Greg Steinberg – Director of IR
Zev Weiss – CEO
Steve Smith - CFO
Jeffery Stein - Soleil-Stein Research
American Greetings Corporation (AM-OLD) Q1 2009 Earnings Call June 25, 2008 9:00 AM ET
Good day and welcome to the American Greetings first quarter 2009 earnings conference call. (Operator Instructions) I’d now like to turn the call over to Mr. Greg Steinberg; please go ahead sir.
Good morning everyone and welcome to our first quarter conference call. I’m Greg Steinberg the company’s Treasurer and I help manage our Investor Relations. Joining me today on the call are Zev Weiss our CEO and Steve Smith our CFO. We released our earnings for the first quarter of fiscal 2009 this morning. If you do not yet have our first quarter press release you can find a copy within the Investor’s section of the American Greetings website at www.invenstors.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 would 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 10Qs, 10Ks 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.
Thank you Greg and good morning everyone. This morning we will share with you our fiscal 2009 first quarter results. Overall we experienced mixed results during the first quarter. While I am pleased with our revenue performance particularly given current economic conditions, I am not pleased by the incremental costs that depressed our earnings.
Some of these cost pressures were anticipated and some were not. For example, we anticipated costs associated with the rollout of our new card line in Canada, but we did not fully anticipate increased costs of sales and distribution during the quarter. I will briefly comment on the items that affected performance and then share some comments on our photo acquisition integration and our full-year outlook.
With respect to revenues, I am pleased with our sales productivity at retail and point-of-sale performance. In North America our card sales increased in many accounts, the results of which were offset by the rollout of the new Canadian card line. In addition, we recognized increased revenues from our retail segment in our international segment. We have spent a lot of time and energy ensuring we get fresh, new products to retail and I believe we are seeing the results of those efforts as consumers are buying the product offering.
The creative excellence reflected in our cards was recently recognized by industry peers at the 20th Annual International Greeting Card Association Award ceremony last month. Eleven of our cards were selected as finalists and we took home five awards which honor the best greeting card and stationary products of the past year. We believe the awards are public recognition of our deep understanding of how consumers use greeting cards to express themselves and to emotionally connect with others.
As I mentioned in my opening comments one of the operational items we worked on during the first quarter was the rollout of our new Canadian card line. As we shared with you last quarter our products in Canada have historically been dual priced in both Canadian and US currencies. As many of you know, our prices are actually printed on the back of each greeting card. With the strengthening of the Canadian dollar the two price points on the back of the cards created some challenges in the marketplace.
To address these challenges we created a new product line for Canada which has caused higher costs in the quarter, costs which are transitional in nature not permanent. Steve will share some additional details around this transition when he reviews the financials with you. We currently expect to complete the rollout of the revised card line in Canada by the end of the second quarter.
Another significant activity of the quarter was the integration of the two recent photo-related acquisitions. Many of you are aware that as a way to expand our current product offering of online social expressions into the adjacent area of online photo sharing and photo personalized products, we acquired both Webshots and PhotoWorks in the second half of fiscal 2008. With respect to the integration process we are on time and on budget. The back office integration including the technology platform has been completed. We are now focused on developing products to enhance consumers’ online experience. Our photo strategy is designed to bring together the strengths of both the Webshots and PhotoWorks websites and then leverage the users across all of our existing websites.
Now let me share a few thoughts on our fiscal 2009 outlook. Most of your recognize that we are a seasonal business with a concentration of our earnings in our second fiscal half. With that concentration and in light of the weak state of the US economy, we are finding it harder then usual to predict consumer buying patterns around this year’s major winter holidays. Given the uncertainty around the consumers’ buying patterns and when we look at the balance of the 2009 fiscal year, the risks and opportunities lead us to view that our original guidance should remain unchanged, but we recognize that there is a higher degree of uncertainty in achieving that guidance.
To remind our fiscal 2009 guidance that we shared in April, was a $1.60 to $1.85 of diluted earnings per share and about $60 million to $80 million of cash flow from operating activities less capital expenditures. Now let me turn the call over to Steve who will provide a detailed review of the quarter and then we’ll take your questions.
Thanks Zev. I have three components to my prepared remarks for today. I will start with the summary of a few major items that impacted our financial statements this quarter. Second I will share a brief review of our reported segments and finally a quick walk-through of a few key components of our financials. We will then open the line for questions.
Overall our consolidated revenue performance from operations during the first quarter was essentially flat with the prior year. Our total revenue was up $8 million from last year’s first quarter or 2%. Included in our $428 million of net revenues was a benefit from foreign exchange of $7 million over the prior year’s first quarter. So holding aside the foreign exchange impact, revenue was up $1 million.
However our operating income was about $34 million lower then the prior year’s first quarter. The decrease in operating income was driven primarily by two factors within the North American social expression segment. First was the rollout of our new Canadian card line and second the lower yielding sales particularly in our seasonal cards. About $20 million or 60% of the increased costs associated with these activities was anticipated in our planning, the remaining 40% was not.
Let me examine both of these incremental costs drivers. As Zev mentioned in his remarks we expect the affect of the new Canadian line conversion to be completed in the second quarter of this fiscal year. As a result we expect the transition costs associated with this conversion to abate during the second half of the fiscal year. The Canadian line costs amounted to about $10 million in first quarter; $10 million of the $34 million of decline in operating income and these line conversion costs we all incremental versus the prior year’s first quarter.
The second driver was lower yielding sales particularly in seasonal cards. The lower yield is a result of a general mix shift towards cards with more content, such as music, and therefore lower margins. Lower yield also means higher distribution costs and increased scrap and returns. These costs are a continuation of some of the costs we discussed with you last quarter. The higher costs of content, distribution, scrap, and returns accounted for approximately $24 million of the $34 million variant in earnings versus the prior year’s first quarter.
Of that $24 million of costs, roughly $9 million was anticipated. Of the $15 million of unanticipated costs, we expect that the bulk will be ongoing, especially the costs related to the increased product content as we expect technology cards will be a growing part of our product mix. To offset some of these increased costs, we are working on productivity improvement projects.
Now I’ll shift to the second component of my prepared remarks which will be a review of our reported segment. Our North American social expression product segment revenues were down about $4 million versus the prior year’s first quarter. The revenue decrease was driven by a rollout of the new Canadian card line. The affect of implementing the new product line was a reduction in revenue and a temporary increase in expense. We expect the rollout to be completed during our second fiscal quarter this year.
Our North American social expression products segment earnings were down $40 million versus the prior year. The earnings deterioration was driven primarily by the items I just mentioned, mainly the rollout of the Canadian card line, higher content and distribution costs, and ultimately more costly sales.
Switching now to our international social expression products segment, revenues were $70 million, which is up about $5 million versus the prior year. This increase was driven by our European business. About one-half of the revenue increase was the result of a small recent acquisition. I will speak to the acquisition in a moment. The balance of the revenue increase was primarily a result of a comparison to a soft prior period. In the prior year’s first quarter, our European business executed some product resets that enabled new products to be brought to the shelf and temporarily lowered revenues.
Segment earnings improved about $3 million quarter-on-quarter, primarily due to this quarter’s increased sales. Within the international segment, we completed a small acquisition in the United Kingdom this quarter. While most of the terms of the transaction were not disclosed, we do report on our cash flow statement that we used approximately $16 million for cash payments for business acquisitions which represents the net consideration paid upon closing the transaction. We are excited about the newly acquired business as it gives us additional distribution in a fragmented UK market and we anticipate leveraging supply chain synergies over time. We do not anticipate the transaction will have a significant impact on our consolidated financial results. The financial impact was considered in our full-year guidance provided in April.
Moving to our retail segment, our retail store operations were able to increase same-store sales by 1% during the quarter. We ended the quarter with 417 doors, down 15 doors compared to the first quarter of last year. We will continue to evaluate our store base and close stores when it makes economic sense. Based on our current forecast, we still expect to close approximately 25 to 30 stores this fiscal year. Segment earnings were down about $600,000 compared to last year’s first quarter due to more promotional activity and higher in-store related costs.
For the quarter, our [internet] interactive segments revenues of $21 million were up $600,000 versus the prior year. This revenue increase includes about $3 million from our recent photo acquisitions offset primarily by lower advertising revenues in our legacy online business. Segment earnings were down about $4 million primarily as a result of the photo acquisitions. As a reminder, the photo business is seasonal in nature with improved margins expected in the second half of the year. The $4 million decline includes about $1 million of amortization of intangibles associated with the photo acquisitions.
Let me shift gears now and explain the status of our licensing performance. Licensing revenue for the quarter, which is reported as other revenue, was about $3 million, which is up almost $1 million versus the prior year. Licensing expenses were about $5.7 million, which is up about $2.3 million versus last year. So for the first quarter the company’s net licensing effort, revenues less expenses, incurred a loss of about $2.7 million, which is down about $1.3 million from the prior year’s first quarter. The change was principally driven by ongoing investments to support existing properties and to develop new properties.
Now let me move from the segment analysis to the third component of my comments today; a review of the key financial statement items. The company’s manufacturing labor and other production costs or MLOPC, were up $32 million compared to last year’s first quarter. This increase was driven by increased costs within our card business, especially within seasonal card activities. As I mentioned earlier, these costs include higher content costs associated with cards that have music and light, higher scrap costs as our sell-through fell below planned levels, and costs associated with the introduction of the new Canadian card line.
Selling, distribution and marketing costs were up $10 million versus the prior year’s first quarter. As mentioned earlier, we incurred substantially higher freight and distribution costs related in the quarter as we shipped more pieces into the field and incurred the supply chain costs associate with those activities. The administrative and general expenses were essentially flat versus the prior year’s first quarter.
Moving down the income statement, the next item I will address is taxes. Our effective tax rate was 30.7% this quarter. During the quarter we recognized a benefit as a result of an amending of a prior year’s returns in foreign countries. We are still expecting a full year effective tax rate to be in the mid to upper 30%.
Let’s now shift gears from our review of the income statement and take a brief look at our balance sheet and cash flow statements. On our balance sheet you will see that our net deferred costs decreased $42 million from about $379 million a year ago, to about $337 million at the end of the first quarter. The four line items of deferred costs on our balance sheet at the end of the first quarter were: (1) prepaid expenses of $110 million; (2) other assets of $327 million; (3) other current liabilities of $71 million; and (4) other liabilities of $29 million.
The second item on our balance sheet that I would like review is inventory. Inventory is about $20 million higher then the prior year. There are two primary drivers of the increased inventory. First the higher cost technology cards I mentioned earlier, and second we are carrying more scan-based trading inventory versus a year ago as more accounts are under the scan-based trading model.
On our cash flow statement let’s look at one item, capital expenditures, for a moment. The company spent about $10 million this quarter which is slightly above the prior year’s first quarter investment of $6 million. We still expect to spend $50 million to $70 million on capital expenditures this year with the higher end of the band driven by possible spending on information technology.
That concludes our prepared comments for today. I would now like to open up the call for questions.
(Operator Instructions) Your first question comes from the line of Jeffery Stein - Soleil-Stein Research
Jeffery Stein - Soleil-Stein Research
I’m wondering if you could just discuss what percent of your greeting card revenues today are technology cards versus let’s say a year ago at this time and secondly if some of these costs are going to reoccur over the balance of the year, why are you still so confident that you can make your initial earnings guidance range?
So the percent for the technology cards is less then 5%. Last year, I don’t know the exact number, but it was much lower then that. We had a small amount out, but very little. On the cost side in terms of why we still feel confident on the year, some of these costs were anticipated so they were in our original guidance and in our plans. Some of them were not, which means we’ve got to make that up either through, on the sales side or find cost savings through the balance of the year and the management team is very focused on that and so we feel confident that we can do that.
Jeffery Stein - Soleil-Stein Research
If you were a betting person Zev, where do you think it’s more likely to come from; cost save or revenue?
Well first of all, I’m not a betting person. Actually unlike I’d say previous years where it was definitely coming from the cost side, looking at what’s happening with point-of-sale, I think it’s going to be a combination of both.
Jeffery Stein - Soleil-Stein Research
Can you talk a little bit about the interactive side of the business, you did cite the fact that you are, that you did see lower revenues from advertising and I’m wondering, is this part of an industry trend or is this AG interactive specific?
I think that there may be some shifts happening in the industry in general, but I think by the time this year is done, we feel that we’ll be able to bring in that revenue line where we had expected and it just was a soft first quarter for them.
Jeffery Stein - Soleil-Stein Research
With regard to Canada, can you share with us your best guesstimate in terms of what types of costs you may incur in the second quarter as you complete this rollout compared to what you incurred in Q1?
It would be low single-digits. We’re mostly through that and there’s a little bit left, but its low single-digits.
We have no other questions in queue; I’d like to turn the call back to Mr. Steinberg for any additional or closing comments.
That concludes the question-and-answer portion of our conference call today. We look forward to speaking with you again at our second quarter earnings release, which is anticipated to occur in late September. We thank you for joining us this morning. This concludes the conference call.