained on this call that are not historical facts, are forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995, including, but not limited to, the expected growth of international market, the expected success of Cross Accessory Division brand extensions, the continued success of Cross Accessory Division shop-in-shops, the continued optimization of the Cross China plant, and the expected continued growth of the Cross Optical Group.

In addition, words such as “believes,” “anticipates,” “expects,” and similar expressions are intended to identify forward-looking statements. These forward-looking statements including the amended 2008 revenue and earnings per share guidance are subject to risks and uncertainties, including, but not limited to, consumers’ reaction to both divisions’ new products, including brand extensions under the Cross name. The Company’s ability to identify strategic, value-added acquisition targets, consumers’ willingness to participate an essential product given the economic climate in the Optical Divisions ability to maximize and develop our need brand in the same manner of the Cross brand.

Additional discussions of factors that could cause actual results to differ materially from management’s expectations are contained in the Company’s filings under the Securities Exchange Act of 1934, including, but not limited to, the annual report on form 10-K for the year ended December 29th, 2007, and other filings made periodically by the Company. The Company undertakes no obligation to update this forward-looking information.

I would now like to turn the call over to Dave Whalen, President and Chief Executive Officer. Please go ahead, Dave.

David Whalen

Thanks, Laurie. Good afternoon, and thank you for joining us as we talk about our third quarter results and the progress we are making against our specific goals and our outlook for the remainder of the year. With me today is Kevin Mahoney, our Chief Financial Officer.

As outlined in our press release today, our third quarter results were positive and we continue to make progress against our specific goals. As we stated in today’s press release just very recently, as the global financial crisis has intensified, we have began to see weakness in present of the Cross Accessory Division market that had been relatively strong for us this year. Given the fact that this spend has developed just as we head in the last segment’s important Holiday Season, we have taken across this approach as it relates to our 2008 full year earnings guidance. This is outlined in the press release. I will get into that later in my comments.

First, however, I want to review our third quarter results were positive from a number of perspectives and our progress against our specific goal. From an operating perspective, I believe our two segments performed quite well this quarter. In what was a very challenging environment, our sales grew 11% and we grew our operating profits. We also made important progress on the integration of our Native Eyewear acquisition by studying that brand up with the same driver of success but it was held at Costa Del Mar. The more time we spend with native customers, the more excited we are about the opportunity we have with that brand.

For the first nine months of the year, our revenue grew 14%, our operating income increased by over 50% and our operating cash flow improved by more than $15 million from the same period in 2007. This performance is further confirmation that our brands are strong, our strategies are sound and our execution is excellent.

Now, I want to review with the strategies and the progress we are making against the season 2008 and Kevin will go into more detail on our third quarter financial results. There are four core strategies to grow share of the value. First, we will grow the Cross brand in the Accessory Division by reshaping our approach for the quality writing instrument market and by developing compelling new brand extensions. We are making good progress here as 10% of our 2008 prospect at revenues will be derived from brand extensions. It is up from 7% in 2007.

In terms of the segment performance this quarter, the prospect may continue to depend on we have seen this year. Revenue increased 18% in international market but declined nearly as much in United States. Much of the United States decline occurred in the month of September and moved as economic crisis intensified. In particular, we have seen declines in our business gifts status that have been quite severe. That said we are not expecting to see much improvement in our United States business in Q4. The market is sluggish all year, and in France, we are using expenses in the region to protect our profit.

Internationally, consumers are responding to our new product, that is the Cross Sauvage that are good in prospect. As continued efforts to place shop-in-shops result of guide in the business, today we have nearly 100 of these shop-in-shops in place in Europe and Asia. Additionally, we have seen growths from emerging market such as India, Middle East, and Turkey. Strong spots throughout all the year and European market have over the past few weeks began to weaken and think it is unlikely that this will moderate before the end of 2008. However, as we look beyond the down at the remainder of 2008 and probably early 2009 we still see the international market as as important growth opportunity for the Cross brand and we will continue to invest at these regions.

With regard to the Holiday Season, which is most important for the Cross brand. We believe we have positioned ourselves in a good way. We launched Cross products on time, which includes new writing instruments such as precious metal extensions for the line and new other accessories such as wallets and ladies’ computer bags. This month, we are participating in Breast Cancer Awareness Month in product designs specifically for the program. In late November, we will mail our holiday catalogue to 300,000 United States’ consumers. Our holiday programs that the United States opportunities are in place.

Even though we are prepared, these are extra ordinary times with our September and October holidays sales are now complete, sell through and reorders during the month of November and December will determine the Cross accessory division outcomes for Q4 in the year. Our optimism for the Cross brand is high. Cross products are always considered great gifts. However, forecast in consumers in refiller activity this holiday season is difficult and will not necessarily be correlated with the strong brand or even good sales for this quarter.

Our second strategy is to continue to lower our accessory division prospects by optimizing the state-of-the-art manufacturing facility we have created in China and the supply chain in Anchorage. This quarter, we decide to move most of the manufacturing operations and are currently remaining at our Rhode Island facility to China. Our Companies in our Chinese operation keep growing and in fact that they are ready to absorb these activities. This will aid in our aim to expand our gross margin.

On an annual basis or actions will save the Company approximately $2 million on an annual basis beginning in the fourth quarter of 2009. The effort will require a modest expense charge of approximately $500,000 or $0.02 per share in 2008.

In addition to the moveof additional operations to China, our Cross Accessory Division management team currently has over 30 cost reduction programs that they are evaluating. Our goals to have many of these in place in time to impact 2009 to serve as a catalyst for gross margin improvements and protection against the tough economy. Cost reductions to expand gross margins is a strategic imperative for the Accessory Division and we will work relentlessly to achieve it.

Our third strategic initiative to grow the Cross Optical Group also continued to be exceptionally well executed. In Q3, our sunglass business grew 40%. Costa Del Mar delivered 12% growth and is up 14% for the first nine months of the year. This growth is a testament to the brand’s strength, given the fact that Costa Del Mar’s core market is Florida, a State which has experienced greater economic challenges than most. For many retailers, Costa has been a bright spot in the difficult time in the sunglass season. In fact, wholesales grown business in 20 of the top 25 customers this year.

As a result, we are gaining shelf space and incremental open to buy inventory dollars. Costa’s sales increases were helped by the introduction of new or recently introduced products for 2008. Styles such as Man-O’-War, Isabella, and Black Fin are selling very well and appealing to a wider range of consumers, including women and college students. Additionally, the brand just launched a 580 silver mirror lens, a first new world lens in 15 years. The first production sold out immediately.

Importantly, in this tough environment, we continue to invest in the Costa brand. Costa remains very involved with the Bassmater Elite 100 Fishing Series which is televised on ESPN. Nearly 50% of the top 100 pros on that tour wear our sunglasses. Additionally, our investments are helping to grow revenue outside the core South East region at rates of 15% to 25%. In this challenging environment, rather than cutback support, we have increased it. It appears that our investment and faith in our brand are paying off. As we have stated before, we know how to win in the premium sunglass market and we will aggressively manage our organization to do so.

Our fourth strategic goal is to utilize the strength of our balance sheet and increase in cash flows to execute market value added acquisitions in each part of our business and provide us with new long term growth opportunities. In terms of our balance sheet, I will state that I am very pleased with the progress of our [inaudible] this year, which significantly improved the cash generated by our Cross Accessory Division business. We have substantially exceeded our inventory reduction goal in what has been a tough environment and we envision a move set at 2008 operating goal.

In terms of acquisitions, as you know, in March we announced the acquisition of Native Eyewear. This brand is a great addition to the Cross Optical Group as it grows our presence in the sport performance sunglass category at price points of $80 and greater. We believe that both the Costa and the Native brands, which are anchored by premium polarized lens technology, a lifetime warranty, and excellent customer service reputation will continue to gain new levels of recognition and acceptance. Both organizations are streamlined to have healthy margins and will benefit from each other in terms of sales relationships and best practices.

In the six months that we have owned Native, everything that we have seen tells us that the acquisition will be a winner for the Cross Optical Group. During this time, we have been aggressive in preparing the brand for a strong 2009. These products that have been developed, its distinct product reduction is the move to low cost suppliers, back off its operation that has been combined those of Costa Del Mar and marketing and sales plans are set. Native will be nominally accretive this year and we have set a strong growth to begin in 2009.

Given our strong balance sheet, we view the current economic environment as potentially a soft source of opportunity. It is certainly, we will continue to look for accretive acquisitions and given the environment industry consolidation at lower value it is probable. If that is the case we intend to be player. In sum I am very pleased with the progress my management team is making to get up towards our 2008 operating goal and are executing against our four strategic initiative.

Now I will turn the call over to Kevin.

Kevin Mahoney

Thanks, Dave. As Dave indicated, our third quarter results positive, our operating income was up 10% for the quarter and up to 52% for the first nine months. Our diluted earnings per share were $0.11 this quarter versus $0.15 last year. However, both years third quarter had non occurring cash benefits. When EPS was neutralized for this items, our diluted earnings per share were $0.09 per share in both quarters.

Our nine months diluted earnings per share are neutralized for non occurring cash item with $0.18 in 2007 compared to $0.26 in 2008. Our revenue grew 11% in the current quarter and 13.7% for the first nine months. Our revenues segments are presented in our press release material. Let me give you some more details for that data.

Our Cross Accessory Division revenues grew 1.3% in the quarter and 5.6% for the first nine months of the year. Adjusted for currency, Cross Accessories group, revenue grew 0.2% in the current quarter and 2.3% for the first nine months of 2008. The Optical Group had revenue increases of 39.8% to 34.5% in the current quarter over the first nine months of 2008. However, adjusted for the Native acquisition, the Optical Group or Costa Del Mar had revenue increases of 11.6% in the current quarter and 13.7% for the first nine months of 2008.

Our Gross margins were 57% in the current quarter versus 56.7% last year and it were 56.2% and 56.4% for the first nine months of 2008 and 2007. I will give you a little more detail in our gross margin data by segment.

In our third quarter, the Cross Division had gross margins of 56%. The Optical Group had gross margin of 59.3%, in a year-to-date basis over the first nine months of this year, the Cross Group had gross margins of 54.4% and our Optical Group had gross margins of 59.9%.

Our operating expenses for the quarter were $19.8 million or 50.7% of sales in comparison to 17.7% or 15.3% of sales a year ago. As I stated, our operating income for the third quarter was $2.5 million compared to $2.2 million in 2007 an increase of 10%. Native contributed approximately $0.4 million of operating income in the third quarter and $1.6 million for the six months since we have owned them.

With respect to our balance sheet and cash flows, our cash on hand at the end of the quarter was $14 million. As Dave indicated, our cash generated by operations for the first nine months of this year were $15.4 million in the same period in 2007.

Our account receivables were increased to $28.3 million from $25.9 million at the end of the third quarter in 2007. Excluding Native, our receivables were up $1.5 million versus last year’s third quarter level. Our receivables were up 9% versus 2007, while our revenues grew 13%. We are managing our receivables quite well.

More detail of our day sales outstanding at the end of the third quarter this year was 68 days that is unchanged from 2007, and we remained vigilant in monitoring our receivables for both segments of our business given in global economic environment where we are operating in.

As for our inventory, our balances exclusive of Native inventory of $1.3 million at the end of this quarter were down $8 million from a year ago. Our gross Cross inventory decreased $9.3 million from a year ago and we will continue to aggressively manage our investments in our Cross inventory. Cross inventory was flat in comparison to a year ago which is positive given to 14% revenue growth that business has shown.

Our capital expenditures were at $1.1 million this quarter slightly below our projection. As public changes in our balance sheet in the end of the third quarter versus 2007, good will, intangibles, and our debt levels were all increased due to the acquisition of Native Eyewear.

Now, I will turn the call back over to Dave.

David Whalen

Thank you, Kevin. As we are all aware, we are operating in a very challenging consumer environment around the globe. Expect my management team is making the kind of progress against our specific initiatives that I wanted to be so far of this year. Thanks for the Coach advantage that has been demonstrated, particularly considering the slow market of Florida. Additionally, we are quite optimistic as to what we can do with the Native brand.

As for our Cross Accessories Group, there are two ways of making progress against our specific goals that we have endured a very tough United States market so far this year, it has taken the brand outside the United States, outside in the United States weakness during the first nine months. Unfortunately, international market has now shown ongoing weakness. Even more so, than we thought just a few weeks ago coupled with the rapidly appreaciating United States dollar, the remainder of the year revenue target has become quite challenging. The negativity in the Europe market was made calibrating our remaining 2008 revenue was very difficult. Therefore, I believe that it is conservative for our EPS and revenue growth guidance in terms of the challenges that Cross Accessories Group is now out facing.

We are revising the range for the 2008 EPS guidance from $0.49 to $0.51 per share, excluding restructuring charges $0.40 to $0.45 per share excluding the [inaudible]. We expect full year revenue growth will be 68%.

We are taking the steps now to prepare for this environment to extend well into 2009 by revisiting our spending plans for our business. Our management team is very focused on achieving a 2010 long term financial goals and we will aggressively manage our spending until the consumer spending has improved the Company’s outlook this year.

Even in view of these market challenges, we remain very excited about our prospects. The awareness of Costa Del Mar is growing among premium sunglass consumers, and they are buying. Native appears to be a great addition to the Cross Optical Group. The progress we have made over the last couple of years about our Cross Brands, will judge our shareholder value. I am very confident that we are doing the right things to build long term value with our brand.

Thank you, and now we will take questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions). We will take our first question from Eric Marshall with Hodges Capital Management.

Eric Marshall – Hodges Capital Management

On the Costa business in the quarter, you guys talked about organic growth of 11.6%. How much of that in market or geographical expansion and how much of it is from the premium core market?

David Whalen

Our both those regions are growing, the core market are growing right now roughly at about 9% to 10% rate and the market, and that we consider that basically a band that runs down from Virginia down to the East Coast through Florida and the South, of Texas. That area is growing in the 10% range and areas outside of that is growing in the 15% to 25% range.

Eric Marshall – Hodges Capital Management

Are you guys seeing very much progress on expanding Native distribution.

David Whalen

We believe there is a big opportunity with regard to that and we have 5 new products ready to go for Native to be really starting to be introduced to the market now for 2009. So we do expect more expension in 2009 when we get our 2009 Anagrams together.

Eric Marshall – Hodges Capital Management

Okay. You guys address flowing to manufacturing part on the writing accessory business, but have you guys looked at taking any actions to lower cost in the sunglass eyewear division?

David Whalen

Well, one of the, we items have we worked on in the past for 3 to 4 months was lowering the cost base for the Native products. They were being produced in higher cost areas than the Costa business has been and we shifted a lot of that production to the low cost areas that Costa is in. That has improved Native margins going forward and then the fact that we are combining back off these operations for both Native down in Daytona provide us more skill in our Daytona operation and that has resulted to lower cost for that division as well.

Eric Marshall

Okay. Even an obvious fact that the strong dollar is going to penalize sale here if it continues the way it is. You guys expect to take up any incremental benefits from your cost to goods sold given what the dollar spend recently?

David Whalen

Yes. It is not really our – right now the majority, we look at it from the Cross business. I think that is what you are referring to…for the Cross business. Our writing instruments that are made in our facility in China, substantial portion of those costs are raw material the labor and overhead that we spend over there is quite small. It is funded in local currency. Right now the majority of our raw material costs are purchased in dollars.

Eventually over the coming months actually, we are going to shift more, more of our raw material sourcing from the United States to mainly in China. And so that we will bring down our material cost much more so than any impact of Dollar/Yuan fluctuation. So to sum it, we will see a lower material cost coming out of China but not because of any variations in dollar to yuan.

Eric Marshall

Okay. And then, when you guys are looking at a more cautious holiday season. Is it that you are seeing the same amount of activity that smaller orders coming out of customers or you just see customers hold off on ordering just because of their own uncertainty?

David Whalen

I think, we are talking right now specifically about the Cross Accessory Division. What we are seeing is customers holding off because of their uncertainties and by that I mean and I mentioned in my comment, we place their large holiday shipments with our larger customers. But at the moment, replenishment is off and it seems like retailers are selling one and then ordering one from us and then selling one in ordering once a month.. They are being extremely cautious with inventory and we have reflected that in our outlook and I think that is the right way to go until we start to see them getting more aggressive with inventory and preparing for the holiday season.

Analyst

Okay, last question and then I will hop off. Is there anything that you guys are doing to from a marketing standpoint to give kind a more of a value proposition in your product offerings, anything that you are kind of promotions or anything like that that you are doing?

David Whalen

Our direction has been on a global basis with the Cross Accessory Division particularly in our Business Gifts area which represents 25% of that division’s business would be aggressive to get the order and sometimes a few cents here, a few cents there really matter. So, from that perspective we are.

Operator

Your next question comes from [inaudible] - BWS Financial.

BWS Financial

Just two questions, first off is what kind of planning are you doing for 2009 given the difficulties you have faced so far in the economy?

Kevin Mahoney

We are revisiting, we have a multiyear operating thing for both of our segments. That is for the Cross segment, we are revisiting with the spending associated with that particularly for 2009 as we speak and with that much more aggressive with that, I would like to go back over the last few weeks. I think as Dave has indicated in his comment, we are on a mission to get to the size of the business in 2010 that we have been talking to investors about over the last six to nine months and with the depth of revenue growth expectations that we have thought then that is the final way to get there just to much more aggressive management of our expense for that. So, we are on top of this.

David Whalen

Again, that applies to the cross accessory division in terms of the Optical group, we have two brands. The Costa Del Mar it is growing at several digit rate in this environment and may have dealing investments to get established in the way we do business here. So, we will be continuing to invest in the soft optical group but we are taking a very hard look at these expenses in the Cross Accessory Division and how to beat the target that we have laid out to every operating part of the turn on sales of operating income for that business.

BWS Financial

What kind of slowdown you seeing from international markets where it is causing you to guide down? Is that offsetting what you consider I think international as a majority of each sale. So, will that put more emphasis on US sales going forward?

David Whalen

We believe that that maybe clear, the slowdown of sales internationally primarily right now in Europe. Asia is holding up pretty well. Europe however and it has really have been in the last three weeks or so that it has slowed down considerably and because that is the case, we have not seen indications of them coming out of that. We thought it was right to be cautious with our outlook. But long term, international markets remain a growth vehicle for us and one where we run that.

Analyst

Okay and then housekeeping question. What was the revenue for our Native during the quarter?

Kevin Mahoney

Let us see, hang on one second, our quarter for Native eyewear about $2.5 million.

Operator

Your next question comes from Patrick Flavin - Flavin, Blake & Co.

Patrick Flavin - Flavin, Blake & Co

The environment that we are in now is exactly the kind of environment that a Native eyewear that is still out there in one of your categories would find itself compelled to begin to think about being bought or to finding some bigger sponsor like yourself that they could be part of. How would you trade that off, David, in a difficult environment to read in terms of cash availability? So, really the question is to what extent would opportunities where they are likely to develop for you to expand your eyewear component? To what extent will your count is doing that?

David Whalen

Just a point of clarification, you started the question by saying Native eyewear is still available to be bought. Native eyewear is what we have bought in March.

Patrick Flavin - Flavin, Blake & Co

Oh, I know I meant something like a Native eyewear.

David Whalen

Oh, something like a Native eyewear. As I said in the comment, I think that there will certainly be opportunities with some validations in the optical area and because of the strength of our balance sheet, I believe that we can and could be a player in the acquisition or the consolidation of the industry. I think there are good brands out there. I think certainly we will be processed as to what we pay and with the brand that we are bringing on but the fact of the matter is I think we have this terrific management team with our Cross Optical Group and I believe that given additional assets, they will get a set of higher returns.

So, if there are plants out there that are available, we will certainly be looking at it.

Patrick Flavin - Flavin, Blake & Co

So, your desire to pursue your consolidation approach is clearly intact. Is the mitigating factor then or the guiding factor be the financing?

David Whalen

I think obviously financing is more expensive in today's environment than to save up and to get a good balance sheet, we expect a fairly predictable cash flows and where the sweet spots of the losses spending, maybe similar to what we spend on Native. That is kind of our sweet spot and so we can handle that quite easily.

Operator

Your next question comes from [Terra Topkins].

[Terra Topkins]

Can you update us on the line of credit with the [EVA] and where you stand with the bank covenant there?

Kevin Mahoney

Yes, sure. The line of credit is $35 million are buying, about $21 million is the most substantial amount of cash. I’ll see if I have got the covenant calculations actually, I do not actually have them with me, I think they are 40 financial covenants just to EBITDA and so forth. We are well clear of all those with key ones of tangible network which we are substantially in excess of $10 million or more. I think quality is the best ratio. The minimum of quality is 1.5 to around 11. In fact, they are going to leverage ratio with well in well ahead of those.

We are not in any danger of reaching any of those financial covenants. I don’t expect that to change at all in the foreseeable future. I think if we were to consider additional acquisitions, some of those leverage requirements has to be modified but it is not something that a friend of mine will spend a pretty big fuss about.

Operator

And we have no further questions on the queue. I would like to turn the call back over to today's speakers for any closing comment.

David Whalen

Thank you for joining us on today's conference call and we look forward to updating you with our yearend results in February of 2009. Thank you.

Operator

That concludes today's conference call. We thank you for your participation. Have a great day.

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