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Consolidated Graphics, Inc. (NYSE:CGX)

Q3 2013 Earnings Conference Call

February 06, 2013 11:00 a.m. ET

Executives

Joe Davis – Chairman & CEO

Jon Biro – EVP & CFO

Analysts

Charlie Strauzer – CJS Securities

Marco Rodriguez – Stonegate Securities

Jamie Clement – Sidoti

Operator

Good day, ladies and gentlemen, and welcome to the Q3, 2013 Consolidated Graphics Earnings Conference Call. My name is Shenae and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of the today’s conference. (Operator instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today Mr. Matt Steinberg of FTI Consulting. Please proceed, sir.

Matt Steinberg

Thank you, and good morning. Welcome to the Consolidated Graphics conference call. During the call, management will discuss the company’s results for the third quarter ended December 31, 2012. You may receive a copy of today’s press release by calling FTI Consulting at 212-850-5600 or by visiting Consolidated Graphics’ website. This conference is being broadcast live over the Internet at www.cgx.com and a subsequent archive will be made available.

Before we begin, I would like to remind everyone that remarks made by management, during the course of this morning’s call, contain forward-looking statements, which involve known and unknown risks, uncertainties or other factors that could cause actual results to differ materially from results, performance or other expectations expressed or implied by these forward-looking statements.

Consolidated Graphics’ expectations regarding future sales and profitability assume among other things, stability of the economy and reasonable growth and the demand for its products, the continued availability of raw materials at affordable prices, retention of its key management and operating personnel, satisfactory labor relations as well as other factors detailed in Consolidated Graphics’ filings with the Securities and Exchange Commission, including the risk factors set forth in our most recently filed Annual Report on Form 10-K, Quarterly Report on Form 10-Q and current report on Form 8-K.

Forward-looking statement assumptions or factors stated or referred to on this conference call are based on information available to Consolidated Graphics as of today. Consolidated Graphics expressly disclaims any duty to provide updates to these forward-looking statements, assumptions or other factors after the date of this call to reflect the occurrence of events, circumstances or changes in expectations.

In addition, during the course of this call, management of the company will reference certain non-GAAP financial performance measures. Management’s opinion regarding the usefulness of such measures, together with the reconciliation of such measures for the most directly comparable GAAP measures for historical periods are included in the company’s 8-K filing today with the Securities and Exchange Commission.

Now with these formalities out of the way, I would like to turn the call over Mr. Joe Davis, Chairman and Chief Executive Officer. Mr. Davis, you may begin.

Joe Davis

Thank you, and good morning. With me on the call today is Jon Biro, Executive Vice President and Chief Financial Officer. Revenues increased 4% to $295.3 million this quarter compared to last year. We achieved this improvement due to growth in digital print which was up 3.6% and election related print sales as well. Election related print sales for the quarter totaled $25.2 million and $37.5 million for the nine months ending December 31, both exceeding our expectations.

Adjusted operating income increased 17.3% to $24.3 million or 8.2% of revenue compared to $20.7 million or 7.3% of revenue in last year’s quarter. Adjusted net income increased 32.4% to $16.9 million versus $12.7 million and adjusted diluted earnings per share increased 43.4% to $1.75 per adjusted diluted share versus a $1.22 last year. The adjusted $1.75 for diluted share is a historical earnings per share record for Consolidated Graphics.

While we are still operating in very challenging times, we remain focused on growing our revenue developing new products and services and improving our technology solution for our customers and this is benefiting certainly our shareholders.

Technological advances have changed the demand for printed materials and printing services. Some printed material such as magazines, long one catalogs, newspaper inserts, books including telephone books and envelopes, among others are clearly in a secular decline. Fortunately, those are not our business. Technology advances have brought opportunities for growth to Consolidated Graphics.

Printed materials and printing services now almost compete with the fact space constantly changing communications, personalized world of internet. Many customers are moving to a print model that requires the capability to produce highly personalized, short run products on demand. They also seek a printer that can meet all their needs and deliver printing materials to the end users quickly and efficiently.

As I said before, Consolidated Graphics is a technology based solutions provider backed by a world-class print manufacturing capabilities. This is why we’ve been investing in these capabilities for years. We have grown to become one of the world’s leading providers of digital print solutions and we have industry-leading sheetfed and web printing capabilities.

The products we produce include packaging, consumer products, personalized compliance materials and marking materials produced across all of our capabilities, which is different from the secular decline business segments I discussed earlier.

Our advanced and integrated digital footprint across the United States, as well as in Prague and Japan, provides our customers the speed and efficiency to distribute then print, the flexibility of print-on-demand and the power of personalization. We now have over 250 high end digital presses on three continents including high speed digital Inkjet Web technology.

We utilize our digital print and technology solutions to serve industries such as financial services, insurance, healthcare, entertainment and custom photo products. As I mentioned earlier, digital print sales grew 3.6% in the quarter due to the additional business from a number of our customers even after decline in sales to some of our custom photo product customers.

Although, we have seen higher digital growth in some prior quarters, silver lining is the fact that these sales are now made up by a more diverse group of customers. We expect growth in customer demand digital print for years to come. We are also seeing growth in demand for large and grand format printed materials and are continuing to invest in equipment technology necessary to meet demands. Example of large and grand format products we produce include retail window clings, vehicle and truck wraps, event signage, bus graphics, bus benches, building wraps and billboards.

Recently, we installed a new press capable of producing high quality display graphics economically at higher speeds compared to conventional technology while accommodating substrates up to 2 inch stick. We also recently placed orders for another two large format presses to accommodate the goals we expect in this part of our business. The cost and time to transport these products to their final destination is a substantial consideration for customers and I repeat not only cost but the time and some of these products are pretty large in size.

The advantage Consolidated Graphics brings to the marketplace is that several of our locations across the country have a capability to produce these products. So we distribute then print, distribute to digital data then print.

We have also utilized technology to dramatically improve our customer print procurement process and we ensure quality including color consistencies across our network of facilities. Sales of large digital grand format print increased 15% this quarter compared to last year. We expect to see increased growth for this product line going forward.

Nine of our strategically located facilities are focused on increasing their share in the speciality packaging market. Speciality packing sales grew by approximately 7% this year. Due to the high cost of shipping practicing products, our customers value our ability to distribute and ship from a number of locations across the country.

Increasingly Consolidated Graphics is a clear choice for large customers seeking a trusted single source provider of printing fulfillment and technology solutions. We take the time to get to our customers, understand their challenges and develop and implement powerful solutions tailored specifically to the way each customer does business. As an example, lot of our clients came to us to improve their print and fulfillment management capabilities.

After gaining a thorough understanding of their needs the Consolidated Graphics team performed a detailed evaluation of existing workflow and develop a single source provider solution that met the clients objectives. Just an example of how we use many of our capabilities planning, production, fulfillment, distribution and technology to implement broad solutions, improved time to market and provide lasting efficiencies to stabilize and reduce cost overtime.

Complementing our broad range of print capabilities, we have continued to expand our WorkSmart Suite technology platform, the most widely used of the WorkSmart Suite solution continues to be streamlined our web to print solution used by over 200 customers representing 330,000 individual B2B users, who have access to 73,000 printed products. Together all of our WorkSmart Suite products deliver significant customer benefits and represent a significant long-term strategic growth opportunities for Consolidated Graphics.

I am pleased to say that our customers like to see the value of our WorkSmart Suite products. One of the key ways we demonstrate our large proportion to our customers is through our Annual emerge conference, which will be held April 30 to May 3rd. We’re bringing together 1,000 of our best customers and prospects as well as our sale representatives to share insights and ideas from around the industry. Emerge includes keynote presentation from industry top leaders, breakout sessions on topics ranging from marketing to technology to print production. Emerge allows us to demonstrate the passion we have for print and technology while providing our customers and prospects with thought provoking ideas and information design to inspire and motive the best possible business performance. We are positioned as a leader in our industry and we look forward to delivering high value print and technology solutions now and into the future.

I will now turn the call over to Jon Biro, Executive Vice President and Chief Financial Officer, Jon?

Jon Biro

Thank you. Good morning, everyone. Sales increased 4% in the December quarter and were $295.3 million, compared to $283.9 million for the same – from digital print growth of 3.6% driven by many customers and higher election related sales, partially offset by lower sales to a handful of customers, including lowers sales into the custom photo products market.

Also during the quarter, we decided to pass on one project due to an uneconomical price point. Digital sales incidentally were 22% of total sales for the quarter and 19% of total sales for the nine months ended December 31. For the 12 months ended December 31, digital print sales were a $194.4 million.

Gross profit increased $4.7 million or 7% to $72.6 million this quarter and gross profit margin improved to 24.6% this quarter compared to 23.9% last year. The increase in gross profit margin was primarily due to lower labor expenses and lower facilities expenses as a result of better leveraging our costs due to the higher sales levels, as well as our cost reduction efforts, including re-locating certain facilities and renegotiating some of our real estate lease rates. These benefits were partially offset by higher subcontracting expenses net of the raw material costs and lower waste paper recycling income.

Selling expenses increased $800,000 to $23.9 million this quarter due to higher compensation expense resulting from the higher sales and declined slightly to 8.1% of sales this quarter compared to 8.2% last year.

General and administrative expenses totaled $24.6 million or 8.3% of sales for the December quarter, down slightly compared to $24.8 million or 8.8% of sales last year. General and administrative expenses declining as a percentage of revenue again demonstrate the benefit of leveraging our cost with higher sales.

Adjusted operating income increased $3.6 million or 17.3% to $24.3 million in this quarter, compared to $20.7 million last year. Adjusted operating margin was 8.2% this year, compared to 7.3% last year. Adjusted net income increased $1.4 million or 32.4% to $16.9 million for the quarter, compared to $12.7 million last year. Diluted earnings per share increased $0.53 a share or 43.4% to $1.75 per diluted share, compared to $1.22 last year. And as Mr. Davis pointed out, the $1.75 per diluted share is a record earnings per share for the company.

Adjusted EBITDA for the December quarter was $42.7 million, an increase of 9.2% compared to last year. On a GAAP basis, we had operating income of $23.3 million this quarter versus last year’s result of $17.6 million. Net income for the quarter was $16.3 million or $1.68 per share, compared to $10.8 million or $1.04 per share last year.

Net capital expenditures were $3.2 million in the quarter and we now expect the capital expenditures for the full fiscal year will be between $40 million and $45 million. At December 31, our total debt net of cash was $143.7 million and we had $219 million of available credit under committed credit facilities. Last, free cash flow during the December quarter was $16.8 million and was $32.1 million for the nine-month period. And I would point out to you that on a per share basis, these are very significant cash flow numbers.

In closing, I’d like to comment on our outlook and while it is very difficult to predict, we are optimistic that the U.S. economy is picking up in the March quarter. If this turns out to be the case, we are comfortable that March 2013 quarterly revenues will be higher than for the same quarter of the prior year.

And with that, I’ll turn it back over to you, Joe.

Joe Davis

Thank you, Jon. We’re at a unique position within the printing industry and I believe our performance this quarter clearly demonstrates this. We’re investing in areas with profitable growth opportunities, including digital print, specialty packaging, large format as well as technology solutions to name a few. I remain confident in the success of our long-term strategy.

Operator, we’re now available for the questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Charlie Strauzer with CJS Securities. Please proceed.

Charlie Strauzer – CJS Securities

Hi, good morning.

Joe Davis

Good morning, Charlie.

Charlie Strauzer – CJS Securities

Joe, Jon, if you could talk a little bit more on the digital side and the photo business, you mentioned there was a slight decline there in some of the work you’re doing with one of your customers. Can you expand a little bit more on your kind of..

Joe Davis

Certainly…

Charlie Strauzer – CJS Securities

The dynamic guarantee?

Joe Davis

I’ll say we had a decline with some customers and somewhat larger customers. But we also have diversified that customer base, which is a real plus to us and we’ve seen an overall increase in the digital business because of that.

Charlie Strauzer – CJS Securities

Excellent. And then what was the same-store growth excluding election in the quarter? I don’t know if you gave that out, and if you did, I missed it, I apologize.

Joe Davis

Well. I’ve not – we never disclose that metric out because one of the things you see is some of our facilities were tied up with election business and couldn’t do anything else. So, the number if you exclude election is 3.7 for sure, but I don’t really think it reflects 3.7 because we were tied up with those facilities and couldn’t work on anything.

Jon Biro

3.7%.

Charlie Strauzer – CJS Securities

For the digital you mean I’m sorry, or for same-store?

Jon Biro

No, no. For same-store sales excluding election.

Charlie Strauzer – CJS Securities

Got it, okay, great. And then lastly when you look at the kind of going into next year, especially with some of the changes from the postal service, now saying that the Saturday delivery is going to be eliminated. Are you seeing – have you talked to any customers about this, this has been talked about for a while. Have you talked to your customers about the potential impact on the direct mail business at all and what they’re trying to do?

Joe Davis

Well, we certainly have some direct mail business. But yes, I’d always think personally that whether it’s delivered on Saturday or Friday or Monday isn’t going to make much difference quite frankly.

Charlie Strauzer – CJS Securities

Okay, great. Thank you very much.

Operator

Your next question comes from the line of Marco Rodriguez with Stonegate Securities. Please proceed.

Marco Rodriguez – Stonegate Securities

Good morning, guys. Thank you for taking my questions.

Joe Davis

Hi Marco.

Marco Rodriguez – Stonegate Securities

In the last quarter you guys discussed a little bit of some self-inflicted issues that affected revenues from a few large customers. Did you see any of those customers come back in this quarter?

Joe Davis

We’ve had some slight return but that’s still to come, but we did have some self-inflicted issues in the negative same-store sales if you’ll exclude election which I don’t like but if you do that, a lot of that decline is from self-inflicted issues and not broad decline in our markets. I had to admit that but the fact lies.

Marco Rodriguez – Stonegate Securities

Got it, appreciate that. And then in terms of the election revenues, it definitely sounds like you had a really strong quarter. Did I get the number correctly, the $25.2 million for the quarter?

Jon Biro

$25 – yes, yes, it was.

Marco Rodriguez – Stonegate Securities

Okay, perfect. And then given obviously that the election, the big election has kind of passed this year now, how should we be thinking about that going forward as far as revenue contribution on an annualized basis?

Jon Biro

Well, we always have some election business. We do ballots as well as political persuasion material. So, it certainly won’t be like but

Joe Davis

Yeah, as a guide, Marco, in fiscal year 2012 we did $8.1 million in election related business in a non-election year.

Marco Rodriguez – Stonegate Securities

Got it. Perfect. And then on CapEx in Q3, if you saw that correctly you guys spent around $4 million or so. I think that’s the lowest spending that you’ve had here since the summer 2009. Are you perhaps with all the heavy investments that you’ve made over the last couple of years, do you feel as if maybe you can slow that down a little bit further, or can you provide some color there?

Jon Biro

We have an intention to slowdown CapEx investments, want to make that clear. So you’re both ready to talk into these things and that calls your CapEx to be low. We have not done that. We’ve invested in all of CapEx that makes economic sense. So you can draw your own conclusion if you are not careful. And I’ve heard some investors ask that question. We have not slowdown our CapEx investments as needed but we made a lot of infrastructure CapEx particularly in technology as well as digital. So we are not going to be required to make as much as that going forward.

Joe Davis

And for the year I said, we will spend between $40 million and $45 million we expect. So still a fairly healthy amount of investment in the biz.

Jon Biro

And you know, next year from what I know at the moment, I would say that it could be less than that next year.

Marco Rodriguez – Stonegate Securities

Got it. That’s very helpful. And then last quick question I have, perhaps you can give a little bit of update here on the competitive landscape, but just kind of what you’re seeing out there in terms of pricing and other type of service offerings? Thank you.

Joe Davis

The printing business has always been competitive. I go back in ways, it was competitive when we were making 14% operating income. If you listen to sales people, this price is always not right. But if you provide a better service and a better product price is not the only consideration. So, I am pleased to say that we have a number of products that we offer and the service level we offer is very difficult for a lot of folks to meet our geographic footprint, nobody can meet that in our piece of the business. We have 70 locations. Nobody has 70 locations in the general commercial printing business in the areas we compete in.

So that gives us a real competitive advantage. Nobody has the digital capacity we have and you combine the digital capacity with the geography Japan, Prague and several places in the U.S. that’s a powerful thing. So I don’t know that price is always the consideration. I mean I went to a nice restaurant last night to know what, I didn’t go there because I thought it was $2 cheaper, and I think we have a lot of that in the printing business.

Marco Rodriguez – Stonegate Securities

Got it. Thanks a lot guys.

Operator

(Operator Instructions) Another question from the line of he line of Jamie Clement with Sidoti. Please proceed.

Jamie Clement – Sidoti

Joe, Jon, good morning.

Joe Davis

Good morning.

Jamie Clement – Sidoti

Joe, in the beginning of your remarks you talked about some other printed product lines that you don’t have really much exposure to at all. Are you all starting to see any and I know you have some web presses but traditional web work, I mean have the runs got into the point in some of these areas among some of your customers where you they’ve either gone digital of they’ve gone half lever, they’ve gone sheetfed, have you noticed any of that migration or is that still yet to come?

Joe Davis

Well, I think we certainly seen shorter runs in the web business as well as the sheetfed business. So, there are many way in presses now that are very economical at lower job in sizes, lower run sizes. So, we certainly have some and it will be a certain market. But our market is not the long, long run, even the web presses that we have, we have number of web presses, they are not the long, long, long run web jobs that some people are involved in. We’re still a service company supported by manufacturing even in our web jobs. I mean our customers, if they’re really long run manufacturing plants people have a slot. You have to have your data there on the fifth working day of the month, so they’ll do whatever they’ll cheat or something. Our customers are not that rigid, we’re not that rigid with our customers let’s say. So, if they have a change, we try to accommodate that. So, it’s just a different market.

Jamie Clement – Sidoti

And I – sort of follow-up question to that, Joe, I before this quarter started or when the September quarter earnings season was going on, I think most of the other public companies that are out there. Even if you look at paper shipments during the quarter, it certainly would imply print declines that were a lot greater than what you all saw.

Connecting that, is there any way of connecting that with what sounded like a pretty optimistic outlook for the March quarter because I don’t expect necessarily here a lot of other companies talking up the advertising and marketing environment just yet. So, what are you seeing and hearing from your customers that causes you to be reasonably optimistic about?

Jon Biro

I think we are in a different marketplace, a different business than some of the larger public companies in the printing industry. I mean some companies as I understand I mean I think is pretty well acknowledged that there is a secular decline in really long run printing and magazines, catalogues, newspaper inserts, envelopes, books including public telephone book, so that’s not our business.

Our average sheetfed job is a probably $3,000 or $4,000 project and we serve into some million dollar projects. But we do a lot of smaller projects and digital some are one-off. So, we have a lot of things that other people are producing in the short run. Market materials, collectible cards, photo books, personalized insurance compliance documents and even our specialty packaging business is not long run specialty packaging, we’re not doing Kellogg’s cereal boxes, that’s not our business. We’re doing more short run specialty packaging for our customers and I will also say where service is a big element.

Jamie Clement – Sidoti

And Joe

Joe Davis

Does that answer your question, Jamie?

Jamie Clement – Sidoti

It does and I appreciate. And the last question I had is just, as you look back at the quarter did the fiscal cliff and all the bad headlines and all the bad news reports on the Nightly News every night, did that impact a portion of your customers? I mean did some customers say to you, heck, we’re just not going to market and advertise into this kind of environment, there’s too much uncertainty? Or was your customer base a lot more resilient than you might have thought?

Jon Biro

I would say that – I believe it is sort of hard, you get a lot of anecdotal evidence but I think our customer base is somewhat optimistic.

Jamie Clement – Sidoti

Okay.

Jon Biro

From what I see.

Jamie Clement – Sidoti

Okay. Very good. Thank you all very much for your time as always.

Jon Biro

Thanks.

Joe Davis

Sure.

Operator

At this time, there are no additional questions. I would now like to turn the call over to management for closing remarks.

Joe Davis

Well, I was certainly pleased to report in this challenging environment the record earnings per share with almost $0.75 for the quarter. I am very, very pleased with that. And I thank all of our customers and employees for all they do to assist Consolidated Graphics and servicing our customers and making it a different company than a lot of others out there. So and I also thank you for your time today.

Operator

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

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