American Greetings Management Discusses 2013 Results - Earnings Call Transcript

| About: American Greetings (AM-OLD)

American Greetings (NYSE:AM-OLD)

2013 Earnings Call

May 09, 2013 9:30 am ET

Executives

Gregory M. Steinberg - Director of Investor Relations and Treasurer

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

Analysts

Michael Schechter

Adam Cohn

Kevin Ziets

Operator

Good day, and welcome to the American Greetings Corporation Fiscal 2013 Results Conference 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.

Gregory M. Steinberg

Thank you. Good morning, everyone, and welcome to our fiscal year end 2013 conference call. I'm Greg Steinberg, the company's Treasurer. Joining me today in the conference call are Steve Smith, our CFO; Chris Haffke, our General Counsel; Bob Tyler, our Chief Accounting Officer; and Gui de Mello, our Assistant Treasurer.

We filed our Form 10-K for fiscal year 2013 this morning. If you do not yet have our 10-K filing, 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. We do not plan to update any forward-looking statements.

If you'd like more information on the risks involved in our forward-looking statements, please see our SEC filings. Previous earnings releases, as well as our 10-Qs, 10-Ks and annual reports, 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 of 2012 and the merger agreement announced at the beginning of April 2013, today's conference call will have a format similar to the last 2 quarters' conference calls. Our CFO, Steve Smith will offer some prepared remarks, which will be followed by a question-and-answer session. We will be limiting our prepared remarks to historical results. We're not addressing fiscal 2014 guidance. We will not be discussing the proposed Going Private transaction. We will also not be entertaining any questions or commentary regarding future performance or the Going Private transaction during the question-and-answer session. For information on the proposed transaction, please see our SEC filings made on April 1 and April 17 of this year.

We will now proceed with comments from Steve, followed by a question-and-answer session. Steve?

Stephen J. Smith

Thanks, Greg. In light of the filing by 10-K this morning, we will focus our comments solely on the full year results and the many items that have impacted our performance during fiscal year 2013. Also, I will be focusing on the main items of variance between fiscal years 2013 and 2012 and will encourage the listeners to refer to the 10-K for further details.

I have 4 components to my prepared remarks. I will start with comments on how the Clintons transaction impacted our financial results, then share our consolidated results for the year, then review our business segments. And finally, I will touch on a few additional key components within our financial statements. We will then open the line for questions.

As discussed in the previous quarters, the acquisition of certain assets of Clinton Cards has significantly impacted our financial results. 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 brand Clinton Cards.

Since that time, we've been making significant changes to improve the business. Our strategy to improve the Clinton operations has included reevaluating the overall product offering within the stores, remodeling some of those stores, re-merchandising the card assortment, aggressively renegotiating leases, installing a new computer system and reducing overhead costs. We are well on the road to a productive turnaround, and we are pleased with the results we saw this past fiscal year. Let me briefly summarize how Clintons impacted our financial statements, both at a consolidated level, as well as at the segment level.

During the fiscal year, we recognized the net increase in revenue of about $188 million. This net increase to revenue was comprised of both the Retail Operations segment revenue of $244 million, less the eliminations associated with intersegment revenue of $56 million, which represented sales from our U.K. wholesale business to our Retail Operations segment.

During the fiscal year, the overall effect from Clintons was a drag to consolidated earnings of approximately $32 million. This $32 million drag includes about $43 million of transaction and integration costs and about $3 million of intersegment items, partially offset by the earnings benefit from the Clintons operations of approximately $14 million.

Let me briefly explain the figures behind Clinton's operating performance and then the transaction and integration costs. The Clinton operations are reported in our new segment called Retail Operations, and that business segment reported earnings of about $7 million for the fiscal year just ended. Included within that segment's results were about $7 million of costs associated with the integration of the new business. Holding aside the integration costs, the Clinton operations contributed about $14 million of incremental earnings to fiscal 2013. We'll have you note that we did not own Clintons for the full fiscal year, but rather only 8 months. Historically, the business lost money during the first few months of its fiscal year.

Continuing with the cost associated with Clintons, in addition to the $7 million of integration costs within the Retail Operations segment I just mentioned, we also recognized about $17 million of bad debt expense and a $4 million impairment of a deferred asset related to our supply agreement. These 2 impairments, along with the approximately $3 million of intersegment eliminations that decreased consolidated net earnings, were captured within our International Social Expression segment.

Lastly, within the unallocated segment, Clintons created a $15 million drag on earnings, as we reported about $7 million of transaction cost and approximately an $8 million impairment of a senior secured debt.

Also please note that the impairment of the senior secured debt owed to us by Clinton Cards was previously reported below the operating income line under Other Non-operating Expense and now has been more appropriately classified as part of operating income under Other Operating Expense.

Switching gears from a review of some of the ways Clintons has impacted our results to a review the consolidated performance. Let me start with our revenues. Our fiscal 2013 consolidated revenue of $1.869 billion increased about $174 million from last year's revenue of $1.695 billion. Foreign exchange was unfavorable compared to the prior year by about $4 million. In addition, scan-based trading unfavorably impacted revenue by about $2 million compared to the prior year.

So holding aside the impacts from both FX and SBT, revenue increased about $180 million or just over 11%. The revenue increase of $180 million was solely driven by the acquisition of Clinton Cards, which contributed net incremental revenue of about $188 million to the fiscal year.

Holding aside the impact of foreign exchange, scan-based trading and Clintons, our consolidated revenue was essentially flat as it was down about $8 million or less than 1%. The slight revenue decrease was driven primarily by some softness in both our international and nonreportable segments, but their softness was partially offset by an increase in our North American segment's revenues.

Switching from revenue to earnings. Our operating income of $94 million in fiscal 2013 is down meaningfully, compared to the $150 million of operating income in the prior year.

Before I compare the year-over-year performance, let me remind you there were a handful of major items that impacted our operating performance last fiscal year.

Last year's operating income was negatively impacted by a $27 million goodwill impairment. Scan-based trading conversions also reduced our operating income by about $7 million. Partially offsetting these reductions to our prior period operating income was a gain of about $4.5 million associated with the sale of certain characters from our intellectual property portfolio. So holding aside these items, operating income for fiscal 2012 was approximately $179 million.

This year's operating income of $94 million was also impacted by a number of factors that I will now summarize. As previously mentioned, we had approximately $43 million of transaction and integration costs associated with Clintons. In addition, during the year, we had roughly $99 million of additional expenses, primarily associated with the settlement of a lawsuit. Third, operating income was negatively impacted by about $8 million related to scan-based trading conversions. Fourth, we incurred about $7 million of cost associated with the proposed Going Private transaction.

Holding aside these 4 items, operating income during fiscal 2013 was approximately $161 million, which is down about $19 million, compared to the prior fiscal year, also adjusted for several factors. Clintons' net operational benefit to our earnings was approximately $11 million net, which includes the $7 million of segment earnings, the fact that those earnings absorbed $7 million of integration costs and then offset by about $3 million related to intersegment items. In addition, FX negatively impacted operating income by about $2 million.

So holding aside Clintons, FX and the items for both fiscal years that I just described, operating income was down about $27 million year-on-year. This decrease is best explained at our segment level.

I'll now review our segment results and how they differ from the prior year. Our North American segment's revenues of $1.245 billion were up about $17 million compared to the prior year. The increase was driven primarily by higher sales in seasonal greeting cards. Our North American segment earnings of $160 million were up about $10 million versus the prior year. Note that during the prior year, this segment recognized a goodwill impairment charge of approximately $21 million that did not repeat in 2013. Without that goodwill impairment, the segment earnings are down about $11 million year-on-year.

The primary drivers of this decreased performance were higher marketing and product management expenses of $10 million. In addition, we had increased product-related costs, higher in-store product display costs, additional costs related to our systems refresh project and increased scrap. Mostly offsetting these increases were lower field service and merchandiser cost and lower bad debt expense.

Within our International segment, revenues, before the impact of intersegment items, were about $332 million, a decrease of about $16 million versus the prior year. FX adversely impacted revenues by about $3 million. Revenues were also negatively impacted by the $4 million impairment of the deferred asset related to Clintons. Most of the remaining decrease was due to lower sales, gift packaging and other ancillary products.

Within the International segment, we had a loss of about $11 million before the impact of intersegment items. This loss compares to earnings of about $20 million during the previous year, a reduction in earnings of about $31 million year-on-year.

During the prior year, this segment recognized a goodwill impairment charge of approximately $6 million that did not repeat in 2013.

During fiscal 2013, we incurred charges related to Clintons that included approximately $17 million of bad debt expense and an impairment of a deferred asset of approximately $4 million. The remaining decrease of approximately $16 million was primarily driven by a combination of lower sales volume, unfavorable mix and higher scrap.

Our AG Interactive segment's revenues of $64 million were down about $4 million versus the prior year, driven by lower advertising revenues. Segment earnings were up $2.5 million from $14 million in the prior year to $16.5 million this year. The increase of $2.5 million was driven by decreased cost in several areas, including our sales administration, product management and marketing.

Let me shift from the segment analysis to briefly comment on the status of our licensing business. Licensing revenue for the year, which is reported on our income statement as other revenue, was about $25 million, which is down almost $7 million, compared to the prior year. Licensing expenses were about $19 million, which is down about $8 million, compared to last year. So during fiscal 2013, the company's net licensing effort or revenue less expense was about $1 million higher than the prior year.

Let me now move to the fourth and final part of my comments today: a review of several more of the key components of our financial statements. The company's manufacturing labor and other production costs were up about $76 million, compared to last year. Almost 60% of the increase is directly related to Clintons. The remainder of the increase was primarily attributable to a combination of higher product content cost and an unfavorable change in sales mix, both domestically and internationally.

Our selling, distribution and marketing expenses increased by about $120 million versus the prior year. The increase was driven by the additional expenses within our new Retail Operations segment as a result of the acquisition of Clintons. The administrative and general expenses increased $48 million versus the prior year. Over 80% of that increase was driven by Clintons-related items such as the bad debt expense, transaction cost and the addition of the Retail Operations segment. The balance was primarily the result of additional cost for the proposed Going Private transaction, together with increased legal expenses, partially offset by lower bad debt expense in North America and lower employee-related cost throughout our organization.

Let's now shift gears from a review of several items on the income statement to take a brief look at a few items on the balance sheet and statement of cash flows. 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 evaluation work and other analysis is yet to be completed.

Accounts receivable decreased about $8 million, compared to last year. The decline was primarily the result of the Clintons transaction and the fact that our wholesale business no longer has accounts receivable from the Clinton Cards company.

Inventories increased by about $34 million compared to the prior year. About $31 million of the inventory increase is due to the acquisition of the Clinton stores.

Accounts payable increased about $34 million, compared to the prior year. About 40% of that increase is due to the acquisition of Clinton Cards. 10% is due to legal costs, partially related to the Going Private transaction, while the remainder is due primarily to slight differences in timing of payments at the end of February in each of the last 2 years.

The last item I will address is capital expenditures on our statement of cash flows. In fiscal 2013, we invested about $114 million compared to about $78 million in the prior year, an increase of $36 million. The increase in capital expenditures was driven by about a $31 million incremental investment in our systems refresh project and about $11 million of capital for the new Clintons retail business.

So that concludes our prepared comments for today. Before we take questions, let me remind everyone that as stated at the beginning of the call, in light of the proposed Going Private transaction, we will not be entertaining any questions or commentary regarding future performance or the Going Private transaction during the question-and-answer session. For information on the proposed transaction, please see our SEC filings made both on April 1 and April 17. Camille, please open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take our first question from Michael Schechter with Mentor.

Michael Schechter

It's Michael Schechter with Towerview. Two questions for you guys. The office, the new world headquarters move, what did you spend in the quarter and the year and how much is running through the income statement versus the CapEx line? And the same with the systems refresh, what was the gross amount for the year and how much is through the income statement on the balance sheet?

Stephen J. Smith

Sure. Okay. As it relates to the systems refresh project in the quarter, we spent a capital of about $11 million and had expense of about $1 million for a total spend of about $12 million in the quarter. For the world headquarters, world headquarters, the capital was about $1 million, and the expense was just under $2 million for a total of just under $3 million total spend.

Michael Schechter

And how much for the year?

Stephen J. Smith

For the year, on the systems refresh, we spent $49 million, almost $50 million on capital and about $9 million on expense, a total of $59 million. Would you like the same for the world headquarters?

Michael Schechter

Please.

Stephen J. Smith

Sure. For the world headquarter's capital, about $8 million. And world headquarter's expense, a shade over $4 million for total of just about $12 million.

Michael Schechter

And how far along are we through the systems refresh and what do you think you have left to spend?

Stephen J. Smith

Well, as you know, it's a multi-phase project. We have Phase 1 going on now. They're working hard on Phase 1, and we expect that to be implemented during this fiscal year '14. The timing and sizes of Phases 2 and 3 will be dependent on the blueprint for those phases. And so, because we don't know those blueprints yet, it's premature to comment as to the cost or timing of those phases.

Michael Schechter

How much is left to spend for Phase 1?

Stephen J. Smith

We haven't commented publicly on that, so I'm not sure that I could give you that specific figure.

Michael Schechter

Okay. And world headquarters, the plan is still to build this operation?

Stephen J. Smith

Well, as you know, the company through its Board of Directors delayed the project in light of the proposed Going Private transaction, and we believe that, that is delayed until at least the closure of that transaction, if not further.

Michael Schechter

If not further, meaning the plan...

Stephen J. Smith

Meaning, we don't know what will happen post closing. There are a lot of things that will be examined.

Michael Schechter

Okay. And if there's no closing, if that transaction does not occur, will you continue to build it out or still reevaluate it?

Stephen J. Smith

Well, it wouldn't be management's call on that. We would go to the Board of Directors and revisit with them pros and cons of that activity and seek their advice and decision.

Michael Schechter

Okay. And just getting back to the systems refresh, if I remember, we were talking about a $150 million number. What has been spent year-to-date and is there any thought about whether you outsource Phase 2 and 3?

Stephen J. Smith

So what's been spent year-to-date is the full year and that was the $59 million I mentioned a few minutes ago.

Michael Schechter

What did you spend so far, I mean, in the last 3 or 4 years doing this?

Stephen J. Smith

I misunderstood. So over the last couple of years, we spent $83 million, $84 million.

Michael Schechter

Including this year?

Stephen J. Smith

Including this year, yes.

Michael Schechter

And is there any thought about whether you outsource Phase 2 and 3?

Stephen J. Smith

I don't know enough about whether that's possible, Michael. We're examining all the ways to make it an efficient project, but I don't know whether that's feasible.

Operator

And we'll take our next question from Adam Cohn with Chesapeake Partners.

Adam Cohn

I had a quick question on Cardstore.com. And you guys have spent probably around $40 million or so over the last few years. And I just wanted to get an update on where you stand from a profitability and revenue perspective.

Stephen J. Smith

Well, first of all, Adam, as you know, we have that business activity as part of our NASEG [ph] segment, our North American segment. And we tend not to get into too many details within segments because it comes a slippery slope. But what we can tell you is that in the fourth quarter, the revenue and EBIT both improved over the prior quarter, and so we're pleased by that.

Adam Cohn

And one other question. On Clinton Cards, recently there was an interview with the CEO from Clinton Cards, who talked about refurbished stores sales are up 10% to 15% and profitable. Can you just give me kind of an update on where you stand for Clinton as well?

Stephen J. Smith

Well, Clinton Cards has a couple of challenges going on as we speak. It's in the middle of a turnaround, as it was noted in those articles. The second factor is a number of stores aren't yet stabilized, meaning, we're still working through the rent negotiations with a number of landlords. And third, due to the seasonality of the business, it's hard to really predict accurately with the turnaround how they'll perform intra-year. So given those factors, we would tell you that we're pleased with the fourth quarter, but one quarter does not a trend line make.

Operator

[Operator Instructions] And we'll take our next question from Kevin Ziets with PrinceRidge.

Kevin Ziets

I guess my first question is, it looked like there was -- in maybe in the fourth quarter, we don't have the detail -- but a pickup in pricing on the seasonal business. Can you talk about your pricing strategies?

Stephen J. Smith

Well, we don't talk about strategies. We can talk about results, so let me comment on that, Kevin. First, as you imagine, our pricing is determined by customer pull. And we have seen over the last year that our pricing strategies, in particular with regard to our Papyrus brand and our innovative products are winning in the marketplace. And you see that in that pieces and prices table in the 10-K, where the company was up about a little over 1%, 1.3%, and about 75% of that improvement is price. And as you reflect correctly, it was driven by the seasonal business recently.

Kevin Ziets

Is that mix shift in the business as well that's driving that? Or maybe I should say anniversarying against dollar store rollouts from prior years?

Stephen J. Smith

There is mix shift occurring the business in its complete financial statement, meaning both at revenues and COGS. The effect of price in this particular snapshot is not quite as reflective of the value channel as you would think it might be. This is more of the higher-end product being pulled through, good demand, and we're frankly pleased with it.

Kevin Ziets

Okay. And am I correct in saying that, that sort of accelerated towards the end of the year, in the fiscal year?

Stephen J. Smith

Let me see here. Hold on. Let me look at something. I would say that that's accurate. And looking at the 4 quarters, pricing did accelerate marginally over the course of the year.

Kevin Ziets

Okay, great. In terms of Clinton and the retail strategy, I guess can you comment from a longer-term perspective of what kind of hurdles you're looking for before and whether you want to hold the asset from a long-term perspective? Or is it more kind of a fix and then sell and dispose of the asset and keep a long-term contract like you've done in the past?

Stephen J. Smith

Well, Kevin, unfortunately, we're not going to be commenting about the future and so I can't answer your question.

Kevin Ziets

Okay. I thought I'd give it a shot. Can you comment about I guess why the -- if sort of investing in the new headquarters is the right strategy, why the Go Private sort of changes that whether or not you go forward with that?

Stephen J. Smith

Those are 2 separate questions. As we've outlined in our filings, we've talked about the net incremental cost of the move being in the neighborhood of $35 million, net of the different incentives we received from the state of Ohio and the area we're moving into. And when you look at that, relative to the other options we have both in this building and elsewhere, it seems to be a prudent thing to do over the longer term. As to whether or not it occurs, it's driven by decisions made at the board level and that in part is driven by what happens with the Going Private transaction.

Kevin Ziets

Okay. Does the net cost that you mentioned, does that include potential proceeds from selling the building you're in?

Stephen J. Smith

Yes, net of taxes.

Kevin Ziets

Net of taxes as well.

Stephen J. Smith

Yes.

Kevin Ziets

Okay. And the it seemed like the other -- I guess the -- sorry, the $8 million charge for impairment of debt, that seemed down in the quarter from the 9-month number. I'm just curious why that would be. I think it was a $10 million number in the 3Q 10-Q.

Stephen J. Smith

Yes, very good. You're correct. There was a lift in operating income due primarily to that senior secured debt calculation. And what happened is we get an update from the administrator. And when they update that, we update our books and records.

Kevin Ziets

Okay. So I guess why would it have gone down?

Stephen J. Smith

It didn't -- the impairment went down because the view of the administrator as far as the collection of the assets from the estate improved slightly over the quarter.

Kevin Ziets

Okay, got you. And then can you say what consolidated cash flow was for 2012 under the indenture, under the bond indenture?

Stephen J. Smith

Kevin, I think I can tell you we are certainly in compliance with the covenants. We prefer not to get into any type of non-GAAP numbers. As you know, the senior notes are filed, and you're free to review the indenture in the company's publicly filed information to calculate that.

Kevin Ziets

Okay. I'll try one question somewhat specific, and if you can't answer it, then so be it. Is bad debt expense, or just specifically the Clinton bad debt expense, is that considered not [ph] back to that calculation?

Stephen J. Smith

I'd rather not comment to that specifically at this point in time.

Kevin Ziets

Okay. And then lastly, can you say where cash balance is today or most recently?

Stephen J. Smith

How about as of the end of fiscal year? We prefer not to comment intra-quarter. And so, as you can see on the financials, our cash balance at the end of the year was approximately $86 million.

Kevin Ziets

Okay. I'm sorry. I think I said that was my last one. Just one more. With regard to the seasonality of Clintons, would you expect there to be a larger intersegment impact on the first quarter results?

Stephen J. Smith

So we can't speak to the future performance of the company. We will tell you that intersegment items did move meaningfully during the course of the fiscal year, and that's all we can comment to.

Kevin Ziets

Okay. Can you say what sales were to Clintons in last year's first quarter?

Stephen J. Smith

We won't do that. And just for your benefit, Clintons' store count has substantially changed from 735 to 400. And therefore, that might be a meaningless comparison.

Operator

And it appears there are no further questions at this time. Mr. Smith, I'd like to turn the conference back to you for any additional or closing remarks.

Stephen J. Smith

Actually, we'll turn it over to Greg, please.

Gregory M. Steinberg

Thanks, Steve. We thank everyone for joining us this morning, and that does conclude today's conference call.

Operator

And this does conclude today's presentation. Thank you for your participation.

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