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American Greetings (NYSE:AM-OLD)

F1Q 2014 Earnings Call

July 10, 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

Owen Douglas - Robert W. Baird & Co.

Marjorie Gochberg Kellner - Harvest Management, L.L.C.

Operator

Good day, and welcome to the American Greetings Corporation First Quarter Fiscal 2014 Earnings 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, sir.

Gregory M. Steinberg

Thank you, Devona. Joining me today on the call is 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-Q for our fiscal 2014 first quarter this morning. If you do not have yet our 10-Q filing you can find a copy within the investor section of our 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 would 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 the reports, and the proxy statement relating to the Weiss family's proposed acquisition of the company are all 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 December 2012, today's conference call will have a similar format to the last 3 quarters conference calls. Our CFO, Steve Smith, will offer some preferred remarks which will be followed by a question-and-answer session. We will be limiting our prepared remarks to historical results, we are not addressing fiscal 2014 guidance, and will not be discussing the proposed Going Private transaction. We'll 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 particularly the proxy statement on file with the SEC.

We'll now proceed with comments from Steve, followed by the question-and-answer session. Steve?

Stephen J. Smith

Thanks, Greg. I have 3 components to my prepared remarks today. I will start with the comments on the larger items that impacted our consolidated results this quarter, and move to review of our reported segments. And finally, a quick walk through to the few key components of our financials. I will be focusing on the main items of variance between our first quarter of this year and last year's first quarter and would encourage listeners to refer to the 10-Q for further details. We will then open the line for questions.

Our consolidated revenue of $497 million increased approximately $104 million from last year's first quarter revenue of $393 million. Last year was negatively affected by a noncash impairment of deferred cost of about $4 million related to our supply agreement with the Birthdays subsidiary of Clinton Cards, which was reflected in total revenue. Last year was also negatively impacted by about $1 million as a result of scan-based trading conversions. This year was negatively affected by scan-based trading conversions of about $3 million. In addition, this year was negatively affected by about $3 million of foreign exchange, compared to the prior year's first quarter. While the impact of scan-based trading and foreign exchange occur regularly, we are calling out these items to assist listeners with their year-over-year comparison.

So holding aside the Clinton's supply agreement impairment, the SBT conversions and FX, revenue was up about $105 million or 26% quarter-on-quarter. Most of the year-over-year revenue increase related to unusual or noncomparable items. About 60% of the $105 million increase was driven by the acquisition of Clinton, which happened during our second fiscal quarter of last year. As a result, in the first fiscal quarter this year, we recognized a net increase in revenue of about $64 million, comprised of both Retail Operations segment revenue of $75 million, less the eliminations associated with intersegment revenue of about $11 million, which represented sales from our U.K. wholesale business to our Retail Operations segment. In addition, we estimate that approximately 16% of the $105 million increase was related to the cycle of our fiscal calendar.

Due to our fiscal calendar cycle, the current year's first fiscal quarter ended on May 31, 2013, compared to May 25, 2012 in the prior year. As a result, we had 6 more selling days in these year's first fiscal quarter. This fiscal calendar cycle will not impact the number of days in our full fiscal year. Approximately 10% of the $105 million total increase in revenue was from a large order in our fixture business, a business unit which is reported within our non-reportable segments. The remaining portion of the total revenue increase was a combination of sales increases within the North American segment, primarily gift packaging and seasonal cards, and everyday card increase within the International segment and a slight increase in our licensing revenue.

Our consolidated operating income was about $55 million this year, compared to about $12 million in the prior year's first quarter. Last year's operating income was negatively affected by about $31 million of charges and expenses related to the Clinton Cards transactions. The $31 million reduction in operating income included about $17 million for bad debt impairment, an $8 million impairment of senior secured debt, a $4 million impairment for deferred asset related to our supply agreement and $2 million of transaction cost.

During last year's first fiscal quarter, we also recognized about $2 million of incremental expense related to the termination of an agency agreement related to our intellectual properties licensing group. This year's first fiscal quarter includes cost and fees associated with the Going Private Proposal for approximately $4.5 million, the negative effect of scan-based trading conversions of about $2 million and a gain of approximately $2 million related to the adjustment -- to the impairment of the senior secured debt of Clinton Cards.

Holding aside the effect of the Clinton Cards transaction, the prior-year contract change in our licensing group, the Going Private transaction cost and the current and prior period effects of scan-based trading conversions, our operating income was up about $14 million quarter-on-quarter. We estimate that nearly 50% of the $14 million increase in operating income is related to the 6 additional selling days in the current year's first fiscal quarter, when compared to the prior year's first fiscal quarter. The current year quarter also was favorably impacted by the effect of the increased sales within our fixtures business, increased sales of both greeting card and gift packaging products, lower marketing and lower product management expenses. These favorable items were partially offset by both higher scrap expense and the operating loss from the Clinton Cards operations during the quarter, when compared to the prior period.

I'll now review our reported segments and how they differ from the prior year's results. Our North American segments revenues of $328 million were up about $20 million compared to the prior year's first quarter. We estimate that approximately 2/3 of the increase is related to the additional selling days in the current year's first quarter. The remaining increase was primarily driven by higher sales of greeting cards, gift packaging, party goods and ancillary products. Our North American segment earnings of $66 million increased about $10 million versus the prior year. We estimate that the majority of the increase is related to the additional selling days in the current year's first quarter, which was partially offset by unfavorable product mix and higher scrap expense. In addition, decreases in marketing and product management expenses of approximately $3 million were partially offset by increased technology maintenance costs.

Switching now to our International segment. Revenues were about $60 million, a decrease of about $3 million versus the prior year. The decrease was driven by the elimination of intersegment sales to the Retail Operations segment of approximately $11 million. Net of the elimination of those intersegment sales, segment revenue increased approximately $8 million compared to the prior year's first quarter. This increase was primarily due to higher sales of greeting cards of approximately $8 million. The increase in cards quarter-over-quarter was due to both the decrease in shipments to Clintons during the last year's first quarter, as Clintons was going into administration, as well as due to the additional selling days during this year's first quarter.

Within the International segment, from an earnings perspective, we reported a break-even quarter this year, an improvement of almost $23 million compared to the same period in the prior year. The vast majority of the improvement in segment earnings was driven by costs incurred in the prior period that did not repeat. During last year's first quarter, there were approximately $21 million of Clinton-related costs including bad debt expense of approximately $17 million and impairment of approximately $4 million. The remaining improvement was the result of higher sales volume due in part to the additional selling days during the year's first quarter versus prior, and cost savings related to strategic actions in our prior year.

Our AG Interactive segments revenues of about $15 million were off marginally versus the prior year. The slightly lower revenue was primarily due to lower advertising. Earnings for the segment were down about $500,000 versus the prior year's first quarter due to the slightly lower revenues.

Let me shift from the segment analysis to briefly comment on the status of our licensing performance. Licensing revenue for the quarter, which is reported on our income statement within other revenue, was about $7 million, which is up almost $3 million compared to the prior year. Licensing expenses were about $3.5 million, essentially flat to the prior year. So for the first quarter, the company's net licensing effort, or revenue less expense, was about $2.5 million higher than the prior year's first quarter.

Now let me move to the third part of my comments today, a review of several of the key components of our financial statement. The company's manufacturing labor and other production costs were up about $40 million compared to last year's first quarter. The Clinton Cards Retail Operations caused a net increase of approximately $20 million during the current quarter compared to the prior years first quarter. In addition, MLOPC increased approximately $16 million due to higher sales volume and unfavorable product mix. Finally, MLOPC increased approximately $4 million due to higher scrap expense compared to the prior periods.

Selling distribution and marketing expenses were also up, up about $43 million versus the prior year's first quarter. The increase in the current year was driven by approximately $44 million of expenses related to the operations of Clinton Cards. Also contributing to the increase were higher supply chain cost of $3 million, driven by primarily higher sales volume. These increases were partially offset by lower marketing and product management expenses of also approximately $3 million.

The administrative and general expenses were down about $9 million versus the prior year's first quarter. This decrease was driven primarily by lower bad debt expense as the prior year included approximately $17 million related to Clinton Cards being placed into administration, which did not repeat. In addition, legal-related expenses decreased by approximately $3 million. This year-over-year decreases were partially offset by expenses within our Retail Operations segment of approximately $6 million, as well as costs and fees related to the Going Private Proposal of approximately $5 million.

Other operating income was $3 million this year, compared to an expense of about $10 million in the prior year's first fiscal quarter. Last year included an impairment of about $8 million related to the senior secured debt of Clinton Cards. Last year also included an expense of about $2 million related to the termination of certain agency agreements associated with our licensing business. During this year's first quarter, based on an updated estimated recovery information provided by the administrators, we recorded an adjustment to the Clintons impairment, resulting in a gain of about $2 million. Without these 3 items, other operating income improved approximately $1 million quarter-on-quarter.

Let's now shift from a review of the income statement to a brief look at a few items on our balance sheet. Before I review some of the specific accounts, I should mention that the purchase price allocation for Clintons is still preliminary as the end of our first fiscal quarter -- at the end of our first fiscal quarter, and therefore subject to revision, as the valuation work and other analyses are being completed.

Accounts receivable increased about $25 million, compared to the last year. The increase was primarily the result of the increased sales in both our North American segment and our fixtures business unit. Inventories increased about $23 million compared to the prior year, driven by the acquisition of the Clintons stores. Accounts payable increased by $11 million compared to the prior year, the increase was also a result of the acquisition of the Clintons stores.

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

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take our first question from Owen Douglas with Robert W. Baird.

Owen Douglas - Robert W. Baird & Co.

Just have a quick question regarding the Clinton Cards business. Just wondering, are you able to share with us any sort of plans with regards to how you think this business will evolve in terms of the revenue opportunity, the timing for it to become a meaningful contributor to your bottom line, as well as just generally, any other thoughts to how this integration is proceeding?

Stephen J. Smith

Sure, Owen. So first of all, as we commented last quarter, this is a business that's in a turnaround mode. We had a healthy fourth quarter, and during the call, we cautioned people that 1 quarter does not a trend line make. As we've seen this quarter, the business did not perform on an operating basis at a profitable level, and so we were disappointed by that. The business is in turnaround and as it's stabilizing, we hope that the business will be able to generate earnings profit through the next few years. And the timing of that is yet to be determined as the turnaround continues. Recently, we have been able to narrow the number of doors we have opened from over 700 to now just under 400, 395, 396. And with that, some new systems they have in place and remarketing, we see a path toward a better future for that business, but it will take us some time.

Owen Douglas - Robert W. Baird & Co.

Okay. Now -- again, I remember in the past you mentioned that they didn't have very good systems to be able to measure progress, but are you able to give a sense as to, this quarter at least, which either the rough proportion of stores that were profitable on a four-walls basis versus others?

Stephen J. Smith

Well, the challenge there is they did not have the systems in place they do now. So comps versus prior are very difficult. And we will, by later this year, be able to lap the systems that were installed last fall, early last winter. So we'll have a better visibility to that in about 6 months.

Owen Douglas - Robert W. Baird & Co.

And what proportion of stores would you say today, or in most recent period, were profitable?

Stephen J. Smith

We haven't comment on that, so I'm not so sure we would like to do that on the open [mic] [ph].

Operator

[Operator Instructions] We'll take our next question from Marjorie Kellner with Harvest Management.

Marjorie Gochberg Kellner - Harvest Management, L.L.C.

I was wondering if I could ask if -- actually, the quarter looked very nice, we were actually happy to see that, and we had tried to compare it to the projections that has been in the old proxy and it looked materially better to us than the old proxy. And of course, the updated proxy on Friday had new projections, and I wondered if I could ask you a question about the -- I was having trouble with the cash flow statement. I can see where the EBITDA comes through, but I was wondering where that cash flow is going because it seems that the cash flow wasn't increasing, so -- and it wasn't CapEx. So I'm just wondering why we weren't seeing it in the cash flow statement?

Stephen J. Smith

You're referring, Marjorie, to the proxy or to the actual reported financials of the Q?

Marjorie Gochberg Kellner - Harvest Management, L.L.C.

To the proxy.

Stephen J. Smith

So we aren't, at this time, commenting on the proxy or any of the other statements that have been recently filed with regard to the transaction. So I'm sorry, we'll not be able to help you with that particular question.

Marjorie Gochberg Kellner - Harvest Management, L.L.C.

Okay. Then in terms of the Q, when we go through the sales -- could you just repeat what you said in the beginning, $120 million was you thought the extra selling days of the increasing sales?

Stephen J. Smith

For the corporation at large? Yes, I would be glad to repeat that. So we had, in the first quarter, we reported a total revenue that was $104.7 million greater than the prior period. If you remove the effect of FX, SBT period-on-period and the Clintons contract impairment in the prior period, you end up with the same figure about $104 million, $105 million on a [quote] [ph] adjusted basis. Against that $105 million, the components are: $64 million, or about 60% of the increase, due to the Clintons acquisition; about $11 million due to the increased revenue and the fixtures business, which is in our non-reportable segment; about $17 million, 16%, due to day count, which leaves you in the neighborhood of about $15 million of increased revenue excluding the FX, the SBT and Clintons and day count. And then we gave you the reasons which were due to cards in North America and the U.K., giftwrap in North America and licensing globally.

Marjorie Gochberg Kellner - Harvest Management, L.L.C.

Okay. And so in the next -- I mean, obviously, I know you can't really give projections, but in the second quarter, those 5 days come off? Those extra 5 selling days?

Stephen J. Smith

So the day count between the quarters is much more comparable within 1 day. Yes, the day count catch up occurs in the fourth quarter, but the second quarter of this year is roughly comparable to the second quarter of last year.

Marjorie Gochberg Kellner - Harvest Management, L.L.C.

Okay. And will you be having meetings to go over the proxy and shareholder meetings before the vote? Will you have a roadshow or something?

Stephen J. Smith

That is not currently anticipated.

Marjorie Gochberg Kellner - Harvest Management, L.L.C.

So how should we address questions about the [indiscernible]?

Stephen J. Smith

One second, please. So if you have questions about the proxy process, that would be to Georgeson, our proxy advisor. If it's questions about the numbers within the proxy, that would go to the advisors to the Special Committee, PJ Solomon and Sullivan & Cromwell.

Marjorie Gochberg Kellner - Harvest Management, L.L.C.

So could you give us a contact person there?

Stephen J. Smith

It would be in the proxy itself. I don't have that with me in the conference room we're sitting in.

Operator

[Operator Instructions] It appears there are no further questions at this time. Mr. Steinberg, I'd like to turn the conference back over to you for any additional or closing remarks.

Gregory M. Steinberg

Thank you, Devona. We do thank everyone for joining us here this morning. And that does conclude today's conference call.

Operator

And that does conclude today's conference. We appreciate your participation.

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