American Greetings Corp. F1Q11 (Qtr End 05/28/2010) Earnings Call Transcript

Jun.30.10 | About: American Greetings (AM-OLD)

American Greetings Corp. (NYSE:AM-OLD)

F1Q11 (Qtr End 05/28/2010) Earnings Call

June 30, 2010 9:00 AM ET

Executives

Greg Steinberg – Treasurer and Director, Investor Relations

Zev Weiss – Chief Executive Officer

Steve Smith – Chief Financial Officer

Analysts

Jeff Stein – Soleil Securities

Mimi Noel – Sidoti & Company

Keith Curtis – Brant Point Capital

Operator

Please standby. We’re about to begin. Good day, everyone. And welcome to the American Greetings Corporation First Quarter Fiscal 2011 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.

Greg Steinberg

Thank you, Alicia. Good morning, everyone and welcome to our First Quarter Conference Call. I am Greg Steinberg, the company’s Treasurer and Director of Investor Relations. Joining me today on the call are Zev Weiss, our CEO and Steve Smith, our CFO.

We released earnings for the first quarter of fiscal 2011 this morning. If you do not yet have our first quarter press release, you can find the copy within the Investor section of the American Greetings website at investors.americangreetings.com.

As you may expect, some of our comments today 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 forecast or estimates, and we do not plan to update any forward-looking statements.

If you’d like more information on our risks involved in forward-looking statements, please see our annual report or our SEC filings. Previous earnings releases, as well as our 10-Qs, 10-Ks and annual report are available on the Investor section of the American Greetings website.

We will now proceed with comments from both our CEO and CFO, followed by a question-and-answer session. Zev?

Zev Weiss

Thank you, Greg, and good morning, everyone. Today I’ll cover three main topics. First, I will share few thoughts on product leadership strategy. Second, I will comment on the status of the integration of both Recycled Paper Greetings and Papyrus into American Greetings. And finally, I will speak to our outlook for fiscal year 2011. Steve will then present more details behind our first quarter financial results.

I’m pleased that our first quarter earnings per share of $0.75 were the highest we ever achieved in the first quarter. Our first quarter EPS benefited from solid performance in our core business units, the changes we made over the last 18 months to our portfolio businesses and the shares we repurchased over the past several years. We have made investments into our core greeting card business in an effort to distinguish ourselves in the marketplace and deliver great products to our customers.

Over the past few quarters we have talked about a key component of this initiative, product innovation. The objective to continuously create distinct product is part of our product leadership strategy. Our product leadership goal is to create the best greeting card product in the industry. Achieving product leadership will attract more consumers to our product and help our retail partners grow their retail productivity.

More specifically product leadership requires that we not only have the best product but that we also offer differentiated merchandising. In order to ensure we have the best product we continuously surveyed consumers, studied large quantities of sales data and test products to ensure we create greeting cards that offer a high degree of satisfaction to our consumers.

Let me share with you a few examples of some of our recent products that appear to be enhancing the consumer experience. For younger more contemporary card buyers, we recently launched just-between-us a card buying that delivers heartfelt sentiments along with fresh photography.

This past Christmas we piloted a greeting card with an LCD screen, which included a digital slideshow. Since that time we have developed and introduced new LCD greeting cards. These new cards feature high quality LCD displays with digital content that feature comic relief, along with celebratory wishes through audio and playful multi-image sideshows.

Another greeting card we recently developed, bring music into the card in a whole new way. This greeting card delivers the appropriate sentiment for the desired occasion and it also features an iTunes gift code redeemable for one song download of the recipient’s choice. We are very proud of our distinct products and we will continue to work hard to surprise and engage the consumers when shopping the greeting card aisle.

It was about 18 months ago that we meaningfully changed the profile of the corporation by altering the mix of businesses through one divestiture and two acquisitions. At that time, we sold our retail store operations and we acquired Papyrus and Recycled Paper Greetings. The net effect of these three transactions was to enhance our focus on our core greeting card business. We acquired these best-in-class product lines as part of our strategy to satisfy the full range of consumer needs in our category.

Shortly after the transactions were announced, we stated that our goal with Recycled Paper Greetings and Papyrus was to protect what makes these products unique, particularly the creative models, but also to leverage our economies of scale to benefit the consolidated group overtime.

Over the past 18 months, we have been working to integrate these new businesses where appropriate. I’m pleased to say we have made significant progress on the integrations. First after much analysis and discussion we decided to combine Recycled Paper Greetings and Papyrus under one new company, Papyrus-Recycled Greetings or PRG. This structure allows us to keep important components of the new business separate while still allowing them to benefit from the scale of the larger group.

Second, we have passed a major milestone in the back office integration of the organizations. We have transitioned PRG’s order-to-cash process into our existing platforms, thereby reducing duplicative work streams in order to decrease back office costs. We will continue the integration process and expect to have it completed by the end of this fiscal year. I want to thank our many associates over 400 have been directly involved for their hard work and dedication in this process.

While we still have work to do on this integration and all systems are not yet perfectly integrated, I’m pleased with our progress. We previously estimated that the integration we eventually contribute $15 to $20 million of annual operating income and incur one-time cash costs of about $20 million.

We currently believe that estimates of future benefits and costs is still reasonable and we want to remind you that while we incurred a few million dollars of integration costs last year, we expect that the vast majority of the remaining integration costs will be incurred this year.

Last quarter we shared our outlook for revenue and cash flow for fiscal year 2011. As our first quarter earnings were in line with overall internal expectations, at this time we are so comfortable with those full-year projections.

We had forecast that revenue would be down slightly in the neighborhood of 1% to 2% driven primarily by party goods transactions that we announced last year. Our first quarter revenue decline was down net of foreign exchange about 2.6% or slightly unfavorable to our anticipated trajectory.

We also had forecasts that our full-year cash flow from operations less capital expenditures was expected to be $125 million. The $125 million estimate included a modest benefit from the combination of taxes, working capital and deferred costs, as well as, reduction in cash flow due to the anticipated cash costs associated with the integration efforts.

We previously forecasted and still expect our capital expenditure will be around $40 million. We currently believe we will achieve these targets as our first quarter cash flow from operations less capital expenditures slightly exceeded our internal plans.

This would also be an appropriate time to mention that subsequent to our first quarter we successfully refinanced our credit facility and paid-off the outstanding balance under our term loan. This refinancing helps to extend our debt maturities that ensures we have the financial flexibility to support our business. I should note that the costs associated with the refinance were previously expected to be part of our full-year projections.

Before I pass the call to Steve, I’d like to mention a change in leadership of our interactive segment. Earlier this month Josef Mandelbaum, the Chief Executive of our AG Interactive -- an AG Properties Group resigned. Josef joined the American Greetings 15.5 years ago, when our organization like many organizations was just discovering the internet.

He led the group from its early years until now, helped us establish our leadership position online and designed and created a profitable business model. Josef is leaving because he accepted a CEO position for an internet company in Israel. I want to personally thank Josef for his many contributions and wish him and his family much success, good health and happiness.

Now, let me turn the call over to Steve, who’ll provide a detail review of the quarter and then, we’ll take your questions. Steve?

Steve Smith

Thanks, Zev. I have three components to my prepared remarks today. I will start with comments on a few larger items that impacted our consolidated financial results, then I will share a review of our reported segments, finally a quick walk through a few key components of our financial statements, we will then open the line for questions.

Our consolidated revenue was down $17 million or 4% from last year’s first quarter revenue of $413 million, included in our $396 million of revenue was a benefit from foreign exchanges of $7 million versus the prior year’s first quarter.

Additionally, since we sold our retail operations midway through the first quarter of last year, this year we did not have the benefit of the $12 million of revenue that occurred last year prior to the sale. So holding aside the foreign exchange impact, as well as, the sale of our retail operations, revenue was down about $12 million or about 3%.

Our operating income of $55 million was up almost $33 million over the operating income of $23 million in the prior year’s first quarter. However, last year’s results included a loss of almost $35 million associated with our retail operations. Holding aside the loss from our retail operations last year our operating income was down about $2 million.

Shifting now to review the reported segments and how they differ from the prior year’s results. Our North American segment’s revenues were down about $15 million or 4.6% versus the prior year’s first quarter, about 1.5% of the decrease was due to lower sales of party goods products. This decline was anticipated as part of the party goods transaction we announced this past December. The remainder of the decline was driven primarily by lower sales of seasonal greeting cards.

A North American segments earnings were down $6 million versus the prior year. This was driven equally by a combination of lower revenues, as well as, incremental costs associated with the integrations of both Papyrus and Recycled Paper Greetings. As current economic conditions remain choppy and we continue with the integration work that Zev mentioned, we expect continued pressure on revenues and earnings in the near-term.

Switching now to our international segment, revenues were about $58 million, which is an increase of $2 million versus the prior year driven by non-card product sales. Segment earnings also increased about $2 million quarter-on-quarter, driven by the higher revenues and costs associated with savings within the supply chain.

Our AG Interactive segment revenues of $19 million and earnings of about $2 million were both unchanged versus the prior year’s first quarter. 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 as other revenue was about $4.2 million, which is up almost $1 million, compared to the prior year. Licensing expenses were about $4 million down $1 million, compared to the last year. So for the first quarter, the company’s net licensing efforts or revenues less expenses, was almost $2 million better than the prior year’s first quarter.

Let me move to the third part of my comments today, a review of several of the key components of our financial statements. The company’s manufacturing labor and other production costs or MLOPC were down about $9 million versus the last year’s first quarter. The bulk of the decline was driven by lower sales volumes, mostly as a result of the sale of our retail operations last year. In addition, inventory scrap expense was down a few million dollars, compared to the prior year.

Selling, distribution and marketing expenses were down about $15 million versus the prior year’s first quarter. About 80% of this reduction was related to the sale of our retail operations last year. The balance of the reduction was due to lower spending and our sealed service organization driven by the lower sales volumes. The administrative and general expenses were up about $3 million versus the prior year’s first quarter. This was driven solely by costs associated with the integrations of Recycled Paper Greetings and Papyrus.

The next item I will cover is taxes. Our effective tax rate for the quarter was 39.6%. A federal changes in the healthcare laws called the Patient Protection and Affordable Care Act were signed in March of this year. As a result, we recognized a $1.6 million charge related to do the reduction in deductibility of prescription drug coverage for our retirees.

Let’s now shift gears from a review of the income statement to take a brief look at our balance sheet and cash flow statements. On our balance sheet accounts receivable were about $11 million lower than the prior year. The reduction in the receivables balance was driven primarily by lower sales during the quarter.

I should also note that during our last conference call we discussed the negative effect timing had on some of our collections at year-end. Since then our collections are back to a more normalized level. Inventories decreased by $15 million, compared to the prior year. As we have discussed the last few quarters, our team has continued to carefully manage inventories and as a result inventories are down across almost all of our product lines.

Moving to our debt position at the end of the quarter, debt due within one-year increased to $99 million, compared to $27 million a year ago, while long-term debt decreased to $231 million, compared to $409 million of last year. These changes represent a reduction in our total revolving debt, short-term and long-term of $107 million over the past year.

You may note that at quarter end we show $99 million balance as debt due within one-year. This is simply the unpaid portion of our term loan. Subsequent to our quarter end, we not only refinanced our revolving credit facility, as Zev mentioned, but we also used cash on the balance sheet to repay the outstanding balance under our term loan. As a result, proper classification of the term loan is debt due within one-year at the quarter end.

Shifting to our cash flow statement, one item I would like to mention is accounts payable and other liabilities, which was an incremental use of $37 million, compared to the prior year’s first quarter. As we shared at the end of the fiscal year, we had accrued additional variable compensation in fiscal 2010 due to our better than anticipated performance. The accrued variable comp expense was paid during the first quarter of fiscal 2011, in the prior fiscal year we had below normal levels of variable comp, accruals and payments.

That concludes our prepared comments for today. I would now like to turn the call over to our operator to handle our question-and-answer period. Alicia?

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions) We’ll go to Jeff Stein, Soleil Securities.

Jeff Stein – Soleil Securities

Okay.

Zev Weiss

Good morning, Jeff.

Jeff Stein – Soleil Securities

Good morning, guys. A few questions. First of all, topline. Steve, I think I heard you say that there was a currency gain in the first quarter, is that correct?

Steve Smith

Yeah, Jeff. We picked up about $7 million of favorable FX benefits.

Jeff Stein – Soleil Securities

Okay. And the effect of RPG and Papyrus, net of one-time integration costs, was it positive, negative or neutral?

Steve Smith

You’re speaking to revenue or earnings, Jeff?

Jeff Stein – Soleil Securities

To earnings.

Steve Smith

The benefit is positive on an operating basis alone but if you include the integration costs, it is several million dollars negative.

Jeff Stein – Soleil Securities

Okay. And the $3 million, then, I think you alluded to that number several times. Would that represent the integration expense you incurred during the quarter?

Steve Smith

It would include that, yeah.

Jeff Stein – Soleil Securities

So that would suggest that -- that charges will probably increase in magnitude over the balance of the year?

Steve Smith

Actually charges won’t increase -- they should be roughly in line with what we experience are coming down, now. We had some charges that were put on the balance sheet as a result of the -- the opening balance sheet and purchase accounting. We had charges that were occurring last year and some of the first quarter and then there is a bit of a tail here during the balance of the quarter of this fiscal year.

Jeff Stein – Soleil Securities

So of the -- let’s call it $20 million of integration expenses, how much of that gets capitalized and how much of that is run through the profit and loss statement?

Steve Smith

Only about a quarter was capitalized. Three quarters were run through the P&L.

Jeff Stein – Soleil Securities

Got it. Okay. And the healthcare expense that you booked during the first quarter of the 1.6 million…

Steve Smith

Right?

Jeff Stein – Soleil Securities

…is that a one-time event or will it repeat in subsequent quarters?

Steve Smith

It is a one-time event although we haven’t -- we’re not fully aware nor is anybody, really, all of the effects of the new healthcare laws but what we’re aware of, it is hitting us right now on the tax line.

Jeff Stein – Soleil Securities

Okay. And one final question and then I’ll get back in queue and let someone else talk. How should we think about the effect of the party goods transaction on revenues on a go-forward basis? In other words, are you going to recapture any of that revenues that you gave up through the distribution agreement that you have signed with Amscan or are we looking with sort of a negative $40 million compare year-on-year?

Steve Smith

Maybe that I can answer and then you can add some additional thoughts. Jeff, just to be clear, I’m not sure we were clear on the last quarterly call. So I apologize if we were not. The $40 million is the delta rather than the absolute period on period. So we’re looking at something in the neighborhood of round numbers and it is a little bit seasonal but roughly $10 million of negative impact on revenues quarter on quarter for this fiscal year.

Jeff Stein – Soleil Securities

Got it. Okay. That is very helpful.

Zev Weiss

Does that give you your answer?

Jeff Stein – Soleil Securities

Yeah.

Zev Weiss

Okay. Good.

Jeff Stein – Soleil Securities

Thank you very much, guys.

Zev Weiss

Thanks, Jeff.

Operator

(Operator Instructions) We’ll go to Mimi Noel of Sidoti & Company.

Zev Weiss

Good morning, Mimi.

Mimi Noel – Sidoti & Company

Good morning. Just one question, so far. Can you talk a little bit about the weakness that you think is largely reflective of the macroeconomic environment, how you’ve seen trends shift at all? Are they looking more promising? Is there any reason why you would be less optimistic than you were at the end of 4Q?

Zev Weiss

I think if you just look at retail sales number that are public, it does feel like things could be softening a bit. And I think what we’re seeing is that it is inconsistent. Just as what you would see with the published retail sales numbers. I think as the economy is getting better, some retailers are doing fine and for others it is a bit more choppy, where some months they’re up and some months they’re down. And I think that’s what we’re observing, as well.

Mimi Noel – Sidoti & Company

Are you seeing any -- any consistency between channels and the trends just within the channels?

Zev Weiss

You know, a lot of what our sales rely on is retailer traffic. And you know when people come into the stores and they’re walking by our display are particularly around seasonal, but on everyday as well, we see a difference. And so as you look at what’s happening in general with traffic in retail, I think you would actually see probably what is going on for us, as well. And so as, you know, folks are may be rethinking where their traffic is going to go in terms of retail stores, we get affected by that.

Mimi Noel – Sidoti & Company

And since the comparisons become stiffer as you work your way through the year, is it possible that your core sales declines could weaken as the company progresses through its fiscal year?

Zev Weiss

You know, obviously there is no way for us to know at this point. I think if you look at the plans that we have in place for the back half of the year we feel very good about them. And it’s going to come down to if we get the traffic in the stores, I think we’re going to be fine. And I think it has a lot to do with how we see traffic affecting sales in the future.

Mimi Noel – Sidoti & Company

And those plans for the back half of the year, I know you’re going to be very busy with integration but can you characterize those plans?

Zev Weiss

I just think as we were gearing up for the holiday season, I just think when you look at what we’ve got from a product perspective around the innovation work that we talked about and the new product launches as well as just the refreshes that we’re doing within our line. I think we’ve got a very strong line and it’s going to come down to how well it performs and how many people we get into the store to look at our displays and I think when we get that traffic, I think we’re going to be fine.

Mimi Noel – Sidoti & Company

One additional question, have you given any more -- have you given any further thought to expand distribution of the RPG and Papyrus cards?

Zev Weiss

Well, I think when we think about it a lot and we think that there is a lot of opportunity, that there is a strong demand for, you know, for what both of those brands represent whether it’s the retailers who are looking for a stronger humor program or a more sophisticated customer that they’re hoping to attract with Papyrus. And we’re -- we continue to get very strong demand for both of those brands throughout the industry. And so I think we feel like there is still like a lot of opportunity there.

Mimi Noel – Sidoti & Company

Okay. And that’s something that you’re willing to explore. You’re not hyper-protective about the brands to something you would not wanting to increase distribution.

Zev Weiss

I think what we want to do is we want to maximize the brands to their full potential and it doesn’t mean that you put them everywhere because they’re not appropriate everywhere. And at the same time, we think there are still a lot of opportunity for both of those brands.

Mimi Noel – Sidoti & Company

Okay. Thanks for your time.

Zev Weiss

All right. Thanks, Mimi.

Operator

(Operator Instructions) and we’ll go to Jeff Stein of Soleil Securities.

Jeff Stein – Soleil Securities

Zev, just kind of wondering, putting RPG and Papyrus under one corporate umbrella. How does that change the cost structure or anything else relative that you had envisioned recently?

Zev Weiss

Not -- I think it is very much in line with what our plans were. So it’s not like it’s a new thing for us. And that was part of what -- when we talked about overall expectations for those two businesses that was included in it. And I think what you’re seeing is that the creative and product processes are very -- are still very much intact and if anything we’ve invested more into them.

And we’ve taken areas like -- again, the back office, the distribution, maybe even some of the sales and marketing functions and so the back office piece fits very well into what AG was doing and then we combined some of their sales and marketing effort. And our feeling is that it gives us more focus and strength and it allows us to invest in the product where we think we’re going to make difference with your customers.

Jeff Stein – Soleil Securities

Got it. If you guys are successful in cross-selling the product and selling it into accounts that previously did not carry RPG or Papyrus, does that -- is there a trade-off one for one in terms of what it’s replacing on the shelf or have you been or do you think you can be successful in increasing the amount of shelf space that your customers dedicate to their greeting card displays?

Zev Weiss

I think it’s both. I think when you look at the productivity of RPG and Papyrus and we’ve seen this over and over again, we think we could drive productivity. So you actually get a net increase, particularly when we do it right. And on top of that we think we can expand footage throughout the industry.

We think we can expand footage by continuing to let those brands get the utilization that we think that they could have. We don’t think that they’re -- they’re as exposed as they need to be and could be in the industry. And at the same time, we want to be putting them in the right place, but we still think there is a lot of opportunity to grow footage as well as increased productivity within existing footage.

Jeff Stein – Soleil Securities

Okay. And I’ve been doing some store checks and I mean, your product really does look great but it’s difficult to understand or just by observing what percent of your product might be new versus the prior year. So I’m just kind of curious, do you kind of look at -- I presume you do look at product newness as one of the drivers and kind of curious what percent of your product you would kind of classify as new on the shelf versus the prior year?

Zev Weiss

Yeah. It is something that we look at. It is not something that we share publicly. I think that we continue to feel comfortable that the amount that we’re offering is new. The amount of new that we’re offering is the appropriate amount. And I think that’s been so for a number of years. I think just we continue to feel like the quality of the innovation that’s coming out throughout the lines continues to get better and better. And so it is not so much the amount of new, I think it is the quality of what is being done that just every year I continue to be amazed by, you know, what our organization is putting out.

Jeff Stein – Soleil Securities

Great. And final question, can you comment on potential to see further improvements in yield, kind of what, you know, what inning are you in, as they say?

Zev Weiss

I think we made tremendous strides in yield. And I think it’s going to be the kind of thing where I think it will be years, where every year we’ll continue to try to get better and better and make incremental changes -- incremental improvements from where we are. So I don’t know what inning we’re in. I can’t tell you that. The last 12 to 18 months we saw significant improvements.

I think we’re now moving into incremental improvements and I think you’re going to see us be very vigilant on that and throughout all of our business for this year. And I think it will happen for the next few years. And so our hope is to continue to see benefit. It won’t be as big as it was maybe last year but I think that there is many years of incremental benefit ahead of us.

Jeff Stein – Soleil Securities

Okay. And any comment on kind of what’s going on in the U.K.? Your profits were up a little bit, but from your vantage point, is the environment getting better, worse or about the same?

Zev Weiss

You know, it’s on -- I think it’s definitely better. There is no question it’s better. I don’t think we’re feeling like the overall, you know, consumption levels in general in the U.K. are -- where we would like them to be and this is just in general in retail. However, when I look at what’s happening in the business, I think we’re seeing a lot of progress. And I think they’re doing a very good job at, again, producing great product and taking care of their customers. And as a result I think we’re seeing some good performance there. I don’t think that our folks there believe that the economy is as robust as they would like it to be.

Jeff Stein – Soleil Securities

Got it. Okay. Thanks a lot.

Zev Weiss

Okay. Thanks, Jeff.

Operator

We’ll go next to Keith Curtis of Brant Point Capital.

Keith Curtis – Brant Point Capital

Yeah. Could you guys comment on potential uses of free cash flow? Thanks.

Steve Smith

Our view on that is probably pretty consistent with how we have felt about it in the past. And that first we’re going to look for organic growth opportunities and wherever there is good organic growth opportunities that we feel highly confident about, we feel those are areas we ought to make an investment in.

And then at the same time, we want to make sure our balance sheet remains, I think, very conservative and gives us opportunity to execute if we ever need to do something that we have the flexibility to do that. But I think our bias in general has been to have a conservative balance sheet.

And after that we really look at a few things. On the one hand, we don’t think it is a bad thing to have some cash on hand to maintain flexibility. And then we’re also -- we’ll look at opportunities to return cash to shareholders, which we’ve, I think done quite a bit of in the past. And we look at all share buy-backs and dividends as opportunities to do that.

Keith Curtis – Brant Point Capital

Could you just characterize what you mean by a conservative balance sheet? The company doesn’t seem particularly levered up at this point. So just -- could you define that by more specific parameters and kind of targeted leverage ratios?

Steve Smith

No. That’s not anything that I would look to share over the phone but what I say is that if you look at our practices over the last three or four years and last year we made a number of moves. So we probably got a little bit more aggressive last year. But if you look in general where we are now and where we’ve been over the past few years, I think that is probably a good guide for where we’d like things to be in the future.

Keith Curtis – Brant Point Capital

Okay. Thank you.

Greg Steinberg

Thanks, Steve.

Operator

(Operator Instructions) With no further questions, I’ll turn the conference back to Mr. Steinberg.

Greg Steinberg

Thank you, Alicia. That concludes the question-and-answer portion of today’s conference call. We do look forward to speaking with you again at our fiscal year 2011 second quarter conference call which will be in late September. We thank you for joining us this morning.

Operator

That concludes today’s conference call. Thank you for your participation.

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