Schawk Inc. Q3 2008 (Qtr End 9/30/2008) Earnings Call Transcript

Schawk Inc. (SGK)

Q3 2008 Earnings Call

November 18, 2008 10:00 am ET

Executives

Philip Kranz – Vice President, Dresner Corporate Services

David A. Schawk – President, Chief Executive Officer

A. Alex Sarkisian – Executive Vice President, Chief Operating Officer

Timothy J. Cunningham – Chief Financial Officer

Analysts

Jamie Clement – Sidoti & Company, LLC

[Myron Caplan] – Private Investor

Craig Kennison – Robert W. Baird & Co., Inc.

Presentation

Operator

Good day ladies and gentlemen and welcome to third quarter 2008 Schawk earnings conference call. My name is [Francine] and I will be your coordinator for today. (Operator Instructions) I would now like to turn the presentation over to your host for today’s conference, Mr. Philip Kranz, Vice President of Dresner Corporate Services. Please proceed sir.

Philip Kranz

Thank you. I’d like to thank everyone for joining us this morning. Last night a press release was distributed outlining the results for the third quarter of 2008. If anyone has not received a release, please contact us at 312-726-3600 and we’ll provide you with another copy.

Joining us today from the management of Schawk is David Schawk, President and Chief Executive Officer; Alex Sarkisian, Executive Vice President and Chief Operating Officer; and Tim Cunningham, Chief Financial Officer. Management will begin with an overview of the results and then we’ll open the call to your questions.

Before we begin however, I would like to remind participants that this conference call may contain certain forward-looking statements that are subject to the safe harbor disclaimer found in yesterday’s press release. At this point I would like to turn the call over to David Schawk. Please go ahead.

David A. Schawk

I thank you. Good morning and thanks for joining us. Well the year 2008 is ending up to be one that will touch the people in our business in many ways. For most of the year and certainly most recently, the world economy has gripped in an economic slowdown. As a result, our business volume through the end of the third quarter is down from the level at 2007.

We have responded to this challenge focusing even more intently on client relationships. Although Tim will provide a detailed review of our results in the third quarter and for the first nine months, I would like to briefly summarize some of the key points. Through the first nine months, sales were down 4.5% over the same period of 2007. Consumer products packaging accounts sales were down less than 1%, while advertising and retail accounts sales were down 8.3% and entertainment accounts sales declined 18.1% as compared to the same period last year.

Gross profit declined 1 percentage point as a percent of sales although our cost reduction activities, which began in the second quarter of this year, added 2 percentage points to operating margins as we have not yet realized the full impact of these cost reduction initiatives. The decrease in operating income over 2007 period is a result of lower sales volume; higher SG&A expenses; the impairment of long lived assets; cost reduction plan expenses; and unrealized currency losses associated with foreign exchange transactions as detailed in yesterday’s press release.

The impact of the non-cash $3.5 million asset impairment charge, $1.9 million restructuring charge, $1.9 million unrealized exchange losses and $2.2 million of expenses primarily related to our remediation activities adversely affected operating income performance by $9.5 million in the current quarter.

As we look towards 2009, we anticipate that our operating income will improve as we expect many of these items will not be part of our results. Importantly, while not reflected because of the overall slowdown, our market share remains strong. While we continue to see a steady flow of maintenance type work on behalf of our clients, we have experienced a slowdown with respect to new design and innovation type activities. Importantly though, based on our discussions with our clients, this type of work is being delayed and postponed.

As I said earlier, this year is proving not to be an easy one. However, the impact of the difficult economic environment in 2008 has reaffirmed our wisdom to focus on our clients, as well as our strategy to capitalize on the reinvestment of technology and global position to perform work more efficiently for our clients and more profitably for our bottom line. By closing and consolidating manufacturing locations, and expanding our sales and service offerings while reducing staffing levels, we seek to consolidate technology and workflows, thus allowing the company to improve its capacity utilization.

To combat the business slowdown that we’ve experienced and in an effort to improve margins, the company continues to execute on a cost reduction plan that we discussed last quarter’s conference call. As a result of this plan, we incurred $1.9 million and $5.1 million in restructuring expenses for the third quarter of ’08 and the first nine month period of 2008 respectively.

While we expect to incur a total of between $7.5 million, $8.5 million for the total year, through a combination of restructuring existing businesses and closing selected operations, we will be able to reduce the expense base in 2008 by $4 to $5 million. And in 2009 and beyond by $13 to $15 million, creating profit leverage for when the economy turns. The $13 to $15 million savings expected in 2009 is a higher estimate than we indicated last quarter. We will continue to look for opportunities to increase these savings as we continue to react to market conditions.

As 2009 begins, we are confident the changes made in 2008 will make us a more valuable to our clients in every business. While reducing our cost structure, we have kept in mind that the factors driving secular growth in consumer products packaging, retail and entertainment accounts; an aging population; globalization; privatization; and productivity remain in place and growth will resume.

We therefore have balanced the need to reduce expenses with the need to have talent in place to take full advantage of the future opportunities. As always, downturns in the economy present the highest risk to the returns we can generate for shareholders. Specific challenges also present themselves in 2008 and until the cycle turns. Please rest assured that we are taking highly proactive measures to insure Schawk’s long term sources.

Furthermore, our primary focus in 2009 will be to do what we do best. We’re going to keenly focus, continue focus on new business development; going to create new products and services that our clients are looking for; and we’re going to continue to do acquisitions that will enhance our current offering. And most importantly, we’re going to maintain our cost control. Also we will continue to measure success in our business by our ability to increase market share and deliver profitability. We are confident that by building on the progress we made in 2008 we’ll be able to achieve market share gains in 2009.

We know our geographic and product breadth; innovative and talented people; and strong client-centered culture give us the competitive advantage to continue to be a market share leader in our core business. Now I’d like to turn it over to Tim to go into more details on the financials.

Timothy J. Cunningham

Thanks David. Good morning everyone. Now comparing the third quarter of 2008 with the third quarter of 2007, our sales were down approximately 4% representing decreased sales across most of our business areas, including consumer product packaging sales, our largest area, which represented nearly 66% of sales. On a geographic basis, the softness continued to be particularly evident in our domestic business in the U.S. which represents more than two-thirds of our total consolidated revenues.

Now with respect to Schawk’s operating and net income for the third quarter of 2008, there are several items affecting the year-over-year comparisons and I’d now like to highlight two charges on our financial statements in the third quarter. The first item for discussion is for $1.9 million and it’s connected to the restructuring charges related to the cost reduction plan that David alluded to earlier in his remarks. This is the cost reduction initiative we first disclosed with our Q1 report. We started the cost reduction activities in the second quarter of this year and expect to complete these in the fourth quarter.

However, as David indicated, we will continue to react to current and anticipated market conditions and may consider additional cost reduction actions, which could impact fiscal 2009. The second charge to highlight is a non-cash impairment charge of $3.5 million related to long lived assets.

The largest portion of this amount is a non-cash, $3.1 million long lived asset impairment charge for property which we currently lease to a third party and we have decided to sell. It was determined that the carrying value of the land and building cannot be supported by the estimated market value of that property.

Now, to assist investors in comparing the third quarter and nine month periods of 2008 and 2007, we have included non-GAAP financial metrics and reconciliations to GAAP in yesterday’s press release. Now on this reconciliation and included in the press release, third quarter earnings per share is adversely affected by about $0.05 a share just for the restructuring expense; $0.08 a share for the non-cash asset impairments; and $0.18 a share for the FIN 48 income tax charges due to uncertain tax positions.

Now without these items, EPS would have been $0.08 per diluted share for continuing operation versus the loss of $0.23 per share as reported under U.S. GAAP. Now excluding the restructuring expenses of $1.9 million and the impairment charges on long lived assets of $3.5 million in the 2008 quarter, adjusted operating income was $6 million for the third quarter of 2008 versus

$13.4 million in the same period last year. And again you can review these numbers for both the third quarter and nine months in the supplemental schedules included in yesterday’s earnings release.

Now while most of that decrease was attributable to lower sales, adjusted operating income in the 2008 third quarter was also impacted by unrealized foreign currency losses of approximately

$1.9 million, and approximately $2.2 million of increased professional fees, principally related to the company’s internal control remediation and related matters, in consulting fees related to the company’s re-branding initiative.

Now moving on to interest expense, we continued to lower our interest expense as we have for the past two years. In fact, third quarter 2008 interest expense was down 29% compared to 2007 as a result of a decrease in average outstanding debt and a reduction in average interest rates. Income tax expense for the third quarter 2008 was $5.3 million, which was principally due to the need to provide tax reserves for the uncertain tax positions related to the company’s foreign operations, compared to $4.4 million in the third quarter of 2007.

Now finally with respect to the income statement, I want to briefly touch upon the discontinued operations line whereby the company had a loss of $0.02 per share or $439,000 during the third quarter of 2008. This is the result of the company’s decision to sell its large format printing operation located in Canada.

Moving on to the balance sheet, as of the end of the 2008 third quarter we saw a reduction of approximately $11 million in its accounts receivables as compared to the end of the 2008 second quarter, due to the company’s continued collection efforts during the third quarter 2008. As of September 30, 2008, total of that increased $6 million as compared to June 30, as the company utilized its credit facility to repurchase approximately 636,000 shares of its common stock for about $9.8 million.

As a result, our debt to equity ratio continued strong, although it increased a little over 40% at September, 2008, as compared to a little over 35% at June, 2008. Additionally, our debt to the total capital ratio was 28.7% at the end of the third quarter which compares to a little over 26% at the end of June, 2008. Now in 2008, the company remains well positioned to finance its operations including continued dividends and share repurchases, between operating cash flow and over $72 million of availability on our revolving credit facility.

Now as we reported in previous calls, the company, with the assistance of a major accounting and advisory firm, has been in the process of implementing plans to remediate our material weaknesses and improve our [Sox] program. We anticipate continuing this implementation into the fourth quarter and believe we will make substantial progress with our internal controls by the end of the year. The company expects to continue receiving assistance from the major accounting and advisory firm as we progress through these remediation activities.

Now these remediation expenses will be a key driver of the planned increased G&A expense for the fourth quarter of 2008, as well as higher external audit and related costs until such time as we complete and test the revised internal controls. We expect that such costs could reach up to

$2 million in the fourth quarter of fiscal 2008. Now the executive management team and other business leaders of Schawk remain committed to taking the steps necessary to insure that our operations, accounting and finance functions reflect the control levels required of a $0.5 billion global organization.

And with that we’d like to open the call for questions. Francine.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from Jamie Clement – Sidoti & Company, LLC.

Jamie Clement – Sidoti & Company, LLC

David, you know a lot of companies out there noticed a disruption in their business towards the end of September and beginning of October. How have your – I know you alluded to some delays and that sort of thing, but in terms of just your every day kind of business, has that held up reasonably well through the September, October time frame or are you incrementally concerned about the fourth quarter related to the third?

David A. Schawk

I think it’s been pretty steady actually. There’s no been nothing gigantically big as – increase or nothing that’s gone, you know, negatively. So I think the last three, four months we’ve been pretty steady about where our revenue and numbers been.

Jamie Clement – Sidoti & Company, LLC

And [Kenneth] maybe this – I don’t know if this question should be directed towards you, but can you give us a little bit more detail on the, you know, the remediation work and sort of where you are right now? And in terms of the elevated SG&A, should that be substantially out of the P&L by the first quarter of 2009? Or might we see a little bit of a leak into 2009?

[Unidentified Speaker]

Well, we’re making – in terms of our remediation activities, we’re focused on the remediation for the material weaknesses such as revenue recognition and income taxes. And so there’s a lot of effort and expenditures and we expect to make progress on that, as well as remediating our Sox program, which we expect to have in place by the end of the year. I suppose there is some risk that some expenses could spill into 2009 but it certainly won’t be at the same level of investments that 2008 has seen.

So once we get these controls in place, they have to be implemented and tested. And I just think it’s just as a practical matter, because a lot of these are being implemented in the fourth quarter, you know, kind of the road testing of these so to speak is going to extend into 2009. But it certainly will be a stronger control environment.

Operator

Your next question comes from [Myron Caplan] – Private Investor.

Myron Caplan – Private Investor

Hi guys. I just wanted to ask about the loss on the currency translation. How did that come about?

David A. Schawk

Well, the company has inter-company debt on its books and it has dollar debt on its UK operations. And just with the weakening of sterling versus the dollar, the translation of that runs through the P&L.

Myron Caplan – Private Investor

Became material I guess

David A. Schawk

Yes it did and you can just take a look at what, you know, I think sterling was at $2.00 back – let’s just say back in the second quarter and it’s about a $1.50 now, so that’s what you’re seeing going on. It’s not speculation in currency transactions or anything of that nature. It’s strictly translation. And we’re evaluating how we want to structure this debt and hold this debt in the future, you know, just to remove the noise from the P&L.

Operator

We have no additional questions. One moment, we do have a couple of people just queued up now. Your next question comes from Craig Kennison – Robert W. Baird & Co., Inc.

Craig Kennison – Robert W. Baird & Co., Inc.

Could you help us with that $13 to $15 million in lower costs next year, understand perhaps where you see lower costs, what the buckets are for example? And what’s the incremental change from your previous guidance?

David A. Schawk

Well, the split of that range, the $13 to $15 million, 87% roughly is just plain old employee costs, and 10% is lower lease expense and the balance is lower depreciation because we’ve taken some assets out of the system. We increased the range by $1 million from where we were before.

Operator

Your next question comes from Jamie Clement – Sidoti & Company, LLC.

Jamie Clement – Sidoti & Company, LLC

David, can you talk a little bit about the re-branding process and, you know what the general response has been from customers and just give us a little bit more color on that?

David A. Schawk

Yes. The re-branding, basically the bulk of it is over with. We’ve got most of it behind us. The acceptance of it has been pretty good. You know, it’s an education process. It is a switch in our business. It’s something that, you know, we’re building on and it’s something that we want to continue to work towards to achieve. So I would say right now we’re probably in the 50 to 60% range of being able to, you know, deliver the entirety of what we’re trying to accomplish. And it’s a building process; we’re in the first stage of it. Let’s say we’re in the first inning of a baseball game.

But I will tell you that the response from not only our employees but outside folks that certainly the re-branding was needed and is certainly looks terrific and is, you know, in the marketplace being accepted.

Operator

Your next question comes from Myron Caplan – Private Investor.

Myron Caplan – Private Investor

Was there any gain during the 2006-8 period that occurred in this likewise in the translation of these inter-company [inaudible]?

David A. Schawk

Yes, there were some gains, but not on the same order of magnitude that we’re talking about these losses.

Myron Caplan – Private Investor

Even when the pound went from $1.55 or so to $2.05 or whatever?

David A. Schawk

That happened over an extended period of time. It didn’t happen precipitously.

Myron Caplan – Private Investor

So is the company going to – are you going to issue any guidance for either the remainder of the year or for 2009?

David A. Schawk

I believe it’s the company’s policy not to issue guidance and that will continue to be the policy.

Operator

You have no further questions at this time.

David A. Schawk

Okay. Thanks for joining us today and we look forward to talking to you on our fourth quarter year end results.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a good day.

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