American Greetings CEO Discusses F3Q11 Results - Earnings Call Transcript

| About: American Greetings (AM-OLD)

American Greetings Corp. (NYSE:AM-OLD)

F3Q11 (Qtr End 11/26/2010) Earnings Call

December 22, 2010 9:00 am ET

Executives

Gregory Steinberg - Treasurer, Director of IR

Zev Weiss - CEO

Steve Smith - CFO

Jeff Weiss - President and COO

Analysts

Jeff Stein - Soleil Securities

Gregg Hillman - First Wilshire Securities Management

Philip Lee - First Investors

Ron Gibbs - Platte River Capital

Operator

Welcome to the American Greetings Corporation third 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.

Gregory Steinberg

Good morning everyone and welcome to our third quarter conference call. I am Greg Steinberg, the company's Treasurer and Director, Investor Relations. Joining me today on the call are Zev Weiss, our CEO; and Steve Smith, our CFO.

We released our earnings for the second quarter of fiscal 2011 this morning. If you do not yet have our third quarter press release, you can find a copy within the Investors 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 forecasts 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 Investors 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 speak about our product leadership strategy, and show share some examples of our recent product introductions; second, I will give an update on the integration of Papyrus and Recycled Greetings. And finally, I'll speak about our outlook for the balance of fiscal year 2011.

I am pleased with our overall performance here in the third fiscal quarter, while the pace of the economic recovery remains challenged. We have managed to maintain our level of revenue from our core business, due in part to introducing new and innovative products. The combination of relatively steady revenues along with good expense management has resulted in solid earnings for the quarter.

Steve will provide additional detail about our financial results in a few moments.

Our team continues to be focused on the product leadership strategy in our core business. We believe that product innovation is a key component of product leadership, as it will help to drive interest and excitement in the category, as well as meet the changing needs of today's consumers.

Product innovation is executed in a way that full supports our retail partner strategies and ultimately helps consumers connect with each other in a special and differentiated way. As we have discussed in the past, product leadership also means getting four important variables correct, simultaneously the right card with the right presentation at the right time with the right price. Daily execution of this strategy in tens of thousands of retail stores is not easy. But that is our challenge and we believe that we are meeting that challenge.

Let me give you a few examples of how we meet that challenge. My first example focused on our leadership role in using liquid crystal displays or LCDs in cards. We were a leader in brining LCD greeting cards into the greeting card in last holiday season. We believe that we have improved upon last year's offering and have now created new cards that are available either preloaded with holiday images or ready to be customized with up to 50 of your own photos.

These patented cards feature full color LCD displays and high quality audio. Instrumental music and a customized slide show play automatically each time the card is open. The card comes with its own USB that can be directly connected to a computer for easy photo upload. In addition, the card is rechargeable, which makes it the perfect keep safe for years to come.

Another example is a new collection of cards that we call Illuminotes. These cards feature a unique card fold and a light that is diffused through a frosted vellum window. When opening the card, recipients are presented with a soft glow that enhances the editorial sentiment. Illuminotes offer a charming twist to the traditional greeting card experience.

My last example for today is the greeting card called Flipbook. These cards recall a specific childhood practice, almost everyone remembers, similar to the Flipbook cartoons made in grade school. These cards contain an entertaining animation produced by rapidly flipping thin sheets to reveal a design sure to delight any child. The animation can either tell a story or deliver a birthday message.

With Flipbooks we are introducing the importance of the card giving experience to children. Our creative staff will continue to work hard, to surprise and engage consumers of all ages and to help them make meaningful connections with their families and friends.

It was just over a year-and-a-half ago that we sold our retail store operations and acquired Papyrus and Recycled Paper Greetings. The net effect of these three transactions was to enhance our focus on our core greeting card business. Since the time of the transactions, we have made significant progress in integrating the two businesses, and now the vast majority of the integration work is behind us.

We have integrated the supply chain and back-office functions of Papyrus and Recycled Greetings, while maintaining their separate creative processes. We still have a few items left to finish and expect to have those completed by the end of this fiscal year.

Overall, I am very pleased with our progress in these integrations. Not only have the integrations going smoothly and come in slightly below budget on expenses. But also as we shared with you last quarter, the upside is better than originally estimated. While we originally targeted our run rate operating income of $15 million, we now believe we will realize a $20 million run rate benefit to operating income as a result of these two acquisitions.

Finally, I would like to switch gears to share some thoughts about our outlook for the full year. At this point in our fiscal year, we faced the traditional holiday risk as both Christmas and Valentines Day occur in our fourth fiscal quarter.

In addition with changes in the economy, consumer buying patterns are more difficult to predict. With that said, we are expecting to at least meet our projected cash flow from operations minus capital expenditures goal of $125 million with upside to this estimate, based on a combination of further improvements from the balance sheet and lower than previously anticipated capital expenditures.

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

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 results this quarter. Then I will share a review of our reported segments. Finally a quick walk through of a few key components of our financials. We will then open the line for questions.

Our consolidated revenues were down about $10 million or 2.3% from last years third quarter revenue of $440 million. Including this years $430 million of revenue, it was a benefit from foreign exchange of $1.7 million versus the prior year's third quarter. However, this year we did not benefit for about $9 million of revenue that occurred during last year's third fiscal quarter, because of our Party Goods transaction. So holding aside both the foreign exchange impact as well as the affect of the party good transaction, revenue was down about $3 million or less than 1%.

Our operating income of about $56 million was up almost $14 million, compared to the operating income of about $42 million in the prior year's third quarter. Last year's operating income included $6 million of cost associated with the charges made in our Mexican operations as well as about $12 million of incremental variable compensation expense due to better than expected performance.

Holding aside, both the changes made to our Mexican operations as well as the atypical verbal compensation expense last year. Our operating income was down approximately $4 million quarter-on-quarter, from a prior-year period of about $60 million to our current-year period of about $56 million.

Let me now shift to a review of the reported segments and how they differ from the prior year's results.

Our North American segments revenues were down about $17 million versus the prior year's third quarter. Approximately $9 million or 50% of the decline was due to lower sales of our party goods products. This decline was anticipated as part of the party goods transaction we announced last December. The remainder of decline was driven by lower sales of gift packaging and other ancillary products.

Our North American segment earnings were up $7.6 million versus the prior year. In the prior year, we incurred about $6 million worth of costs associated with strategic changes to our Mexican operations. Beyond the removal of this drag from the prior period, earnings were up a couple of million dollars.

Switching now to our International segment, revenues of about $78 million were up almost $4 million compared to the prior year, driven by increased sales of both Christmas boxed cards and sales of products we distribute on behalf of third parties. As a result, segment earnings improved about $600,000 versus prior.

Our Interactive segment's revenues of about $90 million were unchanged compared to the prior year, while segment earnings of $5 million were up $3.6 million compared to the prior year's third quarter. A combination of both lower back-office cost as well as other cost reduction programs carried out in previous quarters drove the earnings improvement.

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 $8 million, which is down about $500,000 compared to the prior year. Licensing expenses were about $7 million compared to $6 million last year. So for the third quarter, the company's net licensing contribution to earnings or revenues less expenses was about $1.5 million lower compared to the prior year's third quarter.

Let me move over to the third component on my comments today, a review of several of the key parts of the financial statement. The company's manufacturing labor and other production costs were down about $6 million compared to last year's third quarter. About 60% of the decline was driven by lower sales volumes. The balance of the decline was driven by lower scrap, primarily the result of the wind-down of our Mexican operations last year.

Selling distribution and marketing expenses were down about $7 million versus the prior year's third quarter. The decrease was driven reduced e-sales and product distribution expenses, which were the result of lower shipment volume and savings as a result of the Papyrus-Recycled Greetings integration.

The administration and general expenses were down about $11 million versus the prior year's third quarter. Last year's results included atypical incremental variable compensation expense of approximately $12 million due to better-than-expected performance that year. However, this year's admin and general expense included about $2 million of additional stock compensation expense.

So let's now shift gears from a review of the income statement to take a brief look at a few items within our balance sheet and cash flow. On our balance sheet, our long-term debt decreased by $124 million from $356 million to $232 million. Over the past year, we paid off the outstanding balance on our revolving credit facility. And as we discussed last quarter, we refinanced our credit facility and used cash on the balance sheet to also repay the entire balance then outstanding on our term loan.

Our net deferred cost decreased $36 million or 12% from $306 million a year ago to $269 million at the end of the third quarter. The four line items of deferred cost on our balance sheet at the end of the third quarter were prepaid expenses of $89 million, other assets of $285 million, other current liabilities of $54 million and other liabilities of $51million.

Our net deferred costs have come down meaningfully over the last five years. In fact, the net deferred costs have decreased approximately $500 million or 60% compared to year-end peak of $757 million at the end of the fiscal 2002. We believe that the reduction of the net deferred costs is essentially over and we do not expect meaningful further decline.

Shifting to our cash flow statement, one line item I would like to mention is accounts payable and other liabilities, which was an incremental use of $21 million compared to the prior year. As we shared at the end of our last fiscal year, we had accrued variable additional compensation in fiscal 2010 due to our better-than-anticipated performance.

This accrued variable comp expense was actually paid during the first quarter of fiscal 2011. During fiscal 2010, we paid below normal levels of variable compensation based on performance in fiscal 2009. This swing in variable compensation cash payment is the primary driver of the difference in this cash flow line item.

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

Operator

(Operator Instructions) Our first question will come from Jeff Stein with Soleil Securities.

Jeff Stein - Soleil Securities

A question first on your inventory levels. It looks like they were up about 7.5% year-on-year. I'm wondering if you could address that, because obviously that's a higher growth rate than you're kind of trending from the topline standpoint. Is there any increase in cost of goods and paper costs reflected in that? Maybe you could just explain why it's up so much.

Steve Smith

Sure. It's really a reflection of several things. Cost of goods is a small piece of it, Jeff. We also have higher inventories due to the Recycled Paper Greetings integration, that's a new incremental carry, as well as some incremental gift packaging inventory at the end of the period.

Jeff Stein - Soleil Securities

And by the end of the year where would you expect your inventory levels to be relative to the prior year?

Steve Smith

We generally don't forecast line items of our balance sheet or cash flow. We feel pretty comfortable about the inventory levels. We've driven down, as you know, over the last several years to what we believe to be a near-trough level. We wouldn't expect a whole lot of improvement from where we are.

Jeff Stein - Soleil Securities

Guys, in doing some channel checking, I have noticed that the RPG and Papyrus cards have been showing up, at least locally here in CVS stores. I'm wondering if you could just address the issue of potential growth in topline from those two businesses, because it seems that most of the discussion has been centered around cost takeout in terms of driving incremental earnings benefit from those two acquisitions, not topline.

Are you seeing any new account penetration that you could discuss?

Zev Weiss

I think when we first did the acquisitions, we talked about the fact that we felt like the product lines had opportunities to grow within some of our retailers and with some new retailers. The response that we're getting for both of those lines has been very strong. And existing customers as well as new customers have been working with us and looking for opportunities.

In some cases, we've been implementing some rollouts. And in some cases, we've been implementing some tests where we're evaluating what the performance could be and then figuring out how deep we can go with those product lines. But the demand for them has been every bit as good if not better than what we'd thought when we bought them.

Jeff Stein - Soleil Securities

If you could just talk a little bit about your free cash flow guidance for the year. You did indicate some upside. You talked about lower capital spending. I'm wondering if you could clarify what do you mean by balance sheet improvement, how that would affect your cash flow.

And then do you see possibly any upsides on the operating income side from perhaps a better environment or cost reductions or any other factors?

Steve Smith

So, Jeff, why don't we break it in three pieces? I'll speak to the CapEx and let Jeff or Greg speak to the other pieces of balance sheet improvement and maybe have Zev speak to the third piece of your question.

On CapEx, we do anticipate coming in below by about 20% of our initial target forecast of about $40 million for this fiscal year.

Gregory Steinberg

With respect to other improvements on the balance sheet, Jeff, as you know, we're always working hard on receivables inventory, deferred costs and taxes. And one of the things you've seen a little bit more recently is some benefits by having our cash taxes lower than our P&L taxes. And I think there is an opportunity to continue that pattern throughout the rest of the year. And so that's where you'd see potentially a pickup on the balance sheet through possibly cash taxes.

Zev Weiss

On the operating side, there is two components to it. There is everyday and seasonal. On seasonal, looking at the back quarter, you've got Christmas and Valentine's Day, and we're hopeful that they're going to be positive just given the types of things that we're seeing in retail from a foot traffic perspective.

I know at this time it's always hard to believe that. The last three days mean as much as they do for Christmas. And Valentine's Day remains to be seen. But there is so much business left to be done still for Christmas that it's too early to say where the seasonal of that is going to go.

Valentine's, you'll see this year, given which day it's on, we're hopeful that it will be a positive year for us. But it's way too early to know that one.

On the everyday side, the things that we're seeing in the back half of the year both from an overall comp store performance outside of our category, there are signs that things are better. Some channels are seeing bigger improvement than other channels.

From that perspective as well as whether there is expansive opportunities, whether it's in the Papyrus and the Recycled area or in other parts of our business, gives us reasons to be hopeful. But I think it's too early now to say that that's something that you could depend on for the fourth quarter and the next year.

Jeff Stein - Soleil Securities

Zev, can you talk a little bit about the trends within channels, which channels seem to be gaining or losing or showing the best momentum right now? That would be relative to drugstore, mass, supermarkets and specialty.

Zev Weiss

I think if you look at the public information that's out there in terms of where there either is comp store sales increases or people reporting traffic increases, it seems like in two of the areas, almost in the extremes of the market whether it's on the higher side of the market from a specialty perspective, even with mass, or on the more value side of things, there seems to be strength.

Some of the areas in the middle are better than where they were last year, but not as strong as maybe where those two extremes are in the marketplace.

Operator

(Operator Instructions) We'll go next to Gregg Hillman with First Wilshire Securities Management.

Gregg Hillman - First Wilshire Securities Management

Those three new products that you mentioned sound pretty neat. Do you know what the price is for those products, typical prices for those three that you mentioned, Flipbook, Illuminotes and the LED-1?

Zev Weiss

There are different price points, and they range from $5 to up to $20. There are different degrees of technology in those. But they are generally higher-priced than our typical cards.

Gregg Hillman - First Wilshire Securities Management

And have they been fully rolled out, those three products you mentioned?

Zev Weiss

Yes, they have.

Gregg Hillman - First Wilshire Securities Management

Okay. And then just in terms of technology products in general, are they material to your sales at this point?

Zev Weiss

So I don't know how to define material. What I can tell you is, in terms of our overall offering, when you walk into our departments, the impact on the consumer varies in different doors depending on what the size of the department is, or the sales that are generated in that department.

But when you combine those three examples, and there are many others as well, we do believe that it has a significant impact on the consumer when they come into the store. And at the end of the day that's probably the thing that we care about most.

Gregg Hillman - First Wilshire Securities Management

What do you mean an impact? Do you mean they are drawn more towards the aisle and they might just look at the card because it would be interesting to look at and that would cause them to buy another card? Is that what you mean?

Zev Weiss

It's that and more. And I think when you go into the department we sign these cards in a way where they create a lot of impact. They are often fully faced, so we give them a lot of space in the display. And our hope is that in addition to buying that one card, then they continue to browse and buy other cards as well.

Gregg Hillman - First Wilshire Securities Management

Just the other thing about character development at your company. I know in the past you developed that Strawberry Shortcake character and it went on to become a children's TV show that's still running. Is that an area that you would like to emphasize, to produce more characters that people love and are, in effect, eventually licensable?

Zev Weiss

That's an area that we have invested in the past. On TV right now there are a number of characters in the marketplace, beyond just Kibbers and Strawberry Shortcake. Obviously those two are some of our biggest ones. But where we have invested, we have characters out in the marketplace today and you will continue to see us do that into the future.

So it is a very profitable and exciting part of our business and an important part of our business and I would expect to see that into the future.

Gregg Hillman - First Wilshire Securities Management

Okay. I want to ask you about licensing, too, your attitude towards licensing intellectual property from other companies. I think Hallmark is licensing Peanuts and some Walt Disney characters. How do you make the decision to license? And should you be doing more licensing of other characters for your aisles, or other, if you get my drift?

Zev Weiss

Yes, we do a significant amount of licensing, both in the juvenile market where we do that quite extensively, and also content in the general market that's outside of characters.

And our feeling is, wherever we can get the best content to present the best greeting card offering in the marketplace, we are going to get that content whether that's inside our company or if there are people that we can go to on the outside who can do some unique and exciting things for us, we will do that as well.

So we have quite a few partnerships on both sides of that part of the market. And I would expect that to continue in the future.

Gregg Hillman - First Wilshire Securities Management

So you're not biased against outside licensing?

Zev Weiss

Again, I think our focus is, let's put the best greeting card offering in the marketplace in front of our consumers. And wherever we can get that content, we will do it.

Operator

Our next question comes from Philip Lee with First Investors.

Philip Lee - First Investors

A few questions. One, can I infer from your Christmas comments that maybe things are positive so far into the Christmas season, although it's early? And then secondly, I heard Dollar General is going to be bringing your cards into half their stores. Could that be a meaningful benefit next year, maybe 3% or 4% of revenues for you?

Zev Weiss

I'll touch on the first one. As it relates to Christmas, the last three or four days are still important to us. But it's impossible to know how we are going to end up until we get through the last three or four days. And particularly with the way the timing works with a Saturday Christmas and how the weekend plays into it, it's just too early to know how we are going to end up. And I don't think it would be wise for us to share anything until we know how that all concludes.

On the Dollar General side, there have been some announcements that have been shared on their side about opportunities that we've picked up. Having said that, we don't comment on specific customers and accounts. And that's normal practice and we've got to continue that into the future.

So there's nothing that we can share on that.

Philip Lee - First Investors

And can you say at least in general within Dollar stores or even your typical channels, what percent of sales is greeting cards?

Zev Weiss

What I can say is that they have made some announcements and that obviously within their right to do that. But we are going to leave it at that at this point. If there are announcements that they have made that's fine, but we are going to stay away from sharing anything specific about the channel or specific customers.

Operator

(Operator Instructions) Our next question comes from Ron Gibbs with Platte River Capital.

Ron Gibbs - Platte River Capital

Could you discuss AG Interactive in terms of the size of the business, its growth rates, and how profitable it is? And then also what initiatives you're taking in terms of social networking and such to grow that business?

Zev Weiss

So the overall business is less than $100 million in sales. It is a very profitable business. Overall sales have been steady, and within that steadiness there are some areas that are up and there are some areas that are down.

There are a lot of changes as you'd expect that are going on in that business. And we think about that business not just from a revenue perspective but from an engagement, an overall consumer usage perspective.

And social networking is an area that right now there is quite a bit of engagement happening. There is not really a business model around that. So we're not necessarily generating a significant amount of revenue yet. But we're very pleased with the progress that we're making from a social networking perspective in terms of getting customers engaged in our product and engaged with our company.

And then, down the road, we hope to be able to translate that into opportunities to grow revenue, hopefully within our stores but also within the AG Interactive division.

Operator

(Operator Instructions) And it appears we have no further questions at this time. Mr. Steinberg, I'll turn the call back to you.

Greg Steinberg

That concludes the question-and-answer portion of today's conference call. We look forward to speaking with you again at our fiscal year 2011 fourth quarter conference call in April.

We thank you for joining us this morning and wish everyone a very happy holiday season. Thank you.

Operator

That does conclude today's conference. We thank you all for your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!