By Jan Stoddard of Raine Consulting On March 14, 2003, Consolidated Graphics was the first of the “Raine Radar”-profiled companies to announce revised guidance for its fourth quarter ending March 31, 2003. (This was followed several days later by Quebecor World’s announcement that its quarterly profits will fall by more than half from last year and miss analysts' expectations.) Just a short time ago at The Print Outlook 2003 Conference, held in December 2002, Consolidated Graphics was profiled as a success story operating profitably, even with an undervalued stock price. What caused the reversal? As one analyst on the call, surprised by the suddenness of the announcement, asked “Did the bottom just fall out of the market?” This report offers some critical insight from Consolidated into “one of the most competitive print markets ever seen.” Consolidated Graphics, Inc. (NYSE:CGX) today announced revised guidance for its fourth quarter ending March 31, 2003. The Company expects net income for the quarter to be between $1.5 and $2.1 million, or between $.11 and $.15 per diluted share, before any impairment of goodwill that may result from the Company's annual test for impairment as of March 31. This compares with $.36 per diluted share adjusted for goodwill amortization a year ago, and $.42 per diluted share in the December quarter. Revenue in the March quarter is expected to decline by 10% from the December quarter to approximately $168 million. Operating income is expected to be between $4.6 and $5.5 million, or 2.7% and 3.3% of revenue. Topics: - Chairman Comments - Q&A - Additional Comments Chairman Comments: Joe R. Davis, Chairman and Chief Executive Officer. “Since founding the company in 1985, I have not seen a worse overall business environment for commercial printing than we have experienced this quarter.” Last two months have been particularly acute: “We have experienced: * A dramatic reduction in print orders from many major customers in hard-hit industries such as chemicals, computers, and financial services. * A significant decline in print orders from state agencies and organizations including universities and colleges due to tax revenue shortfalls and budget constraints. * Certain local markets are significantly affected; subsequently the companies in those markets have been affected. * The one exception has been in southern California where companies have performed very well. “We are disappointed with the projected results for the fourth quarter; however, they reflect the impact of fragile economic conditions on a cyclical industry with overcapacity.” Under-utilized investments: Previous investments of $162 million (to move equipment to state of the art) are now represented by underutilized investments. It takes a long time for underutilized equipment to be rationalized. And, price-cutting is severe due to last-ditch efforts of some printers to increase utilization. There has been an increase this quarter in local companies closing their doors and the number of calls regarding turnarounds. Ready to take additional action: This quarter, lost volume was replaced by work with lower margins. Historically, the coming three months are seasonally stronger than previous three months. However, if this is not the case, Consolidated will take additional action to stabilize and improve margins including: * Merging under-performing companies with other nearby facilities. In January, an under-performing company was merged and accounts were transferred to other facilities. * Per previous quarterly calls, the wage freeze is still in place, but could be supplemented by wage cuts or headcount reductions. Q & A Session: 1. When asked about the suddenness of the announcement after seven quarters at 40+ mark, Davis explained that the drop in margins is related to severe price competition in the marketplace, not just loss of revenue. For example, one large customer with 30 companies typically sends 75-80 orders to one plant, but is currently now sending only 2-3 orders. This shortfall must be replaced with new business, which has come with much lower margins. Consolidated’s last quarter was pretty good including November and December “which held up pretty well.” However, January was a weak month and, while slightly better, February was still a weak month. March is not expected to be outstanding even though it usually has strong annual report and marketing materials orders. Davis has talked to a number of marketing people who don’t know what to do know in the face of what is happening. These marketing managers are afraid to start out with big campaign if a war is starting. When asked if uncertainties in the macro situation clear up, would orders could come back and be larger than normal, Davis noted that large major companies who substantially reduced print spend will have to, over time, increase print spend to maintain their marketing programs. (Most of Consolidated products are marketing materials used to sell other company’s products.) 2. A question was asked as to whether there was still a seasonal March pick-up or if there was a lack of pick up at all. Davis said that they normally see a pickup (confirmed by longer hours) around the first of March. While they have seen pickup this year, it is not as strong as in prior years. They see cut backs in marketing materials including annual reports. When asked to compare similar bad business environments and recovery timing, Davis stated that during the 1985-1994 oil business and real estate market depressions, they made a lot of great acquisitions at favorable prices, and grew markets and possibilities. However, Consolidated has not operated on a national business in any major recession since it went public in 1994. They expect Consolidated performance to follow the general economy. “As [our customer] companies see some light at end of the tunnel, they will have to market their products. We are part of that process. “For example, the financial services sector has had a severe reduction for mutual funds materials. They will eventually be back in the marketplace.” 3. Davis was asked whether Consolidated will hold off or a speed up their acquisition strategy regarding distressed competitors. Consolidated continues to talk to and evaluate a number of companies, and negotiate with selected companies suffering in the downturn. He cited the example of S&S Graphics, which was purchased for accounts receivable and inventory and has had an attractive return. They are in final stages with one company while other companies are coming to Consolidated that could be negotiated without requiring a lot of money. Regarding debt, there is still an anticipated $8 million pay off against debt (from Dec 31, 2002 debt total of $161 million). The company anticipates no change in the “debt pay down” versus “save for acquisition” strategy if conditions continue. Davis states they are comfortable with current debt levels and wouldn’t mind continuing to increase some debt level based on cash generation opportunities. 4. The strength in the Southern California performance is primarily from client mix. These clients are not chemical companies or in business services, but represent a broad mix of customers who are doing fairly well. 5. When asked at what point Consolidated would decide to scale back operations (how soon and how bad things would things have to get), Davis pointed to an initial strategy regarding press time. Most plants have five sheet-fed presses with two to three shifts. So, initially they could cut shifts or shut down a press to increase efficiency and cut down overhead. Another strategy would be to merge facilities with nearby facilities. (Cited the Long Beach plant where they kept most of sales people and customers during a merger with a nearby facility.) 6. Davis was queried about competitors and their capacity as other companies go bankrupt. Does this capacity disappear or does it still exist as these companies re-organize? He noted that some companies are filing Chapter 11 and re-organizing, but few are successful. Some simply disappear from the system, some equipment disappears, and older equipment is shiped to foreign (Chinese, Asian, South America) markets. He also stated that they are hiring salesmen leaving existing companies having financial difficulties. “If we’re having much lower margins, I would have a strong suspicion that a lot of companies are suffering dramatically today.” Additional comments: “We are aware of the situation and are doing everything in our power.” “Our strategy has not changed with regard to how we are managing our business during these tough times. We remain focused on providing our customers with the service and responsiveness of a local printing company, combined with the economic and geographic advantages of a large national printer. We have historically generated better margins than our competitors, due in part to our scale and technology advantages. We are focused on continuing to use these advantages to maintain market share while controlling costs throughout the organization and further strengthening our balance sheet -- already one of the strongest in the industry.” Following the announcement, Consolidated Graphics’ stock price plunged from a prior day end of $22.60 to $15.50 at closing. Since that time, it has begun to rebound, along with the overall market, to $17.98.