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The Brink's (NYSE:BCO)

Q3 2013 Earnings Call

October 24, 2013 11:00 am ET

Executives

Edward Cunningham

Thomas C. Schievelbein - Chairman of The Board, Chief Executive Officer, President and Member of Executive Committee

Joseph W. Dziedzic - Chief Financial Officer and Vice President

Analysts

Saliq Khan

Andrew Rittenberry

William Alexander von Mueffling - Cantillon Capital Management LLC

Operator

Welcome to The Brink's Company's Third Quarter 2013 Earnings Call. Brink's issued a press release on third quarter results this morning. The company also filed an 8-K that includes the release and the slides that will be used in today's call. For those of you listening by phone, the release and slides are available on the company's website at brinks.com. [Operator Instructions] As a reminder, this conference is being recorded.

Now for the company's Safe Harbor statement. This call and the Q&A session contain forward-looking statements. Actual results could differ materially from the projected or estimated results. Information regarding factors that could cause such differences is available in today's press release and in the company's most recent SEC filings. Information presented and discussed on this call is representative as of today only. Brink's assumes no obligation to update any forward-looking statements. The call is copyrighted and may not be used without written permission from Brink's.

It is now my pleasure to introduce your host, Ed Cunningham, Director of Investor Relations and Corporate Communications. Mr. Cunningham, you may begin.

Edward Cunningham

Thank you, Denise. Good morning, everyone. Joining me today are CEO, Tom Schievelbein; and CFO, Joe Dziedzic. This morning, we reported results on both the GAAP and non-GAAP basis. The non-GAAP results exclude a number of items including U.S. retirement expenses, acquisitions and dispositions and some currency-related items. The non-GAAP results use a full year tax rate of 37.5%, which is the midpoint of the expected full year range of 36% to 39%. A summary reconciliation of non-GAAP to GAAP EPS is provided on Page 2 of the press release. Detailed reconciliations are provided in the release and in the appendix to the slides we're using today, which were included in this morning's 8-K filing and are available on our website. We believe the non-GAAP results make it easier for investors to assess operating performance between periods. Therefore, our comments from this point forward will focus on non-GAAP results from continuing operations.

I'll start with a brief summary of results. Third quarter earnings from continuing operations came in at $0.69 per share versus $0.58 from 2012. The segment margin rate was 8.5%, up from 6.8% in last year's third quarter. Organic revenue growth was 9%. Currency translation had a negative impact of $33 million on revenue, $8 million on profit and $0.11 at the EPS level. On a year-to-date basis, earnings stand at $1.48 per share versus $1.74 in 2012, with a segment margin of 6.6%. Organic revenue growth for the year-to-date period was 8%. For those who model our results, please note that Page 7 of the press release provides the summary of selected results and outlook of items that should be helpful in forecasting 2013 performance in more detail.

I'll now turn it over to Tom.

Thomas C. Schievelbein

Thanks, Ed. Good morning, everyone. The improvement in third quarter results reflects strong performance from international operations but primarily by Venezuela, which more than offset a profit decline in North America. Earlier this year, we provided guidance for our 2013 non-GAAP segment margin at a range of 6% to 6.5%. Today, we're raising our full year guidance by 50 basis points to a range between 6.5% and 7%, and we remain on track to achieve full year organic revenue growth of 5% to 8%. Our initial outlook for 2014 calls for 5% to 8% organic revenue growth and a segment margin rate of about 7%. We are also assuming that there will be a 40% currency devaluation in Venezuela in early 2014. Joe will provide additional details on the assumptions behind our 2014 guidance with more details to come on our fourth quarter earnings call. So that's the big picture.

I'll now cover international operations, which accounted for 77% of our revenue and delivered organic profit growth of 65% for the quarter. We'll start with Latin America, which provided 42% of our revenue for the quarter and is our fastest growing and most profitable market. While Venezuela and Argentina had strong performance in this year's third quarter, but they also benefited from a favorable comparison to the year-ago quarter, which included some onetime charges. Given the significant slowdown in the Brazilian economy, we were pleased to achieve both year-over-year and sequential profit growth there. We're also pleased with our progress in Mexico and remain on track to achieve our 10% margin goal there by the end of 2015.

In Europe, which accounted for about 30% of our revenue for the quarter, profits were relatively flat against a strong year-ago quarter. As we said on our last earnings call, we expect Europe's full year profits to come in slightly below the level we achieved in 2012, which included a favorable commercial settlement that was not repeated in 2013.

Our relatively small Asia Pacific operation has delivered strong revenue and profit growth due primarily to the benefits of a streamlined cost structure that we put in place earlier this year and higher global shipments of precious metals.

Third quarter results in North America, which accounted for about 23% of our total revenue, were down versus last year, and the fourth quarter will also be challenging. We still expect our full year margin in North America to be between the 2% to 3% range we provided earlier this year.

The cash-in-transit market in the U.S. continues to be increasingly price driven. It's clear that we must accelerate our efforts to reduce cost, improve branch performance, change our revenue mix and improve overall productivity and customer service. We've made progress in each of these areas but not enough to offset the severe pressure on volume and price. We don't expect these pressures to abate anytime soon, so we're taking more aggressive steps to align our CIT cost structure with the market and maximize asset utilization.

From a strategic perspective, our plan is to reduce our labor and SG&A costs, improve branch operating margin and shift the mix of business over time from CIT and ATM services to higher value services. On the first issue regarding cost reductions, we have reviewed our entire cost structure and found that we were at a cost disadvantage to our major competitors on overtime. As a result, last week, we announced important changes in our overtime policy, which is now more aligned with our competitors' practices. This chart depicts our view of performing branches versus nonperforming branches in the United States.

Based on internal profitability metrics, only 44% of our branches are currently considered to be performers. Given our current results, this should come as no surprise. Our goal is to get to 75% performing branches by the end of 2016. Hitting this target will be a key factor in reaching our profitability goals in North America. To meet these goals, we're pulling all the levers. We are very focused on cost, and we are driving efficiency into the business. And through our profitability analysis, we are shifting to higher-margin services. That is our next area of focus.

We are tracking efforts to shift our mix toward those lines of business that offer higher-margin growth opportunities such as money processing, ATM management, global services and CompuSafe. Our high-value services currently comprise about 46% of our revenue mix in the U.S.. Our goal over the next 3 years is to grow these high-value services to about 51% of the mix. With the IT initiatives we have underway and with our revamped sales team in place, I'm confident we will have the right people with the right tools to be successful.

Additionally, the mix of CIT and ATM revenue depicted on these charts is expected to change over time with the mix shifting toward the higher-margin ATM business. These shifts will remain lumpy as we get new contracts. I'm providing these additional detail in order to enhance the transparency of our efforts. I will update our progress in the future earnings calls.

Before closing, I want to update you on a couple of recent items. In our continuing effort to strengthen our leadership team in North America, we are moving our most experienced Chief Financial Officer from Europe to North America. With regard to our ongoing portfolio review, we recently completed the sale of our relatively small CIT business in Hungary. These are the latest in a series of actions we've taken over the last 18 months to improve results. We've achieved substantial profit growth across our international operations, and we believe that North America will begin delivering year-over-year profit growth in 2014 that should accelerate in '15 with the goal to reach 7% in 2016. We will continue to take decisive action in North America and elsewhere to improve near-term results and to achieve long-term success. The team is energized, focused on improving performance and committed to creating value for our shareholders.

I'll now turn it over to Joe, who will provide details regarding our results and the outlook. Joe?

Joseph W. Dziedzic

Thanks, Tom. I'll start with a summary of third quarter results and then cover the assumptions behind our full year and 2014 outlook. Total revenue as reported grew 6% and was up 9% on an organic basis due mainly to organic growth in Venezuela, Argentina and Brazil. These 3 countries were also the primary drivers of an unfavorable currency impact of 3%.

Segment operating profit increased $20 million due to a $28 million profit increase in international operations that was partially offset by a $7 million profit decline in North America. International improvement was driven primarily by Venezuela with a smaller contribution from Argentina. Venezuela improved significantly versus last year due to retroactive price increases, volume growth and the third quarter 2012 value-added tax receivable write-off that did not repeat in 2013. The improvement in Argentina was split about evenly between pricing volume growth and the third quarter 2012 government receivable write-off that did not repeat in 2013. Profits in Brazil also improved slightly as pricing began to recover, helping us to mitigate the impact of substantial government mandated wage inflation and slowing volumes. We expect to continue recovering much of this wage inflation in the fourth quarter. The earnings per share bridge highlights the strong growth in segment profit, which was partially offset by unfavorable currency changes in Venezuela and Argentina. Noncontrolling interest reflects amounts owed to minority stakeholders, primarily in Venezuela.

Year-to-date cash flow from operating activities, excluding changes in customer obligations and discontinued operations, declined by $27 million versus last year due to working capital growth to support growth in Latin America and the timing of the insurance recoveries.

Year-to-date capital expenditures and capital leases were relatively flat at $126 million as we continue to reduce maintenance capital spending through efficiency projects. The North America region decreased CapEx by $10 million, primarily due to lower armored vehicle spend. International segment CapEx spend increased by $7 million due to investment in productivity initiatives in Latin America, partially offset by lower vehicle spend in Europe and Asia. Our plan in 2013 is to hold the capital spend to the 2012 level of about $212 million -- $202 million. We will continue to focus on efficiently deploying capital to maintain the level of safety and security that Brink's is known for while reallocating capital to focus on growth and productivity efforts.

Net debt increased by $85 million since year end due to $60 million in acquisitions, the timing of insurance recoveries and an increase in working capital. Our year-to-date margin rate stands at 6.6%. We've raised our full year margin guidance to our range between 6.5% and 7%. This increase is based in our expectation that continued improvement in Latin America profits will more than offset the impact of the profit decline in North America where the full year margin rate is still expected to be in the previously disclosed range of 2% to 3%, though probably at the lower end of this range.

As Tom stated, our preliminary outlook for 2014 calls for a continuation of organic revenue growth in the 5% to 8% range, driven primarily by Latin America, with no significant growth in revenue in North America or Europe. Our initial outlook for the 2014 segment margin rate is about 7%, which assumes profit growth in North America. We expect our profits in Latin America will be impacted by higher spending on productivity investments, which should begin to pay off in 2015, and the currency devaluation in Venezuela, the timing and size of which is difficult to predict. We are currently assuming a devaluation of 40%, which would result in a revenue reduction of about $200 million or about 5% of total revenue. Profits in Europe are expected to be relatively flat with 2013 levels. This is a preliminary forecast, and we will provide more context and details when we report fourth quarter results in January.

Denise, let's open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] The first question will come from Saliq Khan of Imperial.

Saliq Khan

My apologies, I was on the call a bit late, and I'll be speaking on behalf of Jeff Kessler. First question that I had was I want to get a better feel for what's going on in Mexico. Is the integration essentially complete? And what type of growth in margins can we see out of Mexico? And what is the relative size in comparison to Latin America?

Thomas C. Schievelbein

As we indicated, from when we bought Mexico in 2010 which was at 0 margin, we're growing the margins to 10% by the end of 2015, and we're on track to do that. So Mexico remains a very positive part of our operations. In terms of size, it's our third largest country.

Saliq Khan

Perfect. The other question would be -- is to what extent have you begun to sell the CompuSafe business from -- essentially taking it from the onetime sales to more of a recurring revenue model?

Thomas C. Schievelbein

Could you repeat the question, please?

Saliq Khan

Sure. To what extent have you begun to the sell the CompuSafe business and taking it such from a onetime sale to a recurring revenue business?

Thomas C. Schievelbein

It is a recurring revenue business, and so we don't do it as a onetime sale. It is an ongoing business opportunity wherever we provide CompuSafe, primarily in North America but also in a number of the international countries.

Saliq Khan

Perfect, yes. The third question that I had was at what point are you going to be able to repatriate the dollars out of Brazil, Venezuela, Colombia and Mexico? And we're assuming that there are different windows for different countries as well.

Thomas C. Schievelbein

Yes. I'm going to let Joe talk about repatriation.

Joseph W. Dziedzic

The only country we have challenges with repatriating is Venezuela, and that's due to the exchange controls that exist. The other countries, we don't have issues repatriating or redeploying that. The earnings to other countries around the world, they -- it doesn't always have to come back to the U.S.. So when we say repatriate, that could be redeploying to other growth markets outside of the U.S. .Other than Venezuela, it's the only place that we have real challenges because of exchange controls.

Saliq Khan

Another question I had was in regards to the brand and the price premium. You've been pretty successful in Latin America when it comes to being able to compete with the competition. Now that you're seeing more of a competition out there, what is going to be your marketing strategy? Are you essentially going to price in line with other companies or are you using the brand to win over more deals?

Thomas C. Schievelbein

Each market will have a specific strategy depending on the maturity of the market, depending on our position in the market. So it's not a one size fits all sort of strategy, and we will look at each country and make the determination based on that.

Saliq Khan

Great. And the last question I have for you guys was we understand you're about -- you're allowed to invest approximately 30% of your pension to assets and equities. And the markets have done relatively well this year. We do accept the fact that you might be only able to give us all this information that we're asking for in the fourth quarter report, which is going to be in the spring of next year. But can you give us some insight into how -- essentially what kind of experience you've had so far when it comes to the pension portfolio so far this year?

Thomas C. Schievelbein

We've had good performance in our pension assets. We have an assumption of 8% for our long-term return on assets, and we're very comfortable with that and have been performing at or above those levels. We have implemented a de-risking strategy in our U.S. pension like many companies have. As we -- as the funding levels or the funding ratios improved, we'll shift to more bonds to match the inflation and the interest rate movements to reduce the amount of risk and end up with a better matching of the liability. So that will continue to be implemented as the funding ratios improve, and we're very comfortable with the return assumptions that we have today.

Operator

[Operator Instructions] And our next question will come from Andrew Rittenberry of Jennison.

Andrew Rittenberry

Could you just give us a little background? The 44% of branches you said are performing based on, and I think you said, internal profitability metric. Could you just kind of walk us through what your definition is of that and maybe give us a little background in general why are those not performing and how you're going to get to 75% by '16? Just kind your general thoughts on that process.

Thomas C. Schievelbein

Sure. So when we look at this, what we've tried to determine is at what level the branches need to perform so that we get to the profitability goals that we've already -- that we talked to you guys about before, which is the 7% by 2016. So if we look at those branches, 120 to 130 plus branches in the U.S., we look at what their performance is. We look at -- to make sure that their definition of performing would be one where they would cover their SG&A cost, they would cover other allocations and then have at least 500 basis points. So what that means is you have to work on both the top end and the bottom end. We have to work on both the direct cost, which is the overtime we talked about. We have to work on the SG&A, which is what we've been talking about. And we also have to look at the margin -- I mean, at the mix of business so that we can work on the top end. Joe, you want anything else to add to that?

Joseph W. Dziedzic

I think that's pretty much it, Andrew.

Thomas C. Schievelbein

And I mean, really, the more important part of this is to show you what we're doing, and the more important part is the trajectory and the change because that's what's going to determine the profitability increase. It's important that you understand, I think, how we're going to measure it, but it's -- the most important is getting to that 75% performance. Now I'll stop there, but that's the goals that we need to do, that we need to hit in order to get to the margin percentage that we've committed to.

Andrew Rittenberry

Got it, okay. And the overtime change that you mentioned, could you explain that in a little more detail?

Thomas C. Schievelbein

Without getting too deep into pay practices and things like that, what we did was we looked at the overtime comparisons between all of our direct competitors and ourselves, found that we were at a competitive disadvantage, and we have aligned our overtime pay practices more closely to our competitors.

Andrew Rittenberry

Okay. And then just on Slide 10, as you talk about the high-value services mix, moving across 2013 to 2016, is there roughly to think about today what the ATM mix is in 2013 and how you think that progresses to 2016? I know you said it's going to -- ATM mix will be higher within that CIT and ATM bucket, but where is it today?

Thomas C. Schievelbein

Yes, hold on. I've got it here. I got to put my glasses on. Hold on. We're roughly about 9% today of the total, and that assumes we get to 16%. So we have plans in place, and we're executing those to move and to gain more ATM business.

Andrew Rittenberry

And how much of the mix shift is just due to deflation in the CIT business across those 3 years?

Thomas C. Schievelbein

Well, not significantly in terms of deflation. Clearly, it will depend on what the pricing levels turn out to be when we get into those discussions. But because those contracts are lumpy as well, a lot of them are 3- and 4-year contracts.

Operator

[Operator Instructions] The next question will come from William von Mueffling of Cantillon.

William Alexander von Mueffling - Cantillon Capital Management LLC

I had just a question about working capital and your comments about the growth in Latin America. What can you guide us to in terms of how we should think about working capital requirements going forward as you grow in Latin America in the year ahead?

Thomas C. Schievelbein

Well, we've had challenges. I'll point out a few countries. Venezuela has been tough with some of our government-owned customers. The collections there have been tough, which is not a new issue. But as the business continues to grow, it magnifies the working capital impact. Mexico is -- it's had some delays in their collections. Some of those are things that we can correct and some are just market pressures. Greece continues to be a bit of a challenge. It's smaller, but it's not unexpected and not new. It's government continuing to delay payments. We've not had issues with ultimately collecting. It's just been a delay. And then we had a few stumbles in the U.S. with our billing processes that we're rectifying now that's caused it. The sustainable impact and increase in working capital comes from the growth in Latin America. So as that business continues to grow, particularly in the highly inflationary environments, it drives higher need for working capital. And we continue to work diligently with our customers to collect for the terms of our agreement, but it's more market forces in the Latin America region driving the increase. And we historically see growth in the receivables balance in the first 2 or 3 quarters, and then in the fourth quarter, we do manage to collect a lot of cash, and there are some market forces that cause some customers to pay and get current by year end. Particularly in Mexico, we see that.

Operator

And ladies and gentlemen, this will conclude our question-and-answer session, and that will conclude today's teleconference. We thank you for joining today's presentation, and you may now disconnect your lines.

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