Executives
Rajesh Shaw – Chief Financial Officer
Thomas Vacchiano – President, Chief Executive Officer
Analysts
Adam Fisher – Burnham Asset Management
[Steve Roberts – Northport Capital]
X-Rite, Incorporated (XRIT) Q3 2009 Earnings Call November 11, 2009 9:00 AM ET
Operator
Welcome to the X-Rite, Incorporated third quarter earnings conference call. (Operator Instructions) It is now my pleasure to introduce Mr. Rajesh Shaw, CFO for X-Rite.
Rajesh Shaw
Good morning everyone. I’m pleased to welcome you all again to the third quarter earnings call of X-Rite Incorporated. Thank you for your interest and participation.
We will be conducting this call with the same format as last quarter which includes a presentation that will be referenced during the call. The presentation is accessible through our website at www.xrite.com under the investor relations section. These presentation materials will be helpful for you to follow along as we discuss our third quarter results.
Before we begin, I must refer you to our normal Safe Harbor statement regarding forward-looking statements which is on Page 15 of our presentation. In addition, we may refer to certain non-GAAP financial measures in our call today, and I would like to direct your attention to Page 16 of our presentation that provides disclosure on these measures.
Accompanying me on the call is our CEO, Mr. Tom Vacchiano and our Chief Accounting Officer, Mr. Jeff McKee. Tom will cover third quarter 2009 highlights, a summary of X-Rite’s performance for the third quarter and a review of our sales results. I will then cover a more detailed review of the P&L including comments relating to gross margin and operating expenses and a review of X-Rite’s third quarter cash flow, debt reduction efforts and working capital performance. Tom will wrap up with some concluding remarks and then we will take your questions. Now to Tom.
Thomas Vacchiano
Good morning everyone. As I said in the press release quote, we have had a very active third quarter. Let me address some of the highlights. As you see in the press release, our third quarter 2009 net sales were $45.6 million. This was down on a reported basis by 25.6% from the same period last year and adjusting for the currency impact, down 24.8%.
The year over year sales difference was narrowing in the third quarter as compared to the first half of the year and we expect that to continue as we look forward.
We are continuing to see an increase in the number of important customer major account design wins and OEM partner design wins and this is clearly strengthening the company’s view that as the economic climate improves, X-Rite sales potential should continue to improve.
The X-Rite Pantone combination is clearly beginning to bring some exciting new value to the marketplace as myPantone was launched in September on the Apple Application Store. Here we’ve received tremendous positive feedback from the graphic arts community.
We sold over 25,000 copies or downloads of the myPantone application on I-phones and I-pods and in the first 60 days we’ve also earned a number of editor choice awards and category lead awards through that period, so very good stuff in terms of the X-Rite Pantone partnership with that.
Also, you may have noticed in the October 26 issue of Fortune Magazine, Pantone and X-Rite were featured with our world color team and the feature talked about how Pantone/X-Rite can inspire color palates or in fact help companies choose the colors that can add sales potential for their products.
We continue to be enthusiastic about the market reception of our MatchRite iVue systems which continue to perform well from a sales standpoint. Recently, we participated in the fall Ace Hardware Trade Show and here, our iVue paint matching system enjoyed order bookings of $700,000.
And what’s exciting about that for us is, this is really now recovering back to pre-recession sales levels for this show which is a great indicator that at least in those segments where we have powerful new products, we’re bucking the headwind of some of the recessionary pressures that we’re seeing around the world.
We also launched Easy Tracks which is a new low end color scanning system as well as Color Checker Passport which a great new tool for the photo industry. Those products were announced and launched in the third quarter and we expect them to contribute to our sales performance in the fourth quarter of this year.
Despite our year over year sales decline in the quarter and year to date, the company’s profit improvement program continues to deliver improvements in gross margin which Rajesh will talk about a little bit later and our profitability.
In addition, the combination of our profit improvement program and our working capital management program, we continue to see yet another quarter of positive operating cash flows which is also quite positive for our business.
The debt to preferred stock and warrant exchange that we announced in the third quarter combined with our company’s aggressive debt pay down actions from our operating performance continues to provide an additional cushion relative to lender covenants and we have increasing levels of comfort that that is an issue that’s pretty much behind us as we’re focusing now on growing the business and continuing the good work we’ve done around our profit improvement plan.
I’d also like to confirm that the sale of the Viptronic campus which was the last piece of closing down our Viptronics operations has been completed in the third quarter. We did realize $2.3 million of cash proceeds and those funds were used again to pay down debt.
If you look at the Slide 4 in the presentation posted on our IR section of website, a financial summary, you’ll see that in the quarter we had positive operating income of $1.6 million in the quarter, up from the third quarter last year.
Our cash interest expense was favorably influenced by the variety of actions that we’ve talked about. Cash interest in the quarter, $5.1 million versus last year $10 million, and on a year to date basis, you can see also significant year over year improvement in cash interest.
Our net loss was reduced pretty substantially both in the quarter and year over year, and again we continue to I think demonstrate excellence in our expense and cost management in a declining sales environment. We achieved $10.7 million of EBITDA as defined by our lender agreement, and that represented 23.3% of sales in the period, a half a point improvement from the same period last year when we had $61 million in sales.
I think that this is particularly positive when you consider that the third quarter of our year is the seasonally lowest period of the year, and I would say traditionally we normally suffer our lowest level of profitability in the third quarter and yet this quarter because of profit improvement actions, we’ve actually increased our EBITDA profitability percent of sales over our first half of the year which I think demonstrates that our overall business model continues to look healthier and healthier.
If you move to Page 5, net sales by product segment, we look here at the various segments and what we’ve done in the quarter and the next slide, Slide 6 on a year to date basis. I think the most important point around imaging and media is that this decline of 35% in the period is heavily influenced by two of our largest customers in the press and printing manufacturing business.
If you take out their sluggish performance, our imaging business is actually only down something in the range of about 20%. So they’re really dragging down the sector.
The industrial segment you can see rebounding year over year compared to a year to date basis on the next slide, and this rebound is driven first and foremost by rebounds in Asia excluding Japan. So places like greater China, India, Southeast Asia, they’re really beginning to rebound on a year to year basis, and in North America, we’re seeing improvements in certain segments of our industrial markets.
In retail, this third quarter variance is really an anomaly. If you look at the first half of 2009 over first half 2008, we’re actually in pretty good shape and we also believe that our fourth quarter for retail will be in pretty good shape as we celebrate the $700,000 of bookings we got from the Ace Hardware show for iVue systems so really this is really more of a seasonal anomaly than it is a year’s trend for retail.
In the Color Support services area which includes both professional services and repair services, we saw in the third quarter a fair number of our customers’ factories close down for extended periods of time because of the slowdown in the summer and the recession, and as a result of those closing, we saw less repairs than we had been typically seeing in the third quarter.
We’re also seeing part sales for large customers as well as large dealers; we’re also seeing parts sales for repairs also down in the period. The good news there is October, as factories re-opened in September; service repair revenues look like they’re on the uptick starting the fourth quarter of this year, so the difference in terms of year over year looks to be narrowing in the fourth quarter for support services.
We’re pleased that in the color standards area, which is Pantone, we’re pleased to see that the year over year gap is narrowing there as well and this is particularly influenced by a strengthening in our fashion and apparel sub-segment of our standards business. This is partly driven by the smart cards, the cotton smart card standards, but also some of the other products in this sub-segment are also starting to show a turnaround.
If you move to Slide 6 which is net sales by product segment, I think if you look through this chart and compare it to Slide 5, you basically see that our Q3 results are narrowing the year over year sales difference and that the year to date differences while greater than fourth quarter are showing that we’re moving in a positive direction year over year.
I’d like to turn to Slide 7 which is net sales by region. Here you can see that the America’s year over year in the quarter was down 20% from the same period last year. This is being favorably influenced by the industrial sales in the America’s as well as imaging sales in America’s, and in the quarter there was a slight downdraft in media and printing segment and in retail segment in the quarter, but again the retail trend was an anomaly and not what we’re seeing through most of the full year.
In EMEA obviously the economic recovery in most of the countries in Europe is not quite as strong as in Asia and in North America, but this is also influenced by our largest customer, Heidelberg, who’s sales move through EMEA for world wide, and as you know, Heidelberg sales have been heavily influenced by the recession and the slowdown in capital goods purchases.
In Asia Pacific, it’s actually sort of a tale of two locations. If you include Japan in Asia Pacific, then we’re showing a year over year decline of 13% but if you separate Japan which is struggling economically like Western Europe and to some extent, the America’s, if you separate Japan, our balance of Asia Pacific is actually showing pretty strong performance year over year and so as soon as we can get our Japanese team and marketplace moving again, the Asia Pacific story will be quite strong for us as we look out into the future.
I would now move to year to date on Slide 8. It really says the same thing that the other slide says, and that is we’re narrowing the year over year sales difference in really each of the geographic regions.
So with that, we’ll move to Slide 9 which is the third quarter gross margins and Rajesh, you can take it from here.
Rajesh Shaw
As Tom indicated, the company has been very successful in managing through the economic downturn with strong and focused cost reductions and cost control efforts, and this is reflected in the 160 basis point improvement on a year on year basis in the gross margins.
As this slide shows third quarter 2009 was 59.4% versus 57.8% notwithstanding a 25% decline in sales. This is a strong performance, continues to reflect the benefits of the various cost reduction plans.
There were many offsetting factors plus and minus to the gross margin performance, but one significant factor that contributed to the enhancement in margins was the focused effort on reduction of our net freight expense and enhancing the recovery from the freight line, and that made a substantial contribution to the 1.6% gross margin profit improvement for the quarter.
I’ll now move to the next slide, again this is a reflection of the success of the cost reduction effort that Tom referred to. Year on year the operating expenses which include sales and marketing, research and development, and general and administrative are down 23% from the prior year quarter.
This is virtually the same on a year to date basis, and this again reflects the fact of the profit improvement plans that were announced and implemented earlier in the year in January and in April.
At that time, the company announced that for the year we would achieve about $28 million to $30 million of cost reductions, and as you can see from this performance and the year to date performance, we are well on track toward achieving the higher end of that indicated range.
Again, this underscores the point that Tom made earlier that our business model, we have reduced costs substantially and as the sales uptick happens or as Tom indicated this should result in favorable performance for the company.
Slide 11 refers to the year to date cash flows. As we indicated the combination of strong cost control and working capital management, the company generated about $18 million from operations during the year to date. It also benefited from sales of assets. Tom referred to the sale of the Viptronic asset in the third quarter.
Earlier in the second quarter we were also successful in selling the headquarters building. The combination of those two has enabled us to pay down a substantial amount of debt in cash and I will be referring to the debt schedule, debt pay down in the following schedule in a little more detail.
So the company’s balance sheet continues to improve. At the end of the quarter, we had $29 million in cash which is a substantial cash cushion.
Slide 12 as I said, refers to the debt reduction. Just a data point before I delve into the year to date, at the end of September last year the total debt was about $413 million. It gives you some scope for the success of the debt reduction plans that the company has achieved.
The first and second lien debt is down as you can see on this schedule from $270 million at the end of last year down to $187.3 million and net of cash of $29 million. That makes the number for the first and second lien debt of $158.3 million. This is a reduction of about $83.6 million on a year to date basis.
One important transaction that happened during the quarter was the conversion of second lien debt into mandatory redeemable preferred stock. As indicated in the schedule, the fair market value of the warrants associated with the redeemable preferred stock of $15.5 million is treated as a discount in the value of the preferred stock as required under GAAP.
This is indicated on the slide. This amount was accreted back to the face value over 54 months, that is to say, to the redemption date of January 2014. Once again the slide underscores the success of the debt reduction efforts that the company started on last year.
The last slide I would like to talk to is on Page 13. As I said earlier, the company continues to have a strong working capital performance. It reduced its working capital. The day sales were reduced in receivables. The inventory turns improved as well.
The lower payables, day’s payable essentially reflects a larger percentage of payables at September 30, 2009 on utilities and services which have traditionally shorter terms, but other than that, things are as normal.
With that, Tom I’ll hand it over to you again to summarize.
Thomas Vacchiano
Obviously it’s clear that X-Rite’s number one mission is to drive sales growth because given the new infrastructure and cost structure that the team has established over the last two years, the leverage potential in terms of profit contributions and cash flow will be attractive, very attractive as we turn around the sales picture.
So the X-Rite team is aggressively addressing sales growth. We are encouraged by recent customer wins and discussions that are occurring for wins that we would expect in the fourth quarter and into 2010.
We are very pleased to see that our new products like iVue, like myPantone app and others are being received well in a difficult market place and it gives us growing confidence about the future.
I think it’s clear that the profit improvement plan is working. Not only has it gotten us through this difficult period and kept our company safe, but it really does create a real leverage opportunity going forward in terms of both cash flow and profit as we look out into the next few years.
And I would just say that there is no sure thing about what the economy is going to do and what the markets will do over the course of the next few quarters, so we remain vigilant and we’re committed to keep the business safe in the short term while making sure that the company is poised for attractive sales and profit growth which we believe will be amplified when the economic turnaround occurs.
So with that, we’d like to open it up for questions and comments.
Question-and-Answer Session
Operator
(Operator Instructions) Your first question comes from Adam Fisher – Burnham Asset Management.
Adam Fisher – Burnham Asset Management
Q 4 of 08 we started seeing some of the weakness in the end markets so Q4 of ’09 should be down less year over year than other quarters potentially.
Thomas Vacchiano
That is true that Q4 in 2008 marked the first big shift down, and as we’ve been narrowing the year over year gap through Q3, we would expect to continue to narrow the gap in Q4.
Adam Fisher – Burnham Asset Management
On the operating expense side, it sounds like there’s still maybe $1.5 million of operating expense that will show up, that will decrease starting this quarter.
Thomas Vacchiano
I don’t know how you get that figure. What I would tell you is this, we do believe that we will achieve our $28 million to $30 million year over year expense and cost savings. Remember, on the OpEx line, you see where it says $23 million of savings, that’s year to date. That’s only the OpEx savings. That doesn’t include the cost savings which Rajesh talked about earlier is influence 1.6 point improvement in gross margin year over year even though our sales volume was down.
So you need to look at both components. And we continue to expect additional savings in the fourth quarter.
Adam Fisher – Burnham Asset Management
So just to clarify, gross margins still have the potential to go up and operating expenses still have the potential to go down starting next quarter.
Thomas Vacchiano
My point is, we will continue to see year over year savings in both lines.
Adam Fisher – Burnham Asset Management
On the balance sheet, the $29 million of cash, how much more do you think you can extract from the cash to pay down debt before you get to a level that you think you need to maintain the cash balance at?
Thomas Vacchiano
This is actually not a simple number, but let me give you some feedback. First, we generally need about $12 million of cash in the pipe at any point in time, so roughly $12 million of working capital from cash standpoint.
We have $29 million. Of course one of the issues is where that cash is sitting and whether or not it’s sitting in the right place. We’ve instituted some new programs which is improving our cash management performance and optimizing where it sits and providing flexibility so we can move it where it needs to be, which will allow us an opportunity to take the $29 million down if we choose to.
Secondly, over the course of the last year, we’ve also completely paid up our line of credit. We have a $40 million line of credit. There is no draw against that line of credit of any materiality, so at the end of the day, we can choose how much to bring cash down to pay down debt and how much if any we want to use of our line of credit.
So I think we’re in a very good position right now in terms of flexibility of using cash where it’s needed and optimizing that as well as having full access to our line of credit should we decide that we need it at some point in time.
I would support all of that by saying we continue to be operating cash positive and we would expect that to continue in the fourth quarter.
Operator
Your next question comes from [Steve Roberts – Northport Capital]
[Steve Roberts – Northport Capital]
What’s the share count now and going forward?
Thomas Vacchiano
The share count is approximately 85 million, but I don’t know the exact number.
[Steve Roberts – Northport Capital]
That’s going to be for Q4 also, because of the warrants?
Thomas Vacchiano
That actually includes the $7.5 million in warrants.
[Steve Roberts – Northport Capital]
And what’s the stock price on the warrants?
Thomas Vacchiano
Those were penny stocks, and they’re exchangeable for common.
[Steve Roberts – Northport Capital]
You mentioned in the imaging and media business that the two largest customers were down a greater percentage. Who are those customers and when do you expect them to come back or should we expect them to come back?
Thomas Vacchiano
That’s the $64,000 question. The two customers are Heidelberg and [Commori] and these are two very large press manufacturers. Heidelberg has roughly 50% of the press market for offset press and [Commori] is the second largest and has roughly 20% market share.
They’re obviously into the industrial printing capital goods market where they’re selling products from $.5 million to $5 million and their recovery will be heavily influenced by the economic recovery as well as their ability to serve markets like China, India, Brazil where interestingly, the printing markets are actually expanding.
So their traditional markets, Western Europe, Japan and North America are contracting right now, but places like Brazil, India and China actually are expanding. So they’re obviously adapting their product portfolio to try to take advantage of some of the growth opportunities in Brit countries, particularly three of the four countries.
Russia is not doing quite as well as the other three. So with an economic turnaround, with availability of money and financing at reasonable rates and of course as they start penetrating some of these countries more effectively, these will all contribute to their turnaround.
[Steve Roberts – Northport Capital]
But primarily right now they’re more in North America and European centric?
Thomas Vacchiano
I would say that Heidelberg has been Western Europe/North America centric although over the last few years, they’ve been trying to develop the markets in the brick area, and they continue to do that, and since those areas of the world are growing now, they’ve put more emphasis there lately.
[Steve Roberts – Northport Capital]
Does the company plan to do any more debt for preferred changes or are you done with that?
Thomas Vacchiano
We don’t have any current plans at this time. We believe that our capital structure and debt structure is manageable and comfortable and we’re focused now on driving sales growth.
Operator
There are no further questions at this time.
Thomas Vacchiano
Let me close by thanking all of you for your continued interest and support of X-Rite. I would say that our confidence in terms of our future business prospects is clearly increasing, and we look forward to keeping the dialogue going with you. Thank you very much. Have a good day.
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