posted on: July 23, 2008 | about stocks: ATX    

AT Cross Co. (ATX)

Q2 2008 Earnings Call

July 23 2008 4:30 pm ET

Executives

Laurie Chute - Integrated Corporate Relations - IR

Dave Whalen - President and CEO

Kevin Mahoney - CFO

Analysts

David Leibowitz - Burnham

Hamed Khorsand - BWS Financial

Eric Marshall - Hodges Capital Management

Presentation

Operator

Good day, everyone, and welcome to the AT Cross Company Second Quarter Fiscal 2008 Earnings Results Conference Call. As a reminder, today's conference is being recorded. At this time, all participants have been placed in a listen-only mode and the floor will be opened for your questions following the presentation.

It is now my pleasure to turn the floor over to [Laurie Chute] of Integrated Corporate Relations. Please, go ahead.

Laurie Chute

Great. Thank you. Before we begin, I'd like to take a moment to read the Safe Harbor Statement. Statements contained on this call that are not historical facts, are forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995, including, but not limited to, expected gross margin improvement in Cross Accessory Division, the expected success of Cross Accessory Division brand extensions, the continued success of the Cross Accessory Division shop-in-shops, the continue optimization of the Cross China plant, and the expected continued growth of the Cross Optical Group.

In addition, words such as believes, anticipates, expects, and similar expressions are intended to identify forward-looking statements. These forward-looking statements are subject to risks and uncertainties, including, but not limited to, consumers' reaction to the both divisions' new products, including Native products, the Optical segment's ability to maximize and develop the Native brand, the continued positive effect of foreign exchange, and the effects of the current economic environment on consumer confidence.

Additional discussions of factors that could cause actual results to differ materially from management's expectations are contained in the company's filings under the Securities Exchange Act of 1934, including, but not limited to, the Annual Report on Form 10-K for the year ended December 29th, 2007, and other filings made periodically by the company. And company undertakes no obligation to update this forward-looking information.

I'd now like to turn the call over to Dave Whalen, President and Chief Executive Officer. Please go ahead, Dave.

Dave Whalen

Thanks, Laurie. Good afternoon and thank you for joining us as we talk about our second quarter and our outlook for the remainder of the year. With me today is Kevin Mahoney, our Chief Financial Officer.

I'm pleased to say that the second quarter was another good quarter for our company. We exceeded our internal plan in a number of respects and stayed on course to deliver our expectations for the full year. During this period, it was important that within the Cross Optical Group, Costa Del Mar perform well in its peak seasons, and that progress be made on the integration of Native Eyewear into the group. Additionally, the Cross Accessory Division needed to use its non-peak season to continue its drive to prepare for the critical September to December period. Both divisions accomplished their goals.

Here are some highlights from the quarter. Revenues grew by 19% to $43.2 million. We saw increases in both the Cross Accessory Division, which was up 8% to $25.9 million and the Cross Optical Group, which grew 38% to $17.3 million. Gross margin was up slightly versus last year, rising to 56.4% from 56.1%. Operating income was up more than 70%, rising to $3.2 million from $1.9 million in the same quarter of last year. Diluted EPS were at $0.12 during the quarter, doubled the $0.06 in the same period of last year.

And importantly, inventory at the end of the quarter was in very good shape, despite the addition of nearly $1.8 million of inventory for Native Eyewear, which was acquired in late March. Our inventory was $31.1 million, $2.3 million lower than at the same time last year. This results from ongoing improvements in our supply chain management for the Cross Accessory Division.

In what we all realize was a very challenging environment during the first half of the year, AT Cross grew revenue 15%, more than doubled diluted earnings per share to $0.16 and increased operating cash flow more than $10 million. This performance is further confirmation that our strategies are sound and our execution is strong. We're off to a good start.

This is an exciting time for Cross. As I stated earlier this year, our three-year financial plan is to move from where we ended a strong 2007 to a business in 2010 that will generate over $200 million in revenue and a 10% operating margin. The majority of this growth will be organic, but we continue to have acquisition opportunities that should play a part in our success.

We have four growth strategies. First, we will grow the Cross brand in the Accessory Division by reshaping our approach to the quality writing instrument market and by developing compelling new brand extensions.

Second, we will continue to lower our Accessory Division cost structure by optimizing the state of the art manufacturing facility we had created in China and the supply chain it anchors.

Third, we will grow the Optical Group's polarized sunglass business through the Costa Del Mar and Native brands and achieve significant scale and a strong competitive position in the premium performance sunglass market.

And finally, we will utilize the strength of our balance sheet in increasing cash flows to execute smart, value-added acquisitions to strengthen each part of our business and provide us with new long-term growth opportunities.

I'm pleased to say that we saw tangible results from these strategies during the quarter. The sales growth we saw was excellent. Our operating margin improved and we could not be more pleased with the Native acquisition.

Now, let's talk about the Cross Accessory business. In Q2, the Accessory business, anchored by the Cross brand, grew 8%. Revenue increased in all regions with our international business growing 11% and our US business up 3%. Our Tech3, Calais, and Apogee writing instrument lines outperformed prior year's sales performance and remain a constant at retail. Additionally, innovation was a key component in this division's growth. During the quarter, we launched $1.4 million of new writing instrument products, up 11% from last year.

The star of the year, the star product, that is, continues to be the Cross Sauvage, which we introduced in March. The product was designed specifically for women. We believe that it suits a woman's preference for style, balance, and shape in writing instruments and it seems consumers agree. Cross Sauvage will be a big hit this holiday season.

Our Accessory business grew in the quarter as well. Our brand extension sales grew by 6% versus Q2 2007. The growth was driven by Cross Readers which are rapidly becoming the premium reader of choice for the business professional and our Autocross leather collection which continues to be a steady contributor.

Major brand launches planned for Q3 include cufflinks, which have tested well in Europe, Autocross money pieces, this will be our first wallet launch, and new styles of readers. These launches will come in time for our peak holiday season and we expect them to do well.

Also in the quarter, we continued to reinforce our brand position and continued our point of purchase marketing effort. The major effort here is our shop-in-shop program. This year, we will install an additional 32 shop-in-shops in some of our best retail locations. By the end of 2007, we have placed 79 of these shop-in-shops throughout the world and we expect to have a total of 111 set up for the peak season of 2008. On average, in year one, these shops are generating 25% more business than our previous in-store sets and we're seeing similar growth in those shop-in-shops now completing their second year. Shop-in-shops are a major part of our Cross growth strategy.

The second half of the year is the peak for the Cross Accessory Division. Although we, like others, are battling a poor US economy, we feel the Cross business is well prepared for a solid holiday season. Our new products are in place and the investments we have been making in the brand are paying off. Cross products have always been considered great gifts. We know that they will still command that status in the coming season.

We also made progress on our second core strategy which is to lower the quality writing instrument cost structure by optimizing our China facility and the supply chain it anchors. While our CAD gross margins declined 180 basis points in the first half of the year, much of the decline was due to a decision to aggressively manage the reduction of our CAD inventory.

As such, we worked hard to move discontinued product and we provided markdown funds to customers to help them move through over inventory to make room for our new products. These actions, in part, resulted in the reduction of CAD inventory by $4.4 million versus June 2007.

While we will continue to work to drive our CAD inventory down, we believe we are through the events that will impact margin in a negative manner. We expect to see margin improvement in the second half of the year in this division. Additionally, we are continuing to look for ways to make our cost structure and supply chain more efficient. We are very pleased with the performance of our China facility and in Q2 took steps to increase utilization of the facility.

Specifically, we decided that by the end of this year, we will move several component operations such as fountain pen nib and ball pen point production from our Lincoln, Rhode Island facility to China.

On an annual basis, our moves will save the Company $2 million beginning in the fourth quarter of 2009. The effort will require a modest restructuring charge, less than $1 million, but we feel the charge is well worth it. We will continue to aggressively pursue opportunities to lower our cost structure. If we could bring processes into the China facility, we will. If we cannot bring the operations in-house, we will look to establish vendor relationships in China. All of this is with the purpose of lowering our cost and shrinking our time-to-market.

Our third strategic initiative, to grow the Cross Optical Group, also continued to be exceptionally well executed. In Q2, our sunglass business grew 38%. Costa Del Mar delivered 12% growth and is up 15% for the first sixth months of the year. This growth is a testament for the brand's strength, given the fact that Costa Del Mar's core market is Florida, a state which has experienced greater economic challenges than most. Further, Costa's core consumers are sport fishermen and boaters, both of whom are altering their recreational habits due to high gas prices.

For many retailers, Costa has been a bright spot in a tough peak sunglass season. As a result, we are gaining shelf space and incremental open-to-buy inventory dollars. Costa's sales increases were helped by the introduction of new or recently introduced products for 2008. Styles such as Man-O'-War, Isabella, and BlackFin are selling very well and appealing to a wide range of consumers, including women and college students.

Importantly, in this tough environment, we continue to invest in the Costa brand. Costa remains very involved with the Bassmaster Elite 100 Fishing Series which is televised on ESPN. Nearly 50% of the top 100 pros on that tour wear our sunglasses. Further, our college initiative, the 2008 U. of Blue Tour, continued with successful efforts across the South. College students love Costa and now there's a waiting list of colleges that want to be on the tour.

Finally, we continued -- Costa continues to push westward. This year, we became an official sponsor of the Teva Mountain Games in Colorado, and the Professional Longboard Association in California. A key to Costa's success is that we support the activities that our community of consumers value.

In this tough economic environment, rather than cutback to support, we have increased it. It appears that our investment and faith in our brand are paying off. As we have stated before, we know how to win in the premium sunglass market and we will aggressively manage our organization to do so.

Our fourth strategy is acquisitions. As you know, in March we announced the acquisition of Native Eyewear. This brand is a great addition to the Cross Optical Group as it grows our presence in the sport performance sunglass category at price points of $100 and greater. We believe that both the Costa and the Native brands, which are anchored by polarized lens technology, a lifetime warranty, and excellent customer service reputations, will continue to gain new levels of recognition and acceptance. Both organizations are streamlined to have very healthy margins, and will benefit from each other in terms of sales relationships and best practices.

In the quarter that we have owned Native, everything that we have seen tells us that the acquisition will be a winner for the Cross Optical Group. The brand will be nominally accretive this year and significant growth will begin in 2009. What we have seen from this recently conducted -- what we have seen from recently conducted consumer research and our market experience is that the factors that have made Costa such a success story within the premium sunglass category are also quite relevant to Native. Native is a very profitable and authentic brand that can be leveraged. Like Costa with its water sport enthusiasts, Native has a very loyal customer base, particularly those interested in hiking, running, and climbing.

Native will benefit from the infrastructure that Costa will provide and Native will benefit from a rigorous product development approach, enhanced distribution, increased marketing, and compelling sales programs, all of which Costa has in place. The highly skilled management teams at Costa Del Mar and Native Eyewear have created a plan to leverage these positive attributes and are intent on greatly expanding the reach of the brand. We are excited about the prospects for Native Eyewear and expect that it will bring significant incremental value to our shareholders.

Now I will turn the call over to Kevin who will go through our Q2 financial performance in detail.

Kevin Mahoney

Thanks, Dave. As Dave indicated, our second quarter results were quite positive, particularly our bottom line results, which had our EPS doubling from $0.06 to $0.12. In addition, we continue to execute well against our 2008 balance sheet initiatives, as we generated $10 million more cash from operations during the first half of '08 than we did in '07. And this very positive performance was driven primarily by our progress in reducing our Cross division inventory investment during the year.

As for our revenues in the second quarter, I'll break down our revenue growth as follows. Our total revenues grew 19%, of which $3.3 million was derived from our Native Eyewear acquisition, which was not in the comparable period in '07. Our Cross division revenue in the second quarter grew 8.3%, a little more than half of which came from favorable exchange rates compared to '07 and our Optical Group, 38% -- Optical Group grew 38% and, excluding Native Eyewear, Costa brand grew 12%.

Total Company margins in the second quarter grew slightly versus '07 with gains in the Optical Group offset by some weakness in the Cross division, which Dave has already commented on. Our operating expenses for the quarter were $21.2 million or 49% of sales as compared to $18.6 million or 51% of sales a year ago and we had slight gains in the ratio of operating expenses to sales in the Cross divisions, all positive.

Operating income for the second quarter was $3.2 million compared to $1.9 million. Exclusive from the -- exclusive of the contribution from Native, our Cross division and Costa Del Mar businesses, combined, were up almost 15% from the prior year for operating income performance.

Native contributed approximately $1 million of operating income in the second quarter; however, the second quarter is the one where Native derives significant operating leverage and, as Dave indicated, we are managing the Native acquisition in 2008 in a way that after financing costs, it will be nominally accretive for our total Company in '08.

With respect to the balance sheet and cash flows, our cash on hand was $14.4 million. Our cash generated from operations in the second quarter was $5 million more than the second quarter in '07 and, as I mentioned, our cash generated from operations was $10 million in the first half of '08 versus '07.

Our receivables increased to $30.3 million from $24.1 million at the end of the second quarter in '07. Excluding Native, receivables were up 19.7 versus last year's second quarter level of $24 million.

Our Cross division's days sales outstanding decreased seven days from a year ago in both our Americas and our International markets, and we will remain vigilant in monitoring our receivables for both our segments, particularly given the current global economic environment.

As for our inventory, our balances exclusive of Native inventory, which was $1.8 million, were down $4.1 million from a year ago. Our Cross division inventory, or our gross Cross division inventory decreased $5 million from a year ago, and we will continue to aggressively manage our Cross division inventory investments.

Our capital spend in the quarter was $1.1 million in line with our plan. As for other significant changes in our balance sheet in the second quarter, goodwill, intangibles, and our debt levels were all the direct result of the Native acquisition. That highlights the second quarter.

And I'll turn the call back to Dave.

Dave Whalen

Thanks, Kevin. As I’ve said to many people throughout the first half of the year, AT Cross is on firm footings. We are in a strong position to deliver excellent results for the foreseeable future. We accomplished what we wanted to in the first half of the year, specifically Costa Del Mar excelled in its peak season. The integration of Native Eyewear commenced, and the Cross segment prepared for what we expect will be a solid showing in its September to December period.

We are all aware of the current economic environment. Despite this hurdle, we are maintaining the guidance we provided at the beginning of the year. We expect to deliver earnings between $0.49 and $0.51 per share, excluding any modest restructuring charges we may take to lower our writing instrument cost structure. Revenue will be in the $165 million to $170 million range, up from $152 million last year.

We are excited about our prospects. The awareness of Costa Del Mar is growing among premium sunglass consumers, and they are buying. Native appears to be a great addition to the Cross Optical Group, and we are preparing for what we expect to be a solid holiday season for all three brands, but Cross in particular. We are very pleased with our first half performance and we continue to expect a very good year for the Company.

Thank you. And now Kevin and I will take any questions.

Question-and-Answer Session

Operator

(Operator Instructions) We'll go to David Leibowitz with Burnham.

David Leibowitz - Burnham

A few unrelated items, if I may. First question, how much mark down money did you have to put out in the quarter?

Kevin Mahoney

The mark down money that was put out was a first quarter event, not second quarter, and it was less that $0.5 million.

David Leibowitz - Burnham

Excellent. Is that, Kevin, an accrual, or is this just done as needed during the year?

Kevin Mahoney

It was as needed during the first quarter.

David Leibowitz - Burnham

And there is no accrual set up for further mark down money as the year progresses?

Kevin Mahoney

No. No. It was a first quarter event.

David Leibowitz - Burnham

Okay. Good. Second question, the new product introductions in the writing instrument business, what percentage of revenue do you expect them to be this year?

Dave Whalen

Well, we -- our target is to be over 25% on a 24 month measurement. Anything introduced in the last 24 months will be greater than -- represent greater than 25% of the business. We're achieving that target, Dave. I will -- I can get back to you on the specific level, but for this year's business it will be between 12% and 15% for the total year.

David Leibowitz - Burnham

Okay. And the last question, given the strength of the second quarter, the sales increase that you're talking to is not giving much core growth, and I was wondering where the shortfall is, what specific parts of the business are not living up to expectations?

Dave Whalen

I don't follow the question entirely.

Kevin Mahoney

Are you talking about going forward, Dave, or -- in the second quarter?

David Leibowitz - Burnham

Yeah. For the second half, based on the strength of the second quarter.

Dave Whalen

Well, as indicated in the comments, our performance in both our brands that we entered in '08 with, Cross and Costa Del Mar, performed well, both operating towards the plans that we laid out for them. The Native business contributed $1 million of operating income in the second quarter, and as I said, that's the quarter where they get a substantial amount of their operating leverage.

David Leibowitz - Burnham

Right.

Dave Whalen

So, that quarterly benefit is not going to continue in quarters three and four.

Kevin Mahoney

But I think, your question, Dave, was on the sales growth. Look, we are right where we thought we'd be in the Optical Group business. The international markets for the accessory division are performing very well. We did have a cautious outlook for the US for our accessory division business. Until that retail market begins to show greater signs of recovery, we're not going to plan -- certainly not going to plan aggressively and we'll plan very conservatively.

David Leibowitz - Burnham

Thank you very much.

Operator

We'll go next to Hamed Khorsand with BWS Financial.

Hamed Khorsand - BWS Financial

Good afternoon, guys. Just a question here on -- it looks like your SG&A was a little higher than I was expecting this quarter. Just trying to see where that increase came from?

Dave Whalen

Our SG&A in the quarter total Company was down as a percentage of revenue versus last year, and it was down in the Cross division as well as a percentage of revenue. So, I don't know how you modeled out the quarter, but our SG&A spends were slightly better as a percentage of revenue than they were second quarter last year.

Hamed Khorsand - BWS Financial

Now this -- the SG&A you have now for this quarter had some seasonal factors going forward? Would it be at this level or would it be at a reduced level for the remainder of the year?

Dave Whalen

I think the way I'll guide you is for the full year, and I think for the full year, our spending in SG&A as a percentage of revenues for both of our businesses are similar to last year.

Hamed Khorsand - BWS Financial

Okay. Thank you.

Operator

(Operator Instructions) We'll go next to Eric Marshall, Hodges Capital Management.

Eric Marshall - Hodges Capital Management

Good afternoon, guys. Great quarter.

Dave Whalen

Hi, Eric.

Eric Marshall - Hodges Capital Management

I just had a couple question. I wanted to clarify the organic growth in Optical segment was about 12%. Is that what I heard correctly?

Dave Whalen

Yes.

Kevin Mahoney

That's for the quarter. That's where Costa was up.

Eric Marshall - Hodges Capital Management

Okay.

Kevin Mahoney

15% for the first half.

Eric Marshall - Hodges Capital Management

And then the -- on the $3.3 million that Native contributed, was that -- how many weeks in the quarter was that?

Kevin Mahoney

It was the full quarter.

Eric Marshall - Hodges Capital Management

The full quarter? Okay. And then, looking at the gross margins in the last quarter, were they adversely impacted by any inventory write downs or anything like that that were tied to the acquisition?

Kevin Mahoney

No.

Eric Marshall - Hodges Capital Management

And could you go over the timing of the charges related to the China move; some of your additional capacity on the CAD side?

Kevin Mahoney

Yes. Dave had mentioned the maximum amount that we've got earmarked for a possible restructuring.

Eric Marshall - Hodges Capital Management

Is that the $1.5 million?

Kevin Mahoney

No, pardon me?

Eric Marshall - Hodges Capital Management

How much is that? That's $1.5 million?

Kevin Mahoney

No. It could be up to $1 million is what Dave indicated. And we're working on it now. It will probably be a third quarter '08 event. Some of it could be fourth quarter '08. We're going through a lot of scenarios in terms of some equipment that we have here that could be moved over to China. We've got to refurbish it, have it produce the product over there or buy new. And if we buy new, we've got some write off of some existing equipment, etcetera, etcetera. There's some severance costs involved. We started pretty hard. We think there's a couple million dollars of annual margin expansion that's going to be available to us once we make this move. We're not troubled by the dollars but it's Q3, Q4 type event for '08.

Eric Marshall - Hodges Capital Management

Is that tied to lacquering or engraving or components?

Dave Whalen

It's more tied, Eric, to components. I think we've mentioned before that, first of all, the plant in China is working exceptionally well. It's a very efficient facility. We've proven that. We're trying to get as much in there as possible. And the more components we can move in there, it would not only lower our costs but it will shorten our supply chain. So, what we're really trying to do, we know that's the move that needs to be made. What we want to make sure is that we're covered in terms of inventory needs for the peak season and once we're covered for that, we'll begin to make these moves. So, we know that it would be certainly no more than $1 million. But we'll add more clarity on the exact number in the third quarter.

Kevin Mahoney

Just to put it in some context, there's still maybe 20%, a little less than that, of our manufacturing activity resides here. A lot of that relates to our new products. But there is some component activity and what we are working on hard is to see just how much of that and how quickly we can move that over to China. So, this is a good piece of that. There's more that we'll work on to give you some context for what we're after here.

Eric Marshall - Hodges Capital Management

Okay. And then, lastly, can you just kind of maybe enlighten us a little bit on your plans to leverage synergies out of the Native acquisition. Any plans to leverage the distribution and either channel, combine those or so forth?

Kevin Mahoney

Couple of answers to that, Eric. First of all, there's certainly, in the quarter it became very clear that there's opportunity in the field, in the sales force, to leverage activity in accounts where Native is strong and Costa may not be and vice versa. We're also looking at ways to just make a complete, more efficient sales force between the two organizations. But it's becoming clear as we build our 2009 plans that there are definitely opportunities in the field to grow both brands. I think that's very exciting. In terms of the rest of the business, we're already working together.

The Costa team is working with the Native product development team to make sure that we have all the expertise from both businesses working together and developing products that don't overlap but certainly complement each other. That will turn into styles in early 2009 and then the whole Costa, Native teams are working on what back office synergies can be gained and that will come forward to us in their strategic plan that will be presented in September. So, we'll have more on that piece of it at the end of October when we talk.

But it really looks like a very good acquisition. There are opportunities for synergy and there are opportunities for growth and the brands are going to fit very well together at the beginning of what we see as a very diversified branded sunglass portfolio for the Company.

Eric Marshall - Hodges Capital Management

Are there any national or regional sporting good channels that you're selling Costa in, for instance, that you can start selling Native into or vice versa?

Kevin Mahoney

Eric, at a higher level than that, I think we described in the call to introduce Native. Native is primarily a Northeast US brand.

Eric Marshall - Hodges Capital Management

Right.

Kevin Mahoney

It has distribution in retailers such as REI and Eastern Mountain Sports and some presence in the Northwest. And Costa Del Mar, as you know, its roots are in the Southeast, particularly Florida. We're migrating inland, but also into California.

Geographically, obviously there are opportunities to introduce the brands into one another's markets because of where they have been concentrated. So there are also some national accounts where one brand has better relationships than the other and that can be leveraged. In terms of the specialty retailers that are highly focused on mountain versus fishing, for example, the opportunities may be more limited there with the specialty retailers. Clearly, there's opportunity to cross pollinate distribution.

Eric Marshall - Hodges Capital Management

Will you guys combine your wholesale catalogue?

Dave Whalen

I don't think so. I think the strategy is to keep the brands very separate but clear from that perspective, we're very clear to the customers that it's one portfolio and you can buy that portfolio from our Company. But right now that decision hasn't been made and we really want to keep the brand clearly separate in everyone's eyes though. But we're just getting into it and we'll have a more clear idea of that in the fall.

Eric Marshall - Hodges Capital Management

Okay. Well thanks a lot, guys.

Dave Whalen

Thank you.

Operator

And having no further questions, I'd like to turn the conference back over to management for any additional or closing comments.

Dave Whalen

Thank you all for listening. We appreciate your support and we look forward to talking to you at the end of October with our Q3 results.

Operator

This does conclude today's conference. Thank you for your participation. You may now disconnect.

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