Consolidated Graphics F1Q09 (Qtr End 6/30/08) Earnings Call Transcript

Consolidated Graphics, Inc. (CGX)

F1Q09 Earnings Call

August 6, 2008 11:00 am ET

Executives

Alexandra Tramont - FD

Joe R. Davis - Chairman of the Board, Chief Executive Officer

Jon C. Biro - Chief Financial and Accounting Officer, Executive Vice President, Treasurer, Secretary

Analysts

Charlie Strauzer - CJS Securities

Afton Agrannel - Longbow Research

James Clement - Sidoti & Company

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the CGX first quarter fiscal year 2009 conference call. My name is Nora and I will be your coordinator for today. (Operator Instructions) I would now like to turn the presentation over to your host for today’s conference, Mrs. Alex Tramont of FD. Please proceed.

Alexandra Tramont

Thank you and good morning. Welcome to the Consolidated Graphics conference call. During the call, management will discuss the company’s results for the quarter ending June 30, 2008. You may receive a copy of today’s press release by calling FD at 212-850-5600, or by visiting Consolidated Graphics’ website.

The conference is being broadcast live on the Internet at www.cgx.com and a subsequent archive will be available.

Before we begin, I would like to remind everyone that remarks made by management during the course of this morning’s call contain forward-looking statements which involve known and unknown risks, uncertainties, or other factors that could cause actual results to differ materially from results, performance, or other expectations expressed or implied by these forward-looking statements.

Consolidated Graphics’ expectations regarding future sales and profitability assume, among other things, continuing weakness in the economy and reasonable demand for its products, the continued availability of raw materials at affordable prices, retention of its key management and operating personnel and satisfactory labor relations, as well as other factors detailed in Consolidated Graphics’ filings with the Securities and Exchange Commission, including the risk factors set forth in our most recently filed annual report on Form 10-K.

The forward-looking statements assumptions or factors stated or referred to on this call are based on information available to Consolidated Graphics as of today. Consolidated Graphics expressly disclaims any duty to provide updates to these forward-looking statements, assumptions, or other factors after the date of this call and to reflect the occurrence of events, circumstances, or changes in expectations.

In addition, during the course of this call management of the company may make reference to certain non-GAAP financial performance measures. Management’s opinion regarding the usefulness of such measures together with the reconciliation of such measures for the most directly comparable GAAP measures for historical periods are included in the company’s previous filings with the Securities and Exchange Commission.

Now, with these formalities out of the way, I would like to turn the call over to Joe Davis, Chairman and Chief Executive Officer. Mr. Davis, you may begin.

Joe R. Davis

Thank you and good morning. With me on the call today is Jon Biro, Executive Vice President and Chief Financial. This morning we released our June quarter results. Our results were significantly below our original guidance and as a result, on July 23rd, we announced our preliminary results. Our results for the June quarter include revenue of $285.2 million, up 10% compared to $258.6 million for the same quarter a year ago.

The growth in sales compared to the first quarter of last year was primarily due to our recent acquisitions and election related printing, which will continue to ramp up as the year progresses. These sales increases were partially offset by a decline in our same-store sales.

Acquisitions continue to be a meaningful contributor to our growth strategies. As you know, we acquired three first-class companies last year, including PBM Graphics, Cyril-Scott Company, and Pikes Peak. Acquisitions contributed $31.9 million to our sales for the first quarter compared to the prior year. All of these acquisitions broadened our service offering and added value to the entire CGX network.

For the first quarter, our same-store sales were down 2.1%, including election related business, and this decline was greater than we assumed for our original earnings guidance. We are seeing an impact on our sales volumes and selling prices resulting from the current weakness in the U.S. economy.

We continued our cost control efforts during the first quarter and succeeded in keeping most of our variable costs, including labor costs, in line with sales volumes. The decline in sales volumes and weaker prices, as well as lower margins from recent acquisitions, had a negative effect on our operating margins during the quarter. Adjusted operating margin, which excludes last year’s foreign currency gain, declined to 7% from 8.7% last year.

One very bright spot in our business is the fact that revenues from digital printing grew to approximately $30 million in the first quarter, representing about 10% of our overall revenues. This represents an increase of over 150% from last year’s first quarter. We expect this part of our business to continue to grow at a healthy pace.

Last year, we invested $21.5 million in digital printing presses and related technology and recently entered into an agreement with HP to purchase up to 36 additional Indigo digital presses. The majority of these presses will be for a significant photo book printing operation. Photo specialty printing, which includes photo books and similarly digital printed products, is the fastest growing segment of HP’s digital press business. We believe that Consolidated Graphics has the largest fleet of high-speed digital presses in the commercial printing industry, both in terms of units and strategic locations, and we expect to continue to invest in digital technology to satisfy our customers increasing demand.

Another bright spot is the introduction of Storefront 2.0. This new proprietary software, designed by CGX Solutions, will eventually replace Storefront 1.0. We plan to bring this new application to the market during the December quarter. This new software will be much more user friendly and will offer customers enhanced capability to utilize variable data for their printed materials. We expect this software to help us continue to grow CGX Solutions sales and allow us to further leverage our digital print infrastructure.

Today we have 342 active storefront sites, an increase of 23% compared to the number of sites we had last year.

Beginning with our annual meeting on Thursday of this week and through the weekend, we are having our annual associates meeting. This meeting is part of our leadership development program and we will remain very committed to this program. Every year we hire recent college graduates and put them through a three-year training program to teach them the printing industry. I firmly believe that these technology savvy and hard-working associates will be instrumental in our long-term growth and represent a significant competitive advantage for Consolidated Graphics. Today we have 354 associates in the program, including 73 people we hired this summer.

While we cannot predict what the economy will do in the coming quarters, we do believe we have several competitive advantages during times of economic weakness. First, the development of our strategic sales platform, which includes our national sales of CGX Solutions, differentiates us in the market and allows us to mitigate some of the volatility associated with the cycle of our regular local business.

With our nationwide footprint, 70 companies in 27 states and Canada, and our wide variety of capabilities, including our technology solutions, we can become a more cost-effective and value-added one source solution for our customers.

In times like we are experiencing today, businesses are focused on optimizing the supply chains and we believe our offerings provide the solutions these customers are looking for.

Second, because we are strong financially, we will be able to maintain our high level of quality, reliability, and customer service, allowing us to weather economic difficulties better than our weaker competitors. Our financial strength also affords us the opportunity to continue acquiring high quality printing businesses on reasonable terms.

Third, we will continue to make investments in equipment and technology to meet the ever-increasing demands of our customers and continue positioning our business for the long-term. These attributes position us well in all economic conditions and should continue to support our long-term business growth.

I will now turn the call over to Jon Biro to provide you with additional financial information. Jon.

Jon C. Biro

Thank you, Joe and good morning. As a reminder, earlier this morning we filed with the Securities and Exchange Commission the basis for our use and reconciliations of certain non-GAAP financial measures, including adjusted operating income, adjusted operating margin, adjusted EBITDA, adjusted EBITDA margin, and free cash flow. Please refer to this filing for additional information.

As Joe mentioned, the decline in sales volume and a weaker pricing environment had an adverse effect on our operating income and margins. Operating income was $20 million during the first quarter and operating margin was 7%. This compares to adjusted operating income and margin after removing the foreign currency gain last year of $22.4 million, or 8.7% of revenues.

Incidentally, the foreign currency gain is included in the other income or expense line on the face of our income statement.

Adjusted operating income declined 11%, or $2.4 million year over year and adjusted operating margin was down by 170 basis points. Much of the decline in operating income was caused by a drop in gross margins, which were down from 26.4% last year to 24.8% this year. Some of the forces coming into play that caused this drop include lower gross margins generated by our recent acquisitions relative to our base business, the effect of lower sales volumes, and less favorable selling prices, as well as continued start-up costs associated with our digital print business as this business continues to ramp up.

Lower operating income yielded lower net income of $9.6 million, compared to last year’s first quarter of $11.6 million, again excluding the foreign currency gain.

Fully diluted earnings per share were $0.84 for the June 2008 quarter compared to last year’s fully diluted earnings per share of $0.82 excluding the foreign currency gain.

Clearly we are now seeing the benefits of our share buy-backs last year on our earnings per share.

Our adjusted EBITDA improved year over year to $37.6 million from $36.4 million for the prior year quarter, an increase of 3%. Free cash flow also increased to $29.5 million, compared to $24.5 million a year ago, an increase of 20%.

We continue to have a very strong balance sheet and have substantial capacity to make the necessary investments in our existing business and for acquisitions. During the quarter, our free cash flow allowed us to reduce our long-term debt by $21.3 million. At June 30th, our total debt outstanding was $364.1 million, consisting of $255.9 million of floating rate bank debt bearing average interest of 4%, and $108.2 million of fixed rate debt bearing average interest of 5.6%.

Cash on hand was $19.2 million at the end of the quarter.

Capital expenditures in the June quarter totaled $8 million and we expect 2009 capital expenditures to be roughly $65 million, approximating our annual depreciation and amortization expense.

Looking forward to the September quarter, we expect revenues of between $290 million and $300 million, and diluted earnings per share of between $0.85 and $0.95. Our September projections assume, among other things, a year-over-year same-store sales decline excluding election related business of between 3% and 5%, a competitive pricing environment, high share based compensation expense relative to the prior year, and an effective tax rate of approximately 40% for the quarter.

Including election related business, we are assuming a same-store sales decline of between 1% and 3% in our projections.

I will now turn the call back over to Joe.

Joe R. Davis

Thank you, Jon. Operator, we’re now available for any questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Charlie Strauzer of CJS Securities. Please proceed.

Charlie Strauzer - CJS Securities

A couple of questions -- Joe, can you give us a little bit better sense of kind of the back half of the year? I know you don’t give full year guidance but just give us a sense of if we kind of say -- see the same kind of economic downturn kind of linger throughout the year, what kind of assumptions should we build into our models?

Joe R. Davis

I guess the best way to look at that is we have some segments of our business, mainly healthcare and some photobook business and election business that tend to be heavier in the last half of the calendar year. In the March quarter, we tend to have things like annual reports and annual reporting that make the March quarter strong. But the last half of the year, particularly the September quarter and the December quarter are impacted by things like election business and some consumer product business like photobooks and others.

Charlie Strauzer - CJS Securities

And then Joe, if you look at the PBM acquisition, I know you were disappointed with the Q1 contribution. Are you seeing that business pick up? Are bookings for the -- heading into the key selling season picking up as well?

Joe R. Davis

Actually, seasonally that business is stronger in the September quarter, a little bit in the December quarter than earlier in the year. It’s a larger company and our operations have actually improved compared to where they were prior to us owning the company on a comparable basis in the June quarter. We are very pleased with what’s happening to that company. We’ve got a lot of new business going there and we expect that company to be a strong contributor to Consolidated Graphics and we expect a lot of that contribution to come in the September quarter.

Charlie Strauzer - CJS Securities

Got it, and then Jon, just for you, some of the additional assumptions to build into Q2, I’m not sure if you said this but interest rate assumptions for Q2, also what you expect non-cash comp expense to be in the quarter.

Jon C. Biro

Interest should come in around $4 million for the quarter and share-based compensation is going to be $1.8 million.

Charlie Strauzer - CJS Securities

And how should we think about that for the rest of the year? Do you think that share-based comp should be coming down in the second half of the year?

Jon C. Biro

It should be fairly consistent, actually, for the balance of the year.

Charlie Strauzer - CJS Securities

Got it. And then Joe, lastly just on share buy-backs, company buy-backs versus maybe your thoughts on buying back stock personally. I know you had sold some stock a couple of years back but the stock kind of depressed. Have you thought about maybe revisiting your personal holdings?

Joe R. Davis

Well, I’ll address the company first. Our loan agreements with our banks as they currently stand don’t permit us to buy back additional shares at this time. That’s not to say that we may not plan to review with the banks our ability to buy back shares but currently the company is prohibited from buying back shares.

I am from time to time looking at additional investments in the company myself and certainly at these levels, it seems to be a very attractive opportunity. I’d have to find the cash to do that with.

Charlie Strauzer - CJS Securities

Thank you very much for taking my questions.

Operator

Your next question comes from the line of Afton [Agrannel] of Longbow Research. Please proceed.

Afton Agrannel - Longbow Research

Can you provide sales contribution from your strategic sales segment as a percentage of total sales?

Jon C. Biro

We’re not going to disclose that except to say that the growth was good again this year. We’re reassessing how we are going to present that information. We’ve mentioned before that there is some classification issues in that data and we think it’s becoming large enough that we need to revisit how we are presenting that information. That’s what I can tell you at this point -- the growth continues probably around double-digit growth but we’ll have to leave it at that at this point.

Afton Agrannel - Longbow Research

And when you are talking about double-digit growth, is it similar for CGX Solutions and as well as national sales, or there’s a little difference there?

Jon C. Biro

I would say so, yes, both growing very nicely year over year.

Afton Agrannel - Longbow Research

Okay, all right. My second question is when you look at your acquisition pipeline, how many of the potential targets would you categorize could contribute revenues of more than $100 million?

Joe R. Davis

Well, we have never broken that down but I would that there are very few $100 million general commercial printing companies that would fit our profile, acquisition profile. There are a few and we’ve certainly made one over $100 million in the history of the company. PBM was $135 million acquisition revenue. Prior to that, [Henning & Company] was $85 million was our second-largest company. But there are not that many companies of that size, so our average sized company today is about $15 million revenue.

So we look at a lot of companies from $10 million to $20 million, $25 million revenue and we look at a few larger ones, but our acquisition pipeline is still well over $500 million and we are still having a lot of discussions with a lot of really fine companies and we are not slowing down that effort at all.

I guess in this economic climate or this banking climate, we have available bank lines of credit, Jon, of --

Jon C. Biro

Roughly $140 million.

Joe R. Davis

-- $140 million to achieve that and that gives us -- it seems to me it gives us a very competitive advantage in the marketplace. When we talk to a company owner, we don’t have to say well, we’ve got to go see if we can borrow this money and maybe we can do this and maybe we can’t but we say that we have the credit available and we can close the transaction in a very short period of time -- 30 to 45 days, in many cases.

Afton Agrannel - Longbow Research

Okay, great. That’s all the questions I had. Thanks.

Operator

(Operator Instructions) Your next question comes from the line of James Clement of Sidoti. Please proceed.

James Clement - Sidoti & Company

Joe, a follow-up question to the last one with respect to acquisitions -- over the last two years, the vast majority of your acquisition dollars have gone to companies that were either niche in focus or just sort of well beyond what is a traditional small sheet-fed half-web type of printer. You know, whether it’s the Pokemon books or whether it’s direct mail or whether it’s Hennigan, which is sort of its own entity -- are we noticing the beginning of a trend here? Is the acquisition strategy going forward, is the idea more to look for new product lines to offer or companies that have either maybe more of a national or regional focus away from that sheet-fed local business? I’m just curious what your thoughts are.

Joe R. Davis

Well, I think we are going to look at companies where we think we can improve those companies dramatically. For instance, in the Cyril-Scott company in Lancaster, Ohio, that company has some very unique capabilities, all inline finishing capabilities, and had a lot of under-utilized assets and 19 presses. We have 650 sales people around the country who had never been able to sell into that sort of market, so we are able to take that company, bring a lot of business to it from our 650 sales people across the country, so the potential return on our investment is greatly increased, but we can increase the volume of that company.

I’m pleased to say that yesterday, we have 14 of the 19 presses running -- the first time that many presses had been running in a long time. The very unfortunate thing is we had five customers in there who had an electrical fire that shut us down for a short period of time, but we are back up and running yesterday afternoon. We’ve got a great staff there. Accidents happen but how you recover from them is the most important and we don’t think that’s going to have any significant negative financial impact to us.

So we like to find companies where we believe we can bring something to the party, and yes, there might be some operations that we don’t believe we can bring very much to for various reasons but we like to see those that we can grow and think we can help develop those companies.

James Clement - Sidoti & Company

Okay, thanks very much. The other question is about the photobook business, and just from your prepared remarks and with respect to guidance, I was a little unclear on this -- were you all saying that you expected a ramp in this business during this September quarter or were you talking more several quarters out, or maybe even a combination of both?

Joe R. Davis

Well, we have more than -- we have several customers in the photobook business and we are seeing increased demand in that business throughout the year and we would expect more in the peak holiday period, and that typically would be in our December quarter. We are experiencing -- I think we said we have over 150% increase in revenue in our digital business this quarter, as compared to last year. And we sort of are cautious in saying over 150% because we don’t have data for all 70 companies, unfortunately. But extrapolating, we’re comfortable with that 150%, over 150%.

So this business is greatly improving, it’s growing and we have increased demand from our customers to be able to service them even greater with continued capital investment in that business, continuing to grow that business.

James Clement - Sidoti & Company

Let me just -- the last question and Joe, I think this is something that has popped up around the story over the last two weeks and obviously there’s some other print related companies out there that are talking up cost cutting and that sort of thing. How do you feel about your asset base in terms of the 70 companies? Do you feel that is the right number of businesses to have? Do you feel that over time with your investment in digital, where that business can travel a little bit more, that there are some opportunities to consolidate some facilities? What are your thoughts on that long-term?

Joe R. Davis

My thoughts on that is that we have 70 now. We’ll continue to increase the number of companies we have, locations. Consolidating printing businesses, my experience has not been very positive over a long-term basis. In a short-term, yes, perhaps. But over a long-term basis, that doesn’t work too well for me. It may work for other people. It doesn’t work very well for me.

So I see we have a lot of very local customers -- even our national customers want to be serviced locally, so I don’t see much benefit for us to be derived from taking two profitable companies and putting them together. And historically, we’ve had a lot of companies -- we said we’d merger companies. You know, that’s good PR. The truth is, we’ve taken a company that wasn’t doing very well, maybe at the end of its lease or some real estate issue and merged those companies. But that’s not our strategy.

James Clement - Sidoti & Company

Joe, that’s very fair and I wanted to ask the question because there are a lot of other print related companies out there that engage in a lot of different print lines of business that are not the same as yours and I wanted to give you the opportunity to respond to that. Thanks very much.

Joe R. Davis

The other thing that I would say when you say digital, that’s a little bit different business and you say it travels a little better, and we are developing some large digital hubs in a couple of places around the company. Actually, we are doing it in three locations today. I’ll say large digital hubs and we are going to have digital capabilities at each of our companies but if somebody comes in and wants 15 million clicks in a two-week timeframe, we’ll be engaging our large digital hubs to achieve that result and we do have that sort of demand.

James Clement - Sidoti & Company

Okay. Thank you very much for your time.

Operator

We have no further questions. I would like to turn the call over to management for closing remarks.

Joe R. Davis

Okay. Thank you. We certainly appreciate the continued support of our customers who are very, very important to us; our employees, our shareholders, and we look forward to reporting to you on the September results. Thank you for your interest today.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes your presentation and you may now disconnect. Good day.

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