Antero Midstream Corporation (AM) Q3 2010 Earnings Report, Transcript and Summary

(Operator Instructions) Welcome to the American Greetings Corporation Third Quarter 2010 Earnings Conference Call. At this time I’d like to turn the conference over to Mr. Greg Steinberg.

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 third quarter fiscal 2010 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 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 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.

Today I will cover three topics. First, I will share my thoughts on our fiscal 2010 third quarter including a few of our new and innovative product offerings. Second, I’ll provide a brief update on the status of the Recycled Paper Greetings and Papyrus integrations. Finally, I’ll share a few directional comments on our outlook for the balance of fiscal year 2010. Steve will then present more details behind our third quarter financial results. For a third consecutive quarter I can state that I’m pleased with our quarterly performance. While revenues are down from the same quarter last year they are not down as much as we expected. However, our operating income improved meaningfully over last year, putting aside for a moment the unusual charges incurred both this year and last. In addition, our year to date cash flow from operations less capital expenditures of $53 million exceeded our expectations. During last quarter’s call we shared that the strategic investments we made over the last several years to enhance our leadership position in the greeting card category may have contributed to the improvements in our performance. I think this quarter’s results continue to support that assertion. Our yield, also called sell through, has improved compared to last year. I believe the improvement is partially due to our strategy to consistently develop new products that offer the consumer unique and fresh offerings that resonate with them when they shop the greeting card aisle. One of those unique brand offerings is our exclusive partnership with Country and Pop Music star Taylor Swift. Miss Swift has chosen to personally work with our editorial and creative teams to create a line of greeting cards, gift packaging, stationery, online photo personalization products, and online greetings. Each product will be infused with her creative touch. The…

I have three sections to my prepared remarks today. I will start with comments on a few large 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. As Zev mentioned, we had a good third quarter. There were three primary reasons driving our improved performance. First, the benefits of achieving better yield, including lower supply chain and scrap costs. Second, the change in our business portfolio, especially the sale of our retail operations. Third, the reduced overhead costs due to the actions we took at the end of the last fiscal year. Our consolidated revenue of $440 million was down about $14 million or 3% from last year’s third quarter revenue of $454 million. However, included in our reported revenue this quarter was the adverse impact from foreign exchange of $3 million versus the prior year’s third quarter. So, holding aside the foreign exchange impact, revenue was down about $11 million or 2.4%. About $3 million of the $11 million decline was the result of the net revenue lost due to the combination of the divestiture of the retail business partially offset by the revenue pick up from the RPG and Papyrus acquisitions. Holding aside both, the impact of the foreign exchange as well as the net impact of the transactions revenue was down approximately $8 million or about 1.8% for the third fiscal quarter. Our operating income of $42 million was about $265 million better then the operating loss of $222 million in the prior year’s third quarter. However, this year’s operating income included both pre-tax employee termination costs and estimated impairment costs of $6 million associated with the…

(Operator Instructions) Your first question comes from Jeff Stein – Soleil Securities

Can you talk a little bit about the dilutive effect that stock options might have on the fourth quarter and full year share averaging due to the rise in the share price? Based upon your best guesstimate and why don’t we say that if the stock were to trade at these levels for roughly the remainder of the quarter.

We haven’t given specific line item guidance on that item but there is some dilution that it be in the millionish kind of share range, putting downward pressure then on diluted EPS.

This would be for the fourth quarter?

For the fourth quarter.

As you know, that’ll depend on both share price as well as the level of earnings in the quarter that then has an effect on the amount of dilution that’ll show up in the quarter as well.

I’m wondering if you could talk a little bit about what success you’ve had thus far in gaining new shelf space for both Papyrus and RPG in existing accounts and if in fact you have so far, are you gaining incremental space or is it cannibalizing existing space?

Right now what’d I’d say is there’s a lot of interest in the marketplace. A lot of the retailers we talk to recognize that there is strength in that product and that there’s potential. There have been some moves, not a lot, some moves in terms of replacing some of the AG space with some of that product. That’s been most of it; I think for the most part right now there’s definitely some interest. Again, if you look at what’s happening a lot of it has to do with some of the AG product in the AG space may be transitioning over to some of that product as well.

It sounds like at this point it’s mainly a substitution.

Yes, again I think that there’s interest but the selling process of these things are often long. It remains to be seen.

It sounds like you guys have some really exciting new product and technology cards. I’m wondering at this point if you can maybe share with us the number of skus of technology cards that you have in your stores, let’s say your average mass retail stores, let’s say a Target or a Sears or Wal-Mart compared to prior year and what this mix is doing to average retail selling price.

If you go out to retail you could actually see this now out at retail. In terms of the footages it ranges obviously depending on the size of the store, but it wouldn’t be unusual to see a four or in some cases maybe an eight foot statement in the everyday section. Then in seasons it depends on the seasons but if you go out and look at what’s out at Christmas right now especially in some of the larger departments it would not be uncommon to see something in the two foot range in terms of product for Christmas. That would go up and down depending on how strong we thought that holiday was relative to the technology products.

How would that compare to prior year?

From a footprint perspective it’s not a whole lot different then where we were last year. What you’re seeing is the type of product is evolving from really being cards that played music. If you go out and see what’s at Christmas although the truth you’d see probably a lot of it sold down at this point, you see a lot of that moving towards product that doesn’t just play music, there’s recordable features to it, there might be movement, lights, or some kind of a three dimensional aspect to the product. That’s all products that have been selling over the last four weeks or eight weeks for this holiday period.

In terms of getting the type of sell through you’re getting on these cards, when you look at the productivity of this space relative to your paper and ink cards, would you say that it is more productive, I presume its more productive because its higher price point but are you getting more gross margin dollars out of that space then you were a year ago?

I wouldn’t necessarily get into the gross margin aspect of it, what I would say is from a productivity perspective in terms of what its doing out at retail we feel very good about it.

Relating to PhotoWorks, this would be the company’s big quarter I presume and I’m wondering how you’re feeling about that business this year relative to a year ago when the business was not performing very well.

I would say that we definitely feel better then we did a year ago. We redid the site in the fall and both the look of the site and the functionality as well as the product offerings we’re very pleased with the response we’re getting from consumers has been very strong. Overall we feel good. If the marketplace remains a little bit challenging just in terms of the price points of what is out there and what the market is willing to bear I think given the economic times, it remains to be a very competitive environment. If you get a chance to see the site I know you do that, the site looks terrific, the product looks terrific, we’re getting good response from customers both in terms of the activity but more importantly the feedback that we’re getting has been excellent.

Fourth quarter last year your retail revenues were about $65 million. How should we be thinking about the loss of those revenues relative to what you’re going to pick up from RPG and Papyrus? I presume that given the fourth quarter is a heavy quarter for retail normally the negative impact would be greater in Q4 then we saw in Q3.

We haven’t forecast that specific line item. Year to date we’re roughly flat between the two but your logic is correct as it relates to the seasonality of the two different businesses. I would say you’re correct in your assumption.

Your next question comes from Mimi Noel – Sidoti & Company

Would you remind me what the impact to operations from RPG and Papyrus was, did it yield a loss this quarter?

The combination of the two businesses actually wasn’t a loss in the quarter it was slightly positive a couple million dollars. The loss that you might be referring to was related to the prior year loss associated with our Carlton Retail operations which we divested.

When you acquired RPG and Papyrus it was operating at a loss, they were operating with losses and you haven’t begun any kind of integration so to what can I ascribe the improvement?

I think what you’re seeing is some slight improvement related to some of the supply chain aspects that we were able to take on very quickly. A lot of the integration it will take time but there’s certain things that you could jump into right away where there are contracts that AG has that could apply to the new businesses. You’re able to pick up a couple million from that.

Would you remind me what your priorities for free cash flow are and can you give me an idea of what degree of urgency do you have with regard to deployment of that cash flow?

What I’d say is probably consistent with what we said in the past. Our primary goal has always been a very conservative balance sheet. That overall philosophy is from a long term perspective is something that we’ll continue to aspire to and want to maintain. Beside that we’re going to look for growth opportunities and we’ll look in our card business and we’ll look in the interactive side. As we’ve often talked about, our world is not that big, relatively episodic, when they happen they happen. It’s not so much from a sense of urgency to our part we have a high sense of urgency to grow both organically and through acquisitions, those two categories. If the opportunities come up we’re going to want to do them. Beyond that we look to return cash to shareholders in both dividends and stock buy backs have been things that we’ve been very comfortable with in the past and we’ll continue to evaluate those in the future. I think that’s the way we’ve thought about it for the last number of years and I think it remains pretty consistent to where we are right now.

Do you have any sort of perhaps internally, minimum thresholds for ROE for example, where you’d want to keep certain degree of leverage on the balance sheet. Do you have an idea of where your balance sheet is most efficient, never mind conservative?

I think we appreciate the point that if you’re too underleveraged it may not be efficient enough. I think we want to find a good balancing point around that. We don’t have an exact number. We feel that because we want to be prepared for growth opportunities as they’re presented its important that we’ve got flexibility. We don’t want to be in the position where an opportunity presents itself but we don’t have the flexibility to act on it. I think it’s a balancing point between understanding the inefficiencies of being too underleveraged; at the same time want to be able to act when we need to.

Your next question comes from Brian Carlton – Atlantic Investments

I saw the press release yesterday with regard to your association with Amscan and it seemed like from that press release there was a payment that American Greetings would receive, something like $25 million, am I remembering that right?

That’s correct.

Is that included in the free cash flow guidance?

No its not.

With regard to how we try to think about 2011 just a couple of points. Variable comp obviously is running pretty high because the sales has outperformed while costs have come down. You called that out as $12 million in this quarter and I guess probably there’s some amount of that in Q4 as well. That’s normalized next year. If I’m remembering correctly the acquisition occurred in February and April so we’ll be on the other side like improving base operations but on the top line they will be included for most of next year. Again, I’m trying to make sure that I understand the year over year changes potentially here.

I think the history of what you’re saying is factually correct. In terms of how that will apply to next year and all the other moving pieces around it I know this isn’t what you want hear but it really is too early for us to be talking about what happens next year. There’s still a lot that has to happen this year and then there’s lot of work going on our side from a planning perspective.

The tax rate going forward we should be comfortable with mid 30’s is that reasonable?

That’s reasonable. We typically give a little bit of a hit of what we think the next quarter might be but we haven’t been that accurate frankly historically in our predictions of future effective tax rates so we’ve shied away from long term forecasts. Our team has worked pretty hard at maximizing the cash component of our tax effort and we’ve been successful at doing that this year.

You mentioned stock options maybe would be $1 million dilutive in the fourth quarter. If I think about a full year though does that mean $4 million dilutive?

We really have to defer on that one because it really is dependent on stock price and so the near term again we might give a little bit of guidance but going out a full year is tough.

If I look at the change in share count, you’ll have to forgive me for not having enough history, were there significant buy backs within the last year?

There were buy backs in January and over the last four years have been quite a few.

I wonder if perhaps you could speak a little bit about how retailers are approaching the card category overall. Walgreen’s obviously is going through some trial resets now where I think that they’re shifting some space maybe away from some cards and towards food. I wonder about Wal-Mart and some other big retailers, what their perspective is towards cards and how they’re managing that and how you manage in that kind of environment.

I think there’s always some moving. When you look a the changes at retail its hard for them to happen quickly so they don’t move at a rapid rate because its the kind of thing where you’ve got to really rearrange almost the entire area in order to execute those changes. If you were to add up the plusses and the minuses there are some retailers who are making changes in their store who might be reducing cards, they’re probably just as many who are expanding cards. From an overall footage perspective it’s just a question of which retailers have what commitments to which categories.

Do you see yourself gaining versus competition, versus Hallmark for example?

You mean going forward or historically?

Going forward. As retailers adjust and as you have more offerings available can you be a bigger presence as a percentage of total space in the card space?

Clearly that’s our hope. The changes that happen at retail they happen in a relatively slow pace just because of the long term relationships that often supplies have with retailers and also the difficulty that sometimes it entails in terms of moving departments. Clearly our hope is to gain space. When that happens it happens episodically and it happens over a long period of time.

Your next question comes from Jeff Stein – Soleil Securities

How about the tax rate for the fourth quarter, any thoughts there?

We expect the tax rate to be slightly below our statutory rate for the fourth quarter.

Talking about the Amscan transaction yesterday, wondering if you could give us a little bit of insight in terms of what you would expect the earnings per share impact to be on a go forward basis?

When you take a big step back it shouldn’t have a big shift one way or the other. In the short term there may be some revenue that was going into some of the channels that we were selling into and the margin associated with that, that’s lost. The hope is in the longer term that we make that up with either additional revenue in the other channels through some of the new products that we’re able to sell or some of the efficiencies that we’re able to gain as part of the transaction.

Can you tell us roughly what the annual revenue run rate of this segment is?

No, we’re not looking to get into that. I think overall these are not huge numbers.

The $25 million would you expect to capture that before the end of the fiscal year?

Yes we would.

I presume the charges you will take associated with this will also be captured in Q4.

Most likely.

Your next question comes from Mimi Noel – Sidoti & Company

I was wondering as you look at your portfolio do you think there are other candidates or other potential agreements along the lines of Amscan as well?

We always look and we’re always exploring better ways to operate and if there are better ways for us to operate within an existing unit we’re going to look and evaluate it. Beyond that there isn’t anything that I could say about it.

Does that include your packaging, your gift-wrap business?

No it does not.

With no other questions, 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 today’s conference call. We look forward to speaking with you again at our fourth quarter conference call which we expect to occur in the spring 2010. We thank you for joining us this morning and wish everyone a very Happy Holiday Season! Thank you.

That does conclude today’s call. Thank you for your participation.