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American Greetings (NYSE:AM-OLD)

Q3 2013 Earnings Call

December 20, 2012 9:00 am ET

Executives

Gregory M. Steinberg - Director of Investor Relations and Treasurer

Stephen J. Smith - Chief Financial Officer and Senior Vice President

Analysts

Jeffrey S. Stein - Northcoast Research

Paul Simenauer

Sean O'Malley

Owen Douglas

Operator

Good day, and welcome to the American Greetings Corporation Third Quarter Fiscal 2013 Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Gregory Steinberg. Please go ahead, sir.

Gregory M. Steinberg

Thank you, Kyle. Good morning, everyone, and welcome to our third quarter conference call. Joining me today on the call is Steve Smith, our CFO.

We released our earnings for the third quarter fiscal 2013 this morning. If you do not yet have our third quarter press release, you can find a copy within the Investors section of the American Greetings website at investors.americangreetings.com.

As you may expect, some of our comments today may include statements about projections for the future. Those projections involve risks and uncertainties that could cause actual results to differ materially from the forward-looking statements. We cannot guarantee the accuracy of any forecasts or estimates, and we do not plan to update any forward-looking statements.

If you'd like more information on our risks involved in forward-looking statements, please see our annual report or our SEC filings, previous earnings releases, as well as our 10-Qs, 10-Ks and annual report, are available on the Investors section of the American Greetings website.

In light of the proposed going-private transaction that was announced at the end of September, today's conference call will have a similar format to last quarter's conference call. Our CFO, Steve Smith, will offer some prepared remarks, which will be followed by a question-and-answer session. We will be limiting prepared remarks to historical results. We are not updating, reaffirming or otherwise addressing full year guidance, and we'll not be discussing the proposed going-private transaction that was previously announced. We will now proceed with comments from Steve, followed by the question-and-answer session. Steve?

Stephen J. Smith

Thanks, Greg. I have 4 components to my prepared remarks today. I will start with comments on how the Clintons transaction impacted our financial results, then share our consolidated results for the quarter, then move to a review of our reported segments, and finally, I will touch on a few key components within our financial statements. We will then open the line for questions.

I would like to first start with comments on how the recent acquisition of certain assets of Clinton Cards is impacting our financial results. As you likely know, during our first fiscal quarter, we acquired the senior secured debt of Clinton Cards and incurred bad debt and other related expenses, as Clinton Cards filed for administration. During the second fiscal quarter, we acquired certain assets from Clinton Cards, which included approximately 400 stores and related overhead as well as the Clinton Cards brand.

Since that time, we've been making progress to improve the business. We are encouraged by the progress made so far. As we discussed last quarter, our strategy to improve the Clintons operations has included reevaluating the overall product offering within the stores, remodeling some of the stores, re-merchandising the card assortment, aggressively renegotiating leases, installing a new computer system and reducing overhead costs. We are encouraged with the progress so far as well as the preliminary results, although we are still in the middle of the turnaround.

Forecasting the performance of a turnaround that is both highly seasonal and where the ultimate number of stores we will eventually operate have not been finalized, is a difficult task. After the business has had a full year of operations, including having operated through the Christmas season where the bulk of the profit is generated, we will have more confidence on our ability to predict Clinton's financial performance, and as a result, our ability to predict the consolidated group.

Let me briefly summarize how Clintons impacted our income statement, both at the consolidated level as well as at the segment level. During the third fiscal quarter, we recognized the net increase in revenue of about $42 million, which is comprised of the Retail Operations segment revenue of $68 million less the eliminations associated with intersegment revenue from our U.K. wholesale business of $26 million.

Clintons negatively impacted our operating income by approximately $16 million during the quarter compared to the prior year due to the combination of the Clinton's segment loss of slightly more than $11 million and the intersegment items of slightly more than $4 million.

In connection with the additional leverage incurred as a result of Clintons, we amended our credit agreement. That amendment was filed today with our 8-K. Within the amendment, we modified the definition for EBITDA to permit certain add-backs for specific nonrecurring expenses related to Clintons. We are in compliance with the financial covenants under our credit agreement.

Switching gears from a review of the several ways Clintons has impacted our quarter to a review of our consolidated performance, let me start with revenues.

Our consolidated third quarter revenue of $507 million increased about $42 million from last year's third quarter of $465 million. This increase benefited from about $1 million of foreign exchange compared to the prior year's third quarter. In addition, scan-based trading favorably impacted revenue by slightly less than $1 million compared to the prior year's third fiscal quarter. So holding aside the impacts from both FX and SBT, revenue was up about $40 million or just over 8%. The revenue increase of $40 million was driven by the acquisition of Clinton Cards, which contributed net incremental revenue of about $42 million period-on-period.

Holding aside the impact of the foreign exchange, scan-based trading in Clintons, revenue was down about $2 million or less than 1%.

Switching from a review of revenue to a review of earnings, our operating income of $400,000 in this year's third quarter is compared to $33 million of operating income in the prior year's third quarter. This year's operating income was negatively impacted by a number of factors, and the largest of which was the $16 million drag from Clintons that I just described.

Holding aside the effect of Clintons, our operating income was down about $17 million quarter-on-quarter.

The 4 primary drivers of this year-on-year decrease include about $8 million for the combination of additional cost associated with the proposed going-private transaction together with increased legal expenses; about $2.5 million of expenses that I will describe further in my segment analysis for strategic actions in Europe; about $1 million of increase to marketing and advertising within our North American segment; and about $5 million driven by a blend of unfavorable mix of products sold and increased product and product content costs.

I'll now review our segment results and how they differ from the prior year. Our North American segments revenues of $334 million were essentially flat compared to the prior year's third quarter. While we have a small increase in gift packaging and other ancillary products, that increase was offset by seasonal cards. Our North American segments' earnings of $22 million were down about $6 million versus the prior year. While we had about $1 million of increased marketing and advertising costs, the majority of the earnings decline was driven by a blend of unfavorable mix of products sold and increased product and product content costs within the quarter.

Within our international segment, revenues before the impact of inter-segment items were about $102 million, a decrease of about $1 million versus the prior year. Within the international segment, earnings were $3.4 million, again before the impact of inter-segment items. This compares to about $9.5 million during the prior year's third quarter, which is a reduction of about $6 million.

During the quarter, we sold a product line in the U.K. known as Expressions. The product line focused on gifting products, such as plush toys that you might find in a specialty gift store. Expressions was not a greeting card line and was not a strategic business.

In addition to the sale of Expressions, we also reorganized our international giftwrap manufacturing operations and closed our giftwrap manufacturing plant in Italy. The combination of these 2 strategic actions resulted in adverse impact to our operating income of about $2.5 million during the quarter. The remainder of the shortfall of about $3 million quarter-on-quarter was driven by performance and mix in both the U.K. and Australia.

Our AG Interactive segment's revenues of $16 million were down less than $1 million versus the prior quarter while segment earnings of $5 million were up about $1.6 million compared to the prior year's third quarter due to lower back-office costs.

Let me shift from the segment analysis to briefly comment on the status of our licensing business. Licensing revenue for the quarter, which is reported on our income statement as other revenue, was about $7 million, which is up almost $1 million compared to the prior year. Licensing expenses were about $1 million -- $5 million, rather, which is down about $700,000 compared to last year.

So for the third quarter, the company's net licensing effort of revenue less expense was about $1.4 million higher than the prior year's third quarter.

Now let me move to the fourth and final part of my comments today, a review of several of the key components of our financial statements. The company's manufacturing labor and other production costs were about $14 million compared to last year's third fiscal quarter. About 1/4 of the increase is directly related to Clintons. The strategic changes in Europe that I shared at the segment results adversely impacted MLOPC by about $1 million. We also had unfavorable scrap in the quarter of about $1 million. The remaining increase was primarily the result of unfavorable product mix, including increased product and product content costs.

Our selling, distribution and marketing expenses increased by about $49 million versus the prior year's third fiscal quarter. The increase of $49 million is due to the acquisition of Clintons. In addition, marketing expenses increased about $1 million and foreign exchange had an unfavorable impact of about $1 million. The increases from marketing and FX were offset by about $2 million of lower costs in our field service organization versus prior. You may recall that last year, we incurred additional expenses in our field service organization related to expanded distribution into new retailer doors, and those additional expenses did not repeat this year.

The administrative and general expenses increased $14 million versus the prior year's third fiscal quarter. The increase was driven by about $6 million of increased operating expenses related to Clintons while the balance was primarily the result of a combination of additional costs related to the proposed going-private transaction together with increased legal expenses.

Let's now shift gears from a review of the income statement to a brief look at our balance sheet and cash flow. Before I review some of the specific accounts, I should mention that the purchase price allocation for Clintons is still preliminary and therefore subject to revisions, as the valuation work in certain analyses are still being completed.

Our accounts receivable decreased about $37 million compared to last year. The decline was primarily the result of the Clintons transaction, and the fact that our wholesale business is -- no longer has accounts receivable due to it from the Clinton Cards Company. In addition, we had stronger collections with certain customers.

Inventories increased by about $50 million compared to the prior year. About $40 million of the inventory increase is due to the acquisition of the Clintons stores, with the remainder in our North American segment.

Accounts payable increased about $87 million compared to the prior year. About 25% of the increase is due to the acquisition of Clinton Cards while the remainder is due primarily to the timing of payments at the end of November. About $50 million of payments occurred during the last week of November. However, our fiscal quarter cutoff this year was November 23. So although we had a large outflow of payments in the last week of November, their impact on outstanding accounts payable will show up in our fourth fiscal quarter, not our fiscal third quarter.

The last item I will address is capital expenditures on our statement of cash flows. This year, we have invested about $87 million to our first 3 quarters compared to about $49 million last year, an increase of $38 million. The increase in capital expenditures is being driven by about $28 million in incremental investment in our systems refresh project and about $8 million of capital on the new Clintons retail business.

So that concludes our prepared comments for today. But before I take questions, let me remind everyone that for our Q&A period, we will focus on the third quarter results, as we prefer not to comment on the balance of the fiscal year with regard to guidance we had given at the beginning of the year. As with our September earnings call, we will not be commenting on the proposed going-private transaction that was announced in September.

Kyle, please open the line for calls.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take our first question with Jeff Stein with Northcoast Research.

Jeffrey S. Stein - Northcoast Research

Question on the performance of Clinton during the quarter. I know you're not going to talk about forward-looking, but you did indicate you expected the operating loss at Clinton for the year to be under $10 million, and it looks like you're around $16.5 million through Q3. So I'm just kind of wondering how Clinton performed relative to plan in the third quarter?

Stephen J. Smith

Clintons is a challenge, Jeff, because the number of doors as well as the Christmas holiday period haven't occurred, but through the end of the third fiscal, they were on track with our internal plan.

Jeffrey S. Stein - Northcoast Research

Okay. Can you talk about the sale of seasonal cards and holiday cards overall through the -- in the third quarter, and perhaps late into the third quarter? And perhaps, give us a little indication in terms of which channels were tracking well and which, perhaps, might be underperforming?

Stephen J. Smith

Well, as you'll see in our pieces in prices section that comes out in our Q in about 1.5 weeks, our seasonal card business is doing okay. The -- we don't generally comment on very specific channels. The trend within seasonal cards this third quarter versus prior third quarter is roughly similar. Some differences, we're seeing increased pull as we've gained more space in the value area and our innovations product is doing relatively well, too.

Jeffrey S. Stein - Northcoast Research

Okay. Can you talk about the performance of Cardstore.com during the third quarter, and how it compared to your expectations, and year-ago?

Stephen J. Smith

Cardstore is within, as you know, our North American Social Expressions group. We generally don't get into great detail within Cardstore. Revenues are still small but growing. They're tracking pretty much to their internal plan.

Jeffrey S. Stein - Northcoast Research

Okay. And wondering if you could talk a little bit about the comment you made with respect to the effect that product mix and product costs had on your gross margin during the third quarter? Anything -- in other words, what were those factors? Was it more lower priced dollar cards? And when you talk about product content costs going up, does that refer to paper prices or are there other factors?

Stephen J. Smith

I'll try to hit all those, Jeff, elements of your question. What we're seeing are additional product attributes, including embellishments, adding some cost to the card -- the card, our cost of goods. We're seeing some inflation from foreign suppliers, especially for hand-finished cards. The demand pull for this product is fairly strong, and so that's encouraging. I think those are the elements you asked for.

Jeffrey S. Stein - Northcoast Research

So in other words, these would be your -- basically, your electronic card, so to speak, your -- the card -- the higher price point cards?

Stephen J. Smith

We're seeing it in a number of our higher price point cards including innovation and our higher value product.

Operator

And we'll take our next question from Carla Casella with JPMorgan.

Paul Simenauer

This is Paul Simenauer, on for Carla Casella. First, I wanted to see if you guys still have any plans to revisit the headquarters build because I know you guys put out a press release that might be delays. I was wondering if you can just talk about that a little bit?

Stephen J. Smith

Sure. As we said in the press release, our Board of Directors believes, Paul, it's advisable to temporarily delay the project in light of the proposed going-private transaction, so our pre-construction activity has definitely slowed. But it's our expectation, as we said in the release, that, that will be a delay, not a permanent stop.

Paul Simenauer

Got it. So do you know like how long the delay will be? Or it is just indefinite or...

Stephen J. Smith

It's indefinite at this point. It's driven in part by the timing of the proposed going-private transaction.

Paul Simenauer

Okay, great. And then next, I was wondering if you can give us some color on how sequentially the holiday season has shaped up.

Stephen J. Smith

We typically don't comment intra-quarter, and what you're asking is for an intra-quarter type of reaction. A significant portion of the Christmas card sales and holiday card sales occur near the very end of the holiday period, so we prefer not to comment on that question.

Operator

[Operator Instructions] And we'll take our next question from Sean O'Malley with Wedge Capital.

Sean O'Malley

A couple questions. First, with respect to Clinton, as I recall, I think when the transaction occurred, there were 400 doors initially affiliated with Clinton. Can you give us an update on where that stands now?

Stephen J. Smith

Sure. There weren't initially 400. There were initially about 735, and our targeted figure for doors was in the neighborhood of 400. We expect that still to be the roughly approximate number of doors that we'll eventually operate. One of the challenges is the knowing that figure and therefore modeling around it, but we expect around 400 stores ultimately in the portfolio.

Sean O'Malley

Okay. And where are you at this point?

Stephen J. Smith

Well, we're a little bit under 400.

Sean O'Malley

Okay, good. And through the first 2 quarters, advertising spending for Cardstore.com led to incremental expense, I believe, of about $9 million year-over-year. About where would we be for incremental on Cardstore.com advertising this year?

Gregory M. Steinberg

Yes. So actually for the quarter, there was no increase versus the prior. Steve mentioned in his prepared remarks that our advertising expense was up about $1 million this particular quarter, but that increase this quarter actually was unrelated to Cardstore.

Sean O'Malley

Is that because we're now lapping the initial ramp-up in support of Cardstore.com from last year?

Gregory M. Steinberg

Yes.

Sean O'Malley

Okay. And then how much expense, not capitalized expense but expense coming through the income statement, would be affiliated with the systems refresh in this quarter?

Stephen J. Smith

So expense of approximately $3.7 million in the quarter.

Sean O'Malley

Okay. And then the $8 million in administrative expenses affiliated with the going-private transaction, can you give us some idea of what those expenses are coming from?

Gregory M. Steinberg

There's a -- Sean, there's a variety of legal expenses and other advisory expenses that are being incurred in this process. I don't think we're prepared to get into the real details of how much where, but those are the types of expenses we're incurring at this point.

Sean O'Malley

So have the independent directors engaged an investment bank?

Stephen J. Smith

Yes. The -- there was a press release -- I'll look up the date while we're speaking -- that acknowledged that the board special committee had engaged both a financial adviser as well as a legal adviser, and there are costs associated with that, that the company is bearing.

Operator

We'll take our next question from Owen Douglas with Gleacher & Company.

Owen Douglas

I have a quick question, just wanted to drill down a little bit into the Clinton Cards business. So I presume that as you guys are examining these stores and figuring out which ones you're going to keep and how you're going to turn this performance around that you hired some outside advisers and that some of those costs are included in the segment earnings for that retail segment, is that correct?

Stephen J. Smith

The bulk of the costs are within the segment, yes.

Owen Douglas

Okay. So would you be able to sort of quantify how much of that negative $11.5 million was attributed to those advisory costs?

Stephen J. Smith

It's small, but do we have it with us, Greg?

Gregory M. Steinberg

I actually don't have the exact number with me for the quarter.

Stephen J. Smith

For the advisory cost --

Gregory M. Steinberg

Yes.

Stephen J. Smith

It would be --

Gregory M. Steinberg

It's a few million dollars probably.

Stephen J. Smith

Yes. A couple of million dollars would be our estimate, Owen.

Owen Douglas

Okay. So about $2 million to $3 million, let's say, and I presume that last quarter was something roughly similar?

Stephen J. Smith

I don't know that off the top of my head. I hate to comment on the open mic.

Owen Douglas

Okay. Okay, no worries, I understand there. I can circle up with you a later date on that. But then I'm just trying to get a better sense of what Clinton Cards' performance could be once you strip out some of those onetime costs. It seems to me as though it's going to be basically negative operating income this quarter, and that's just the status of affairs, because there's a reason why the company ended up in bankruptcy, right?

Stephen J. Smith

So the business had many challenges in its operations. We won't comment about the history of the prior -- predecessor company. Right now, to give you sense of what's being worked on, it included, as we said in our prepared remarks, a re-merchandising of the card assortment, which was critical, and renegotiating leases also critical. But the brand is strong in the U.K., and that's the primary reason that we've taken on the task, and they're performing well through the end of the third quarter versus the plan. One comment that you make is accurate, and that is that there is a significant seasonality to that business. And the seasonality of that business is impacting the overall consolidated group seasonality, and you're seeing that ripple through both the consolidated group as well as the segment analysis.

Owen Douglas

Okay. Are you able to share some -- like a retail-type metric, for example, of same-store sales? I'm understanding that you guys obviously wouldn't really have the same level of data now as you would have had regarding last year's periods. But do you think that you can give us a sense of what's happening with that top line?

Stephen J. Smith

We'd like to, but you hit the nail on the head, which is we do not have good visibility to predecessor company store sales. Their systems were not strong, to be candid, and therefore, we'd rather not comment on same-store sales, not sure ourselves how accurate that metric would be.

Operator

[Operator Instructions] And there are no further questions in the queue at this time.

Gregory M. Steinberg

Thank you, Kyle. That concludes today's conference call. We thank you for joining us this morning.

Operator

This does conclude today's conference call. Thank you, all, for your participation.

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