Consolidated Graphics F3Q09 (Qtr End 12/31/08) Earnings Call Transcript

Consolidated Graphics, Inc. (CGX)

F3Q09 (Qtr End 12/31/08) Earnings Call

February 04, 2009 11:00 AM ET

Executives

Alexandra Tramont - Vice President, Financial Dynamics

Joe R. Davis - Chairman and Chief Executive Officer

Jon Biro - Executive Vice President, Chief Financial and Accounting Officer

Analysts

Jamie Clement - Sidoti and Company

Charles Strauzer - CJS Securities

Presentation

Operator

Good day ladies and gentlemen and welcome to the Consolidated Graphics Third Quarter 2009 Earnings Conference Call. My name is Anita and I will be your operator for today. At this time, all participants are in listen-only mode. We will have a question-and-answer session towards the end of this conference. (Operators Instructions). As a reminder, this conference call is being recorded for replay purposes.

At this time, I would now like to turn the call over to Ms. Alex Tramont of FD. Please proceed ma'am.

Alexandra Tramont

Thank you and good morning. Welcome to the Consolidated Graphics Conference Call. During the call, management will discuss the company's results for the quarter ending December 31, 2008. You may receive a copy of today's press release by calling FD at 212-850-5600, or by visiting Consolidated Graphics' website. This conference is being broadcast live on the Internet at www.cgx.com, and a subsequent archive will be available.

Before we begin, I would like to remind everyone that remarks made by management during the course of this morning's call contains 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, continuing weakness in the economy and reasonable demands for its products, a continued availability of raw materials at affordable prices, retention of its key management and operating personnel, and 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 statements, 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 make reference to 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 previous filings with the Securities and Exchange Commission. A reconciliation of non-GAAP financial measures discussed on today's call is also included in this morning's earnings release available on our website.

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

Joe R. Davis

Thank you and good morning. With me on the call today are Jon Biro, Executive Vice President and Chief Financial Officer. This morning we released results for our December quarter. The results for the quarter includes revenues of $315.8 million, which is a new quarterly record for Consolidated Graphics, up 9% compared to the prior year.

The quarterly growth in sales compared to last year would be due to our recent acquisitions, election-related printing and seasonal digital business. These sales increases were partially offset by decline in our same-store sales, excluding election-related business.

During the third quarter, we started off pretty well in October, demonstrating a very strong election and other business. In fact the majority of our quarterly adjusted operating income was earned in the month of October. November was very weak and December improved due to a strong seasonal digital business. Even without the digital business, however our business did seem to improve slightly and stabilized somewhat in December relative to the prior year. Nevertheless, we are now clearly feeling the effects of the recession.

In particular, a number of our companies are experiencing significant decline in software demand and as a result, their profits are down dramatically. In general, while we are not losing any significant customers, most of our customers are ordering less from us this year than they were last year.

For the nine months ended December 31, 2008, revenues were up 11% to $898 million, compared to $807.9 million in the previous year. Third quarter operating income includes a pre-tax $17 million litigation charge for a judgment rendered against us within the last week. I will discuss this in a detail a little more.

Additionally, we've recognized a pre-tax non-cash $62.5 million goodwill impairment charge during the quarter. Excluding these charges and foreign currency gains, adjusted operating income of 23.6 million or 7.5% of revenue. And adjusted net income for the December quarter was $12.6 million or a $1.11 per diluted share.

For the nine months ended December 31, 2008 excluding the charges and foreign currency gains, adjusted operating income was $64.7 million or 7.2% of revenues. And our adjusted net income was $32.4 million, or $2.84 per diluted share.

Revenues in digital print grew to $53million in the December quarter, representing 17% of our total revenues. Digital print revenues continue to grow increasing over 140% in the quarter, compared to the prior year quarter. Our heavy investment in our digital printing business is still doing pretty well.

During the December quarter, we invested $13.2 million in new digital presses, and $34.9 million during the nine months during the December 2008, representing 62% of our total capital expenditures year-to-date.

We now have four world-class digital print centers in the U.S, located in Medford, Oregon, Memphis, Minneapolis and St. Louis. We also have our first European facility in Prague, which is primarily a digital facility. Furthermore, 63 of our 70 companies have digital print capabilities. We now have actually over 199 high-speed digital presses, we believe the largest fleet in the commercial printing industry.

Another important reason for our record revenue this quarter was the higher than expected election-related business contributing $16.4 million of incremental sales compared to the prior year quarter. These sales exceeded our expectations, and I am pleased of our election-related business results of the cycle.

Acquisition remains a key driver in our solid revenue growth in the December quarter and continue to be an important component of our long-term growth plans. We continue to seeing many acquisition opportunities in these difficult times. Additionally, we are growing our sales force by hiring experienced sales people, in many cases from failed or struggling competitors.

Now, I would like to discuss cost management. It is critical that we adjust cost as our top line comes under pressure. During the quarter, through stringent labor cost management, we have kept our labor metrics in line with the prior year, despite declining sales. We'll continue to monitor labor and other expenses very carefully and I'm confident that our operating company presidents and their management teams will adjust their operating costs appropriately and revenues fluctuate.

As I mentioned earlier, I'm disappointed to report to you that within the last week, the jury awarded a sizeable judgment against Consolidated Graphics. The case was an isolated incident and involved one of our sales people appealing against one of his employer. A pre-tax charge of $17 million has recorded in the December 2008 financials and it consists of the judgment including punitive damages and estimates of other expenses the judge may award.

In addition, the judge might also award additional exemplary and punitive damages and client has requested to $3.2 million between our log books, and we hope they will have to be. If an additional (inaudible) that will be recognized in the future period. The company intends to continue it's defense at the trial court level and if unsuccessful, we plan to appeal the judge as well as pursue potential insurance reimbursement, which by the way has been previously denied.

I will now turn the call over to Jon Biro, our Chief Financial Officer, who will provide you with additional information. Jon?

Jon Biro

Thank you, Joe. As a reminder, early this morning we have filed the form 8-K with the Securities and Exchange Commission, which includes the basis for our use and reconciliations of certain non-GAAP financial measures, including adjusted operating income, adjusted operating margins, adjusted EBITDA, adjusted EBITDA margins, free cash flow, adjusted net income and adjusted diluted earnings per share. Please refer that this filing in the earnings press release for additional information.

Again we announced record revenue for the second consecutive quarter in large part due to this recent acquisitions of PBM Graphics and Cyril-Scott. Acquisitions contributed incremental revenue was $37.1 million in the quarter compared to last year. Revenue growth was also driven by higher election-related business, contributing incremental quarterly revenue of $16.4 million and solid seasonal digital work.

These revenue gains were partially offset by decline in same-store sales excluding the election-related business of $27.3 million during the quarter. Overall same-store-sales declined 9.4% without election-related business and 3.8% with the election business. Our election-related business totaled $20.8 million during the quarter, and $35.2 million during the nine months ended December 31, 2008.

This compares to $4.5 million and $7.3 million respectively for the same period last year. Comparing the calendar year 2008 election cycle to the 2006 cycle, we grew our election business by 70% and this compares to our forecasted growth of 50%.

Gross margins declined to 23.7% from 26% compared to the same quarter last year. The decline was due to relatively lower gross margins generated by the recently acquired businesses. Fortunately, both of these recently acquired businesses improved sequentially generating higher revenues and profits in the December quarter compared to the September quarter.

On a same-store-sales basis excluding the acquisitions, our gross margins declined a 110 basis points over the last year, despite the increase in election-related digital print business, as our traditional offset printing businesses margins were squeezed due to falling volumes and to a lesser extent price pricing pressure. As a result of lower gross margins, gross profits declined 1% year-over-year to $74.8 million.

Selling expenses declined 6% despite the higher sales volumes and declined as a percentage of revenue from 9.6% last year to 8.3% this year, due to the effect of the recent acquisitions that have lower selling expenses as a percentage of revenue and lowers sales commissions due to a change in sales mix.

General and administrative expenses increased $4.5 million or 22% to $25 million for the quarter. $2.2 million of this increase was due to the acquisitions, including a $700,000 increase in non-cash intangible asset amortization. Other G&A increases included a $1.5 billion in non-cash FAS 123R expense and an increase in bad debt expense of $1.2 million compared to the prior year. Rising bad debt is a concern and we are closely monitoring the collectibility of our receivables and credit worthiness of existing and new customers.

As a percentage of revenue, G&A expenses increased from 7.1% last year to 7.9% of revenue in this year's third quarter. The lower gross profit and higher G&A partially offset by lower selling expenses, yielded lower adjusted operating income, excluding charges in foreign currency gains of $23.7 million, a decline of 3.4 million or 13% compared to last year. As a percentage of sales, adjusted operating income was 7.5% in the third quarter, and that compares to 93% last year.

Although down year-over-year, sequentially operating... adjusted operating margin increased in the September quarter to 17.2%. During the December quarter, our operating presidents successfully managed labor costs including headcount, thus reducing their operating expenses as revenues declined.

Adjusted net income was $12.6 million during the quarter, or $1.11 per diluted share and this compares to last year's quarter of $19.2 million or $1.56 per diluted share. Excluding the goodwill impairment and litigation charges, our quarterly effective tax rate was 37% compared to last year's abnormally low 19%.

Charges during the quarter included a $63.5 million pre-tax or $46.1 million after-tax of non-cash goodwill impairment charge, and a 17 million pre-tax or 10.4 million after-tax litigation charge.

On an earnings per share basis, the goodwill impairment charge was $4.06 per diluted share and the litigation charge was $0.92 per diluted share. In simple terms, this goodwill write-down is being driven by the declining of stock price, the weak economic environment in our near-term outlook. In fact, the company looks forwards that goodwill charges delay are all individually profitable and generate reasonable more cash flow.

Despite this fact, the SEC is forcing companies to use the current valuations for purposes of value reporting units; in our case, individual operating companies. And as a result, this exercise yields and required a goodwill charge. At quarter end, we have made good plan to estimate, calculate the charge. In connection, we're preparing our fiscal year ending March 31, 2009 financial statements where you'll find our calculations and perform another round of required impairment status and this may very well result in other non-cash charge.

Free cash flow for December quarter was $23.5 million and was $34.4 million year-to-date. Capital expenditures during the quarter totaled 21.4 million and was $56 million year-to-date. We currently expect 2009 capital expenditures to run between 70 to $75 million. The remaining capital expenditures will primarily included further expansions of our digital print capabilities and equipments to serve the collectable trading card market.

We currently expect fiscal year 2010 capital expenditures to decline to approximately $40 million. At December 31, our debt outstanding was $355.5 million, consisting of $250 million of floating rate bank debt and an interest rate of 2.3% and a $105.3 million of fixed rate, debt-bearing an average interest rate of 5.7%.

Cash-on-hand at the quarter end was $19.5 million, and available credit under our existing credit facilities was $115.8 million. Our former U.S credit facility doesn't expire until October 2011, and as defined in credit agreement, our total debt-to-EBITDA was 2.5 to 1 at the quarter end, less than the required 3.0 to 1.

The required debt-to-EBITDA ratio steps down to 2.75 to 1 on April 1, 2009, and then 2.5 to 1 on October 1, 2009. Currently, we're in compliance with all financial covenants required by our credit agreements. Last, year-to-date, we've paid down $30.2 million in debt as a result of cash flows from operations.

As I stated last quarter, in light of the current economic environment, forecasting our revenues and earnings continues to be increasingly difficult. In the March quarter, we expect revenues of between 255 and $275 million and diluted earnings per share of between $0.35 and $0.55.

Our projections assumed a slow down in digital printing business due to the normal seasonal factors. Lower election-related revenue, lower year-over-year acquisition revenue growth and same-store sales decline of between 12% and 18% due to continuing economic headwind and effective tax rate of approximately 40%.

I will now turn the call back over to Joe.

Joe R. Davis

Thank you, Jon. Operator, we're now available for any questions anyone might have.

Question-and-Answer Session

Operator

Thank you. (Operators Instructions). Your first question comes from the line of Jamie Clement with Sidoti and Company. Please proceed.

Jamie Clement - Sidoti and Company

John, Joe, good morning.

Joe Davis

Morning.

Jon Biro

Morning.

Jamie Clement - Sidoti and Company

Jon, just for clarification purposes. The litigation... the litigation charges that you touched is that excluded from any sort of adjusted EBITDA calculations with respect to your credit agreements?

Jon Biro

We have included that charge in accordance to EBITDA. We're still working through exactly how we're going to handle that in our covenant calculations. But for the sake of conservatism, we've included at this point.

Jamie Clement - Sidoti and Company

Okay. So the 2.5 number that you gave includes I guess from the litigation charge in the current quarter?

Jon Biro

That is correct. With that ....

Jamie Clement - Sidoti and Company

Okay. But that might be something that is subject to further negotiating going forward. Is that right?

Joe Davis

Well I think it's subject to some interpretation of the credit agreements. For purposes in this conference call, we have included that charge against our EBITDA calculation. But in fact, my interpretation of the agreement, it needs some room there and we expect to be diligent with our clients about that.

Jamie Clement - Sidoti and Company

Okay. No that's fair enough and you're still at 2.5 with it. So that's fine. But, still with respect to what you're seeing out there in the industry, I mean it sounds like quarter started well, tough November, and then you saw seasonally what you expected to see in December. I mean are we are seeing more kind of like November sort of trends here in the recently completely in January.

Joe Davis

Well December was not a great... is never really a great month in printing business. Lot of holidays, lot of different things. But December was a pretty decent month for us overall. November was the worst and I think it was just the shock of the financial markets, probably affected November.

January is never a great month for the printing business, neither is February. But I think our January will suffer some we don't know quite to the extent of. We're still perhaps know that it won't be a great month. We'll see some; we've projected a decline in same-store-sales for the quarter in our numbers ranging from 12 to 18%. And that's a pretty strong drop but we potentially could experience that and certainly....

Jamie Clement - Sidoti and Company

Yeah alright, I agree. And Jon the 12 to 18% projection, that's on it when you talk about the same stores, the apples-to-apples basis versus the December quarter is the minus 9.4%. Is that the right apples-to-apples the way you described it?

Joe Davis

That's right. That's exactly right.

Jamie Clement - Sidoti and Company

Okay. Sure last question then I'll get back in the queue. You talked about the ramp up in digital business with a couple of important customers in the second half of calendar 2008. If some of that business going forward kind of always be seasonably stronger in the December quarter, like in other words, what I am wondering is, has the seasonality of your business further tilted towards strength in the December quarter?

Joe Davis

Well we have some election business... I mean some digital business that had a lot of seasonality to it. We have some that doesn't have a quite as much seasonal. Some will be heavy weighted in the March quarter. So our digital business is growing and it's getting broader if you will.

Jamie Clement - Sidoti and Company

Okay.

Joe Davis

More than, we certainly have some account concentration there. But we are developing quite a bit of new customers in that segment.

Jamie Clement - Sidoti and Company

Yes. And I guess...

Joe Davis

And it's really based on our ability to service those customers. We believe that we have a superior model to service customers in the digital than many of our competitors.

Jamie Clement - Sidoti and Company

Okay. Joe let me just sort to clarify my question. What I was sort of getting at was your in increase in digital work in the December quarter was astonishingly high, and what I was...and then as we look at guidance for the March quarter, what I was wondering whether there was... some of this business was something that was that you've added over the last two quarters or so? Whether there was a significant component of that that we would expect to see next December quarter that we wouldn't by nature of it necessarily expect to see in the current March quarter, you know what I mean?

Joe Davis

We would expect the next December quarter to be somewhat similar to the prior quarter, maybe it'll add up 140% but, some significant increase, in the range of 40%, 50%. The March quarter, we would expect the digital printing to be up compared to the prior year, probably in the range of 20, 25%.

Jamie Clement - Sidoti and Company

Okay, okay. No, that absolutely answers the question and I appreciate your time. Thank you very much.

Operator

(Operators Instructions). Your next question comes from the line of Charles Strauzer with CJS Securities. Please proceed.

Charles Strauzer - CJS Securities

Hi, good morning.

Joe Davis

Good morning Charles.

Charles Strauzer - CJS Securities

Couple of questions, if you can help me to try to figure out a normalized margin, that you kind of exclude the higher margin election work. What... it gives us a sense as to what operating margin might have looked like in Q3 obviously excluding the charges. Jon can you help us with that?

Jon Biro

Well we didn't necessarily say our election-related business was necessarily higher margins. What we disclosed is our revenue related to election-related business.

Charles Strauzer - CJS Securities

Got it, I think in the past it had some higher margin volume and probably you talked about that in the past.

Jon Biro

Somewhat but, now it's... some what it's pretty right in the business.

Charles Strauzer - CJS Securities

Got it. And if you look back to kind of the '02, '03 timeframe when you have the deal you are experiencing a lot of down turn in the business, you margins...

Joe Davis

Charles, can you speak a loud more in your phone, we are a problem in hearing you.

Charles Strauzer - CJS Securities

Sure Joe. If you look back to the last down turn kind of the post-9/11 years, margins kind of bottomed and normalized were on the 5% level. Are you expecting to see margins kind of stabilize around those levels there or are you expecting to see a little bit more deterioration in near-term before they start to ramp back up in terms of cost cutting?

Joe Davis

Well I don't know that though. Perhaps the March quarter we are yet prepared to say where our margins would bottom. I think we've done a really good job of managing our cost and also our, we think we're getting growing market share. But it's a worth projecting what the economy is going to be for us in March quarter. I am not really prepared to give that.

Charles Strauzer - CJS Securities

Okay and then just sticking up on the market share comments and obviously, there's a lot of competition still in the printing industry. But we are hearing anecdotally a lot of stories about smaller competitors having a very tough time either finding credit or finding sales to keep their businesses going. Can you talk a little bit more about the competitive environment that you are seeing around you and you're...

Joe Davis

Okay we are experiencing already and you know I would say that printing business hadn't been down two months of November, December maybe three months, three or so. We are experiencing already seeing in the industry a number of plant closings, company closings. Some large companies closing individual locations that didn't have much impact on us. But the competitors down the street do have a big impact on us. A 100-year old company, a major competitor to us in Denver closed a couple of weeks ago and we are a mile away from them. And we are the probably top company in town, no questions. I would we are the top commercial printer in Denver.

So we are going to be expanding our market share there, because we've got less competition and we've hired a number of people from that company. Another major competitor in Phoenix went away and we have hired some people from that company. And we through our acquisitions business are aware of a number of other troubled situations from California to New York, if you will, and in between that are in very severe troubled situations I would not expect not... expect a lot of them to go out of business.

Charles Strauzer - CJS Securities

How does that effect your are thinking on the acquisition pipeline, Joe in terms of your thoughts of being more aggressive here or waiting to make acquisitions?

Joe Davis

We have a number of companies that we are in discussions with. I'd say in these particular economic times, acquisitions are important to us. But we have to be very, very careful what we are buying into. And we were taking some very, very close looks, a lot of due diligence on the things we are looking at.

Charles Strauzer - CJS Securities

Got it. And then Jon, just one quick housekeeping question. I don't think you gave us but can you talk about cash flow in the quarter and what that looks like?

Jon Biro

Yeah, I did mention it. Free cash flow during the quarter was $23.5 million and year-to-date, we have paid down just over $30 million in debt. So cash flow has been good for us, especially in the last quarter.

Charles Strauzer - CJS Securities

And if I heard you correctly, about $20 million of cash and about $116 million on your credit lines in terms of dry powder. Do you have other means or capital access, should some other interesting acquisition opportunities come your away that are larger?

Jon Biro

Yeah, we do. Certainly financing equipment is... there are some opportunities for us there, and I think it would be definitive (ph) acquisitions the money would be there. But I think we are well regarded by our bank group, or at least that's what I would expect.

Charles Strauzer - CJS Securities

Okay great. Thanks. I'll get back in queue.

Operator

(Operator Instructions). At this time, there are no additional questions in queue. I would now like to turn the call back over to management for closing remarks.

Joe Davis

Well I appreciate everybody's interest today. We particularly appreciate our customers in these difficult times. Our employees are also working under a lot of stress and strain and I suppose our shareholders as well. And we appreciate all your support that we've been getting in these difficult times. And in addition to that, we look forward to reporting to you in the March quarter at our year-end results. Thanks.

Operator

Ladies and gentlemen, this concludes the presentation. You may now disconnect. Thank you and have a good day.

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