Consolidated Graphics Inc. Q2 2010 Earnings Call Transcript

Consolidated Graphics Inc. (CGX)

Q2 2010 Earnings Call

November 4, 2009 11:00 am ET

Executives

Joe Davis - Chairman and CEO

Jon Biro - Executive Vice President and CFO

Alexandra Tramont - FD

Analysts

Charlie Strauzer - CJS Securities

Jamie Clement - Sidoti and Company

Rick D'Auteuil - Columbia Management

Presentation

Operator

Good day ladies and gentlemen and welcome to the Q2 2010 Consolidated Graphics earnings conference call. My name is Samira and I will be your operator for today. At this time, all participants are in a listen-only mode. We will conduct the question-and-answer session towards the end of this conference. (Operators Instructions). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the call over to Alexandra Tramont of FD. Please proceed.

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 second quarter ended September 30, 2009. You may receive a copy of today's press release by calling FD at 212-850-5600, or by visiting Consolidated Graphics website. The 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, stability of the economy and reasonable growth and 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 earlier filing today, with the Securities and Exchange Commission.

Now with these formalities out of the way, I would like to turn the call over Joe Davis, Chairman and Chief Executive Officer. Joe, 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. This morning we released financial results for the September quarter.

Sales in the September quarter were $251.6 million, down 15%, compared to the prior year. Adjusted operating income was $9.4 million in the September quarter, compared to $21.1 million last year.

Adjusted net income was $3.8 million or $0.34 diluted earnings per share in the September quarter, compared to adjusted net income of $10.1 million or $0.88 diluted earnings per share in last year’s quarter.

Our results for the quarter reflect the weakness we continue to see in our industry. In general most of our customers are buying less print than they were a year-ago and our sales declined, many of our fixed costs to come at higher percentage of sales causing our profit margins to decline.

Personally there are some signs of stability. We are seeing improvement in customer demand in some instances as the economy improves and complexity in our industry is declining. Over the past year, several large operators and many small operators have closed their doors.

We expect many more operators, especially smaller ones to close over the coming year, as it becomes more difficult for them to remain competitive. In this environment, we believe we continually have to market share.

A printing company has to do more than just print to be competitive in this environment. For example, today, a successful printing company needs to have the ability to help their customers reduce their investments in printing materials, by reducing their inventories. Help them improve returns on their marketing dollars and provide solutions to increase their ability to efficiently comply with their specific industry regulations.

Many customers were located throughout the US or their local managers to have the ability to order marketing materials customize for their location and also with the assurance that the printing materials will have the same look, feel, with consistent logo, brand images, legal disclaimers and more.

Our proprietary, store front, software application provides a solution. Our fleet of 220 high-end digital presses which we believe to be the world’s largest fleet allows us to respond quickly and provide our customers with customized market material, calendar, greeting cards and photo books.

Our technology solutions allows us to produce market materials customized for an individuals buying habits or even including map from the recipient's home to the advertiser place of business.

Furthermore, our customers know that we can distribute electronic files to any of our 70 locations reducing their time to market and lowering cost, while at the same time ensuring consistency of the printed piece across our network.

Our digital print sales remain a bright spot and are down only 1% year-to-date, compared to the prior year. Our strategic sales defined as technology-related sales and sales to national customers served by multiple CGX locations throughout the United States, Canada and the Czech Republic have also held up better than our traditional local print business.

We have best-in-class capabilities for our commercial printer and therefore, have a distinct competitive advantage. We have the advantage of technology and scale and the benefit of being financially strong. We also have the responsiveness of a local printer.

Each of our 70 locations has a management team and sales force that enables them to make the quick decisions needed to provide first class customer service. For all these reasons, we believe, we will continue to have opportunities to make good acquisitions and hire topnotch sales people, as many commercial printers find it difficult to compete in today's environment.

Owners of these companies have the option to join us, continue to run their company and gain the advantages of being part of a large organization. Their sales people benefitted because they can now have more products to sell to their customers.

Our company in St. Louis Nies/Artcraft recently acquired assets for the Kohler Print and hired their former sales people. This transaction will increase our market share in the St. Louis area. In the current time, we expect these kinds of opportunities to continue to be available and expect these transactions will be an attractive way for us to grow our business.

For the time being however, conditions in our industry very depressed. As stated in the previous earning conference calls, we are responding to this weakness in the industry by aggressively cutting our costs.

We previously told you about reducing our labor costs through headcount reduction through the salary and wage cuts. We are also working hard to reduce cost in other areas and we will continue to respond the realities of the current environment and make adjustments as our revenues fluctuate.

In summary, let me reemphasize that this remains a very challenging economic environment for industry and Consolidated Graphics. We will continue to monitor and adjust our cost and we’ll continue to invest in our business, including substantial investments in technology and our people.

I will now then turn the call over to Jon Biro to provide you with additional financial information. Jon?

Jon Biro

Thank you, good morning. As a reminder earlier this morning, we filed with the Securities and Exchange Commission the basis for our use and reconciliations of certain non-GAAP financial measures that will be referenced on this call. Please refer to this Form 8-K filing for additional information.

Sales in the September quarter were $251.6 million, compared to $297 million in the prior year, a 15.3% decline. The sales decline was primarily due to a year-over-year same-store sales decline a 13.2% impact, caused by the current economic environment and lower election-related business, which had a 2.1% year-over-year impact.

Gross profit declined 24% as the lower sales had the effective increase in fixed cost, such as depreciation and facilities related costs as a percentage of sales, thereby, reducing the gross profit margin from 24.4% in last year’s quarter to 22% this year.

Selling expenses declined $3.2 million or 12% from the prior year quarter, due to the decline in revenues and were up only slightly as a percentage of revenues from the prior year.

General and administrative expenses declined $2.3 million or 9% to $22.4 million in the September quarter, compared to last year. The decline in G&A expenses was primarily due to a reduction in compensation costs and bad debt expense.

Despite the decline in G&A expenses as a percentage of sales these expenses increased from 8.3% last year to 8.9% this year, due to the fixed nature of many of these expenses.

Operating income for the September quarter included non-recurring charges of $2.6 million related to litigation and the impairment of certain production equipment. The litigation charge relates to the previous disclosed lawsuit that resulted in the charge in the December 2008 quarter.

If we exclude these charges, adjusted operating income for the September quarter was $9.4 million or 3.7% of sales compared to $21.1 million or 7.1% of sales in the prior year. Lower adjusted operating margin was due to the reduced sales which caused gross margins to decline and G&A expenses to increase as a percentage of revenues.

Adjusted net income for the September 2009 quarter was $3.8 million or $0.34 diluted earnings per share, compared to adjusted net income of $10.1 million or $0.88 per diluted share for the prior year quarter.

The effective tax rate of 51% for the September 2009 quarter increased from the prior year's rate of 41%, primarily for two reasons. First, a higher state income tax rate, and secondly, a larger percentage impact of somewhat fixed permanent differences because our pre-tax income was lower.

Free cash flow was very solid in the September 2009 quarter at $55.8 million compared to an $18.6 million use of cash in the September 2008 quarter. As of the end of September, our total debt outstanding was $232.7 million, a reduction of $81.5 million, or 26% from March 31, 2009.

As of September 30 2009, our available credit under existing credit facilities was $215.2 million. Cash on hand was $11 million at the end of the September quarter and capital expenditures totaled $6.9 million for the September quarter and totaled $11.4 million for the first six months of the fiscal year. We currently expect 2010 capital expenditures to be approximately $20 million.

Looking ahead of the next quarter based on our limited visibility of our future sales and earnings. We expect sales to come in at $250 million to $265 million range, and it is likely we’ll see a seasonal pickup compared to the September quarter.

This implies a year-over-year same-store sales decline of between 10% and 15%, excluding election-related business. Assuming this level of sales, we would expect that we will continue at least generate breakeven adjusted net income for the December quarter.

I will now turn the call back over to Mr. Davis.

Joe Davis

Thank you, John. We continue to operate in a weak environment. As I said, we will continue to adjust our cost as sales fluctuate. We also continue to invest in our business, particularly in technology and people.

We're making decision today that will enable, Consolidated Graphics to be a stronger company as the economy returns to more normal conditions. We are very fortunate and that we have a very strong balance sheet, one of the strongest we believe in the industry and we think this will serve us well during this downturn.

Operator, we are now available for any questions any of you might have.

Question-and-Answer Session

Operator

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

Charlie Strauzer - CJS Securities

Joe and Jon, can you just answer just couple of quick questions here. First is, if you look at the guidance, obviously you’re giving a pretty conservative range here at the low end implying kind of flat sequential from Q2.

What would kind of happen for you to kind of hit the low end of that range? I would think that seasonally you typically see a pretty good pickup in your fiscal Q3 calendar, Q4 your on top line, even when you look last year, with the economy ticking in nose-diving you still saw a pretty decent sequential improvement. Can you talk a little bit more about that?

Joe Davis

Talking about last year, most of our customers planned their marketing budgets out several months in advance. We may not have that actual contract, but they've got it planned. So, last year we saw a rather strong October and we saw November and December down dramatically. So, we also saw January and February down dramatically. So, operationally last year certainly had a lot of election business in the month of October and that this October we’ll have some election business. Some of the democrats really spend more money sounds to me like when I hear the news this morning.

In any event it’s very, very difficult to predict what the December quarter revenue might be. I would tell you that historically in our industry that we’re in overall, November, December, January, February are not robust months. It's very, very difficult in this environment to predict how those months are going to be this year. To some degree may be we have taken well a conservative approach. But, compared to the clients in previous quarters we think it’s a very reasonable approach.

Charlie Strauzer - CJS Securities

Also, if you can talk a little bit more about, I saw you bought Kohler out of St. Louis and an asset purchase, are you starting to see more of those types of assets coming to market where banks are basically taking control now, are you starting to see a little bit more of a over pickup in kind of the seizures, and people just closing their doors in terms of the potential targets deal?

Joe Davis

Well, we’ve seen a number of printers close their doors, some fairly largely. Denver LA for instance, two rather large companies they have locked the doors one day. We’re seeing a number of smaller companies close down. We have full-time people involved in acquisitions, Jim Cohen heads that group. We’re talking to a number of people today. Unfortunately, most of the situations we’re looking at are in a distress situation.

We have the expertise, we believe to assist them in salvaging what they can from their business, and joining up with a larger stronger company. Sometime this means that it we will be a toughie, and sometimes its standalone, sometimes it’s a combination of the above. But today banks were a lot more aggressive about closing down companies earlier in this calendar year.

I think banks have begin to give customers a little bit more, become a little more lenient with smaller companies today, perhaps because they don’t want to take the hit themselves. But in many cases the banks are asking for, you know sort of getting prepared for what’s to happen. They are asking to the owners for personal guarantees. In some cases they are asking the owners for a second lien on their home. Some cases they are asking for a deed of trust in lieu of a second lien on their homes. In some cases they are asking for more cash to be put into the business.

So banks are kind of positioning themselves to take whatever action they deem necessary in order to preserve their, best collateral that they’ve got. We are, working with a number of banks as well as owners. We don't work with banks unless the owners approve it, but in some cases the owners have asked us to talk to their banks and see if we can work out something that gives the banks a maximum amount of recovery while at the same time preserve against many jobs as we possibly can.

Charlie Strauzer - CJS Securities

So you basically, you are starting to see a little bit more of a pickup in the backlog in terms of those discussions at least?

Joe Davis

We are seeing a lot of opportunities in that arena. When I say a lot I mean a lot.

Charlie Strauzer - CJS Securities

I would imagine that given that you’re at the discussion level at the banks that the multiples you are talking about would probably be, rather they would be pretty…

Joe Davis

I don’t know that in this economy multiples are an appropriate thing to discuss. I mean, we are talking about distress situation and we don’t, multiples are that yesterday’s news.

Charlie Strauzer - CJS Securities

Well, sort of saying it another way I would imagine that these transactions would have the potential to be highly accretive. Well to CGX.

Joe Davis

When we buy a distressed company you certainly hope, step out of the distress situation you'll certainly hope it is accretive, but as within all businesses, there is no assurance that anything is going to be accretive. So we are taking a substantial amount of risk anytime we get while we’re on these situations. Fortunately we think we have some degree of expertise in this and we can reduce our downside risk but there is no guarantee that any of these situation will work out.

Operator

(Operator Instructions). Our next question comes from the line of Jamie Clement of Sidoti. Please proceed.

Jamie Clement - Sidoti and Company

Joe, how would you, as you look at the same-store sales decline in the September quarter, I know this is very, very tricky and I know that it's not scientific but how much do you feel that you've been hurt by pricing versus letter volumes or orders. I know that's very tricky, I know we've been through this over the years, but I'm just curious for your thoughts.

Jon Biro

We can't answer that very scientifically. However, I would tell you that, we believe that most of our customers doing business with us because we have something to offer them, that's different from the low price down the street. We offer technology. We offer service, local presence. I don't think every customer we got is trying to buy it based on, it is not a commodity. As you can buy, have it delivered at the Port of Houston. We are selling service and we are selling quality and timeliness and technology. So price is available in some cases, but overall it's very difficult to quantify that.

Jamie Clement - Sidoti and Company

Would you expect your larger customers whether that's national accounts business or just big Fortune 500 types of companies that maybe you only deal within one market? Would you expect and have you seen those orders start to kind of come up off the bottom yet faster than kind of some smaller business that you might deal?

Joe Davis

Well, let me try to end it with your last question. When you talk about price, we look to give our customers a better solution perhaps at a lower cost, where they get more return on their marketing dollar. We might save them a lot of money on postage; we might save a lot of money on everything, but it’s difficult to see certain industries in certain locations, certainly our volume has improved.

So it’s really related, primarily where we’ve seen volume increases, it’s related to technology, and somewhat of a rebound in customers business. Let’s take the automotive industry for instance, where we have a substantial presence. What was going on in the spring of the year with all of the major companies, you might have imagine they didn’t have a lot of marketing programs going on. Well, that settle down now and we are participating in that marketing after just going forward.

Jamie Clement - Sidoti and Company

Just sort of changing gears a little bit, in your prepared remarks you talked about the lack of visibility several months ahead. Have you referred anything from your customers or from your salesmen that sort of classify the environment out there?

In other words, do you have customers that are kind of taking a wait and see approach, based on some term work that they may have done in the last couple of months, kind to see how that plays out or are they waiting on the consumer that sort of thing, I mean what are you hearing?

Joe Davis

I’m not sure we have good enough data to [face] at all. Certainly we work with a diverse group of industries. If you look at our 70 locations, as you think what industry is hot in that marketplace, we are involved in that. But there are a lot of different industries, there are a lot of different locations, and whether they’re going to continue their marketing plans or not, I think that’s a $64,000 question that we don’t really think we can answer. If at all we could answer that that would be something other than pretty.

Jamie Clement - Sidoti and Company

Yeah, that’s very fair. Thanks very much for your time.

Operator

Our next question comes from the line of Rick D'Auteuil of Columbia Management. Please proceed.

Rick D'Auteuil - Columbia Management

Just a little bit of follow-up to Charlie’s question on the fourth quarter guidance, maybe you can re-educate me on. Is there any reason why margin should be down? So on sequentially flat to up revenues, why we would expect a big pull back to earnings? Are there bonuses or something that’s happening in the next quarter that isn’t comparable to this quarter?

Joe Davis

Rick just for clarification, we only gave guidance on a December quarter which is ---

Rick D'Auteuil - Columbia Management

Yeah, I said Q4, I meant the December quarter. You guys mess me all up with your fiscal years.

Joe Davis

Anyway the December quarter, certainly, we haven’t said we haven’t given guidance. All the guidance we have said, that we expect to operate and at least generate breakeven adjusted net income for the December quarter. We haven’t said our margin would be higher or lower. I don’t mean to be a small about this, I just said you that there is such uncertainty in the economy, that it is very, very difficult to say what our net income per share is going to be in the December quarter. We think that the things we have done will enable us to at least breakeven.

Rick D'Auteuil - Columbia Management

Let me ask in another way. Under what set of circumstances and let’s pick not even to get aggressive, lets pick the low end of your revenue guidance. Under what set of circumstances do you only breakeven, so you make zero cents per share. What would have to happen? Because, I am thinking of Q4, probably has a little better mix of digital in general wouldn’t it or maybe I am off on that?

Joe Davis

We have 70 locations and certainly in Q4 we have a lot of digital business in the healthcare and in other industries. However, we have 70 locations. So we might have some locations that are really down in the December quarter. So, we do not have a few that have a lot of digital business to do, hope to do pretty well in the December quarter.

But we also have a lot, well way more than a majority of our locations don’t have that big of a presence in digital business. They all have a presence in digital, but not throughout extreme. It’s very difficult to predict with a degree of certainly what those 70s are going to do in December quarter.

Rick D'Auteuil - Columbia Management

I’m just trying to, at the margin, what would make things that much less profitable or lower margins than the quarter you just reported? Could you see a pricing wave, I mean, is it that dynamic that you are seeing week-to-week or day-to-day pricing just get ugly or?

Joe Davis

I don’t think we want to get too carried away on pricing a lot of it is volume specific to a particular locations. If we got a larger company that doesn’t have any volume, that won’t work too well.

Rick D'Auteuil - Columbia Management

But overall volume is going to be comparable to what you’ve just reported is what you’re expecting?

Joe Davis

Overall volumes. It’s like I told somebody there, during the six months we were down 21% I think of total revenues, if that were equal across 70 companies who’s [going to held] a lot of these demands. Unfortunately, that’s not the case. I think I said last time I’m still working now to 45%, well that makes the projection management a lot more difficult.

Rick D'Auteuil - Columbia Management

Okay, all right. Appreciate it.

Joe Davis

I’m sure that you didn’t like that answer, but that’s the best I can give you.

Rick D'Auteuil - Columbia Management

I mean again, I’m just trying to understand, if we’re sitting here three months from now and you report $0.50. I’ll kind of accuse of sandbagging and that, maybe that’s all you can do at this point.

Joe Davis

Good problem to have.

Rick D'Auteuil - Columbia Management

Right.

Jon Biro

Better than the alternative.

Operator

That concludes our question and answer portion. I would now like to turn the call over to management for closing remarks. Please proceed.

Joe Davis

Okay. Thank you. As I said before, we’re still dealing with the very depressed market conditions. But we believe we’re holding up better than most. We’re taking the steps necessary to maintain and expand our competitive advantages during this downturn and emerge a stronger company and with an enhanced competitive position.

We appreciate the continuous support of our customers and especially the hard work, dedication and financial and other sacrifices of our employees. We also think our shareholders are looking forward to reporting yield in our December quarterly results. Thank you for your interest today.

Operator

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

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