The Brink's Company
Q2 2008 Earnings Call Transcript

Published: 3 Aug 2008

[Operator:]

Welcome to The Brink’s Company second quarter results for 2008. (Operator Instructions) It is now my pleasure to introduce your host Edward Cunningham, Director of Investor Relations and Corporate Communications for The Brink’s Company.

[Edward Cunningham:]

Thanks for joining today’s call which will proceed as follows

[Michael Dan:]

Thanks, Edward. Good morning or good afternoon and thank you for joining today’s call. This morning we reported second quarter earnings of $1.04 per share versus $0.70 per share last year. Revenue and profits were up at both Brink’s Incorporated which I’ll refer to as Brink’s, and Brink’s Home Security, or BHS. In addition to strong operating results, earnings were also affected by some non-operating factors, including

[Michael Cazer:]

Thanks, Michael and good morning, everyone. As Michael said, second quarter results were driven by solid performance at both operating units. I’m going to provide a little more detail about some of the items that affected earnings. I will also touch on some balance sheet and spinoff related details. In addition to the 26% increase in operating profit that Michael described, our net income was boosted by a 12 point reduction in our effective tax rate. The decline in our tax rate to 24.6% was due mainly to the reversal of tax valuation allowances in non-U.S. jurisdictions, reflecting the continued improvement in our international operations. In addition, the global composition of our earnings helped to lower the overall tax rate. For the full year, we expect our tax rate to be between 31% and 34%. Corporate expenses were up more than $2 million versus the second quarter of last year, driven by approximately $3 million of BHS related spinoff expenses this quarter. Year-to-date expenses related to our strategic review, proxy matters and the spin totaled about $9 million. We’ll probably spend another $8 million to $11 million on this effort, so total expenses for these matters should be in the range of $17 million to $20 million for the year. As you think about our corporate expense for the remainder of the year, I want to note that due to the way our stock option program works and how stock option accounting works, these expenses are lumpy and the majority of them will be incurred in the third quarter. The same thing happened last year. The costs of our former [inaudible] operations were $200,000 in the second quarter, down more than $3 million from the second quarter of last year. The reduction was driven by lower pension and post retirement expenses. The impact of minority interest rose nearly $4 million in the quarter reflecting continued profit growth in consolidated by not wholly-owned subsidiaries, primarily in Latin America. I want to comment on a few items related to Brink’s Incorporated, specifically foreign currency impacts, operating margins and fuel costs. As Michael noted, international operations account for about 70% of revenue at Brink’s so results continue to benefit from the dollar’s weakness. Second quarter revenue was up 21% and operating profit rose 22%. On a constant currency basis, revenues and profits were up 11% and 14% respectively. As mentioned on last quarter’s call, the sequential margin decline at Brink’s was not unexpected. Margins went from 10.3% in the first quarter to 6.6% in the second quarter. Please recall that the first quarter results included about $35 million of higher margin revenue from the currency conversion project versus only $12 million in the second quarter. The conversion should be completed in the third quarter, where we expect conversion-related expenses to be less than $2 million. Additionally, results were hurt by the timing of wage increases in Latin America. On a year-over-year basis as Michael said, Brink’s margin rate increased 10 basis points due to profit increases in both Latin America and Europe, partially offset by the decline in North America. Obviously, fuel costs are another topic of interest these days so I want to put the issue in perspective. It’s widely known that fuel prices, especially for diesel, have increased sharply in the recent months. Fuel costs at Brink’s can vary by region but in total account for a relatively small percentage of our expenses. Most, but not all, of the increases in fuel prices are passed on to customers through surcharges or other contractual arrangements though there is a lag effect when prices break as quickly as they have in the second quarter. Due to the hard work of our branch teams, Brink’s was able to offset a significant portion, but not all, of the increase so the rise in fuel prices did hurt income, but less than one might expect. We are watching our fuel costs closely and taking steps to manage their impact on our business. Turning towards BHS, I would like to give a little more detail on the accounting correction that Michael mentioned. An error was found in the data used to make accounting adjustments when customers cancel their service. The error caused BHS to underreport revenue and operating profit slightly over the last six-and-a-half years. The correction of the error caused a $2.5 million increase in operating profit in the second quarter of this year. On average, the impact of the error was approximately only $100,000 per quarter over the last six-and-a-half years. Please note that the error had no impact on the reported disconnect rate. Remember, when evaluating the performance of BHS on a year-over-year basis, the income benefit from this correction is largely offset by the $1.9 million one-time gain in the second quarter of 2007 from the Katrina insurance settlement. I want to make a few comments on cash flow and balance sheet items. At Brink’s Incorporated, second quarter capital expenditures totaled $39 million and stood at about $70 million for the first half of the year. The run rate typically ramps up in the second half so full year expenditures should be between $165 million and $175 million for the year. Depreciation ran about $30 million per quarter in the first half and should end the year in a range between $125 million and $130 million. CapEx at BHS is running at about $45 million per quarter so far this year, and should finish the year somewhere between $185 million and $190 million. Depreciation and amortization at BHS was a little over $20 million per quarter in the first half and is expected to come in between $85 million and $95 million for the year. We ended the quarter with a $67 million net cash position. This is $39 million more than the balance at the end of March. During the quarter, we bought back $16 million of stock under the $100 million share repurchase authorization. The 10-Q will disclose more details of our purchases during the second quarter and you will see we did not purchase any shares in June, but remember, we also had just decided to fund BHS at the time of the spin with a $50 million cash injection. Program to date we have purchased a total of 884,000 shares for $56 million. Brink’s strong balance sheet, as illustrated through its net cash position and substantial debt capacity, should enable the company to not only weather a difficult business cycle but also pursue growth opportunities in existing and new security markets. A quick update on a few BHS spinoff details. An amended Form 10 was filed and we expect to complete the spinoff in the fourth quarter. We’re excited about the future of what will be two industry-leading security companies and we plan to spend some time on the road this fall to meet both current and prospective shareowners. We’ll disclose more details about the spin as we get closer. Upon execution of the spin, BCO will inject $50 million of cash into BHS. In addition to the cash, the company will have no debt and be in a strong position with financial flexibility to pursue its objectives. Obviously, the spin will also affect the Brink’s Company’s financial statements. In the quarter the spinoff is executed BCO’s income statement will reflect BHS’ results and the expenses related to the spin in discontinued operations. That’s it for now. I would like to close by saying that I’m very excited to be part of the Brink’s team and I look forward to getting to know many of you in the near future. We are ready to open up the call for questions.

[Operator:]

(Operator Instructions) Our first question comes from Steven Fisher - UBS.

[Steven Fisher:]

What part of the business at Brink’s Inc. in North America drove the 7% growth? It sounded like the U.S. part was kind of weak. Was it entirely Canada?

[Michael Dan:]

No. Canada had reasonable growth, we went through the bank bidding season, as they call it, during the last quarter where we were able to gain some share, so Canada is on the uptick. We did have further growth in the United States in some of our value-added services. As you know, when we sign up, for instance, a [CompuSave] customer, it takes a little while for the efficiencies of the new customers to be integrated into our system to fall to the bottom line. So you are seeing the revenue growth from our success in value-added services and we just haven’t seen the benefit yet if it falling to the bottom line.

[Steven Fisher:]

That was one of the things that you mentioned, one of the things that would drive potential improvement in the business for the back half of the year. Is that specifically [CompuSave] or is it other parts of the value-added services?

[Michael Dan:]

It will be all three. We are looking for some strong improvements in our global services business and on a domestic basis, which we are starting to see already. The [CompuSave] is key and of course our [iVault], and [iCash] high value services are starting to gain traction; our pipeline is pretty full. We are pretty excited about where we are in the U.S., we are just not happy with the results. Labor was a big factor in the shortfall and I think it was really a management focus issue. A lot of things to do in running this business, but management is on it in the U.S. and the metrics there are tracking in a positive fashion.

[Steven Fisher:]

In terms of the costs that you mentioned and the way you have them in the press release, is that the relative order of magnitude in terms of labor, fuel and legal settlements?

[Michael Cazer:]

I would say that it was 50% labor, 50% fuel and the legal settlements.

[Steven Fisher:]

You mentioned that in order to hit the margin targets you would need some cost reductions in the back half of the year. Where do you think those reductions are going to come from?

[Michael Dan:]

The U.S. labor cost.

[Steven Fisher:]

Can you just be a little more specific about what types of labor you’re talking about?

[Michael Dan:]

In our business when labor costs inch up, it is usually on an overtime basis, so it is very, very expensive. The labor makes up our largest operating expense and once again management, I think, lost a little bit of focus controlling those costs. There is also a lot of pressures, as you can imagine, in the marketplace for our employees with the high gasoline prices and we lost some focus. Management has set up a special cost reduction program, a focus program and we are seeing strong positive results already in addressing that issue.

[Steven Fisher:]

So it sounds like just trying to run more efficiently?

[Michael Cazer:]

Get back to running as efficiently as we were.

[Steven Fisher:]

Right. You mentioned the [iVault] and the cash logistics, given that the banks today are experiencing unabated pressures, what are you seeing in your discussions with them? You mentioned the pipeline is full. Are they more or less willing to spend more money in order to save money at this point, than they were six months ago?

[Michael Dan:]

I think what we are seeing, is any way retailers and the financial sector can save costs, they are looking. If it is a reduction in frequency of stops or pickups, they are all trying desperately to lower their costs with the pressures they face which we are very cognizant of. On the other hand, there is an opportunity there for our outsource solutions and we are seeing the pipeline full. We are seeing that activity come to bear. So that’s why we are seeing in the revenue growth. It is just a matter of on one hand, we have an offsetting growth, our high valued services, and we are facing this undue pressure on our standard stop prices and they are balancing out. It is a little difficult situation for us now, but management is focused on it and I think we’ll see improvements, on top of that we’ll see improvements in the third and fourth quarter in the U.S. business unit.

[Steven Fisher:]

You mentioned that the tax rate was mainly due to the valuation allowance. Can you just give us the numbers there? How much of that actually was on the valuation allowance versus the geographic mix?

[Michael Dan:]

The valuation allowance drove about an $8 million to $9 million reduction in our tax expense for the quarter. We expect that to have about a 2.5% impact on the rate versus what we had previously forecasted for the year. The remainder was due to the basically other items and mainly the global mix of earnings.

[Michael Cazer:]

You might recall that in the last couple of years we have had a little bit higher tax rate than normal because we were forced to reverse our tax loss carry forwards in some of our European operations, which we appropriately did. What has happened is the good news is our success in improving our operations in Europe requires us now to recapture that, which is having the effect that you see.

[Operator:]

Our next question comes from Brian Butler - FBR.

[Brian Butler:]

First on Brink’s North America, can you give some color on pricing and thoughts on competitors out there? Are they chasing business with lower prices? How competitive is it?

[Michael Dan:]

Yes, it’s always in a competitive marketplace and the more desperate they become they think that the solution is just to get more density and more volume. We are facing maybe a little more of that than normal because of the high fuel prices and the difficulties that they face. When it’s tough on Brink’s it’s tougher on the competitor so in the long-term, it doesn’t keep me up at night.

[Brian Butler:]

Are you holding up on price at this point?

[Michael Dan:]

Yes. We have volume issues, number of stops we are making for customers we feel some pressure there, but we are holding steady on the price.

[Brian Butler:]

Thinking about what’s under Brink’s control in North America and what’s the economy, if the second half looks like the first half from an economic point of view, how confident are you that we can see an improvement in the second half based on what processes you have in place?

[Michael Dan:]

I feel pretty good. Once again about half of the shortfall in the second quarter on a year-over-year basis was legal settlements and the other was labor and I see the weekly statistics on how that’s being managed by the management team here in the U.S. and they are making strong progress. I’m confident that we are going to get back to the normal run rate. The question is, what is the economy going to do? How much worse can it get? I just don’t know. But I’m confident we are going to get back to the run rate that we were on last year because the two factors were the legal settlement expenses and overtime costs and they are tracking very positively.

[Brian Butler:]

On the tax rate, is that lower range the right range to be using when you start looking into the future into ‘09 and beyond?

[Michael Cazer:]

We were in the process of regrounding our range. We suspect as the business continues to grow globally, that will obviously have a beneficial rate on the year. I think in the next quarter’s call we’ll probably have some more insights as to next year.

[Operator:]

Our next question comes from Steve Velgot - SIG.

[Steve Velgot:]

I just had a question on the decision to have two brands, I wondered if part of that is giving Brink’s the ability to go into the monitoring business, maybe more on the commercial side? Could you just give us a little more color on some of the factors there?

[Michael Dan:]

Well, it’s a very, very complex decision process we went through, which included which company should have the brand. Whether the brand should be in a third company. We looked at every aspect that you could possibly imagine. We had the general guiding principles on what we were trying to accomplish, which I stated in my prepared remarks and then all the financial and the tax and capital market situations just fell right in line and supported the decision that we made. We filed the documents on the intra company agreements with the last Form 10 which clearly states that Brink’s Home Security has the use of the name for three years and then there is a further two-year non-compete which is inclusive of The Brink’s Company not entering the commercial monitoring business or the home security business for five years which gives adequate time for Brink’s Home Security to rebrand and have a strong growth story for the capital markets.

[Operator:]

Our next question comes from Jeff Kessler - Imperial Capital.

[Jeff Kessler:]

First with regard to the summer programs and the rate of install that you had, had part of the fall off in your installs in Brink’s Home Security been due to competition from, I’ll call it cut rate or mass market summer programs? Have you felt any pressure from that or has the brand been able to take you beyond that competition at this point?

[Michael Dan:]

It’s not cut rate competition, Jeff. It’s just the general economic situation in the United States which we’ve been feeling for a period of time. It was also our conscious decision, as you recall a year ago to a year-and-a-half ago to scale back dramatically our home technology business because we saw this housing slump coming which turns out it makes us look smarter and smarter in hindsight all the time, which slowed the machine down a little bit. Pricing is holding up well, our monitoring rates on a per subscriber basis continues to inch up as it always does a couple percentage points, 3 percentage points per customer per year so it’s just the economic conditions, nothing else.

[Jeff Kessler:]

If I could just stay on Brink’s Home Security. Post the spin and I’m sure these are questions that are going to be asked to Bob and Steve but the key question will be how is that business going to define its growth strategy going forward? Up until now they have grown totally organically, I’m just wondering if there is any thought process on the corporate side that you guys have had with them with regard to what acquisitions? I realize there’s been an EDA concern up to this point. Do you think that may change a little bit? Do you think that there may be some new ports or new instances in how they intend to grow ARPU as well?

[Michael Dan:]

That’s a big question, Jeff. The answer is yes, yes, yes and yes.

[Jeff Kessler:]

I’m just trying to preempt the road show, that’s all.

[Michael Dan:]

That’s exactly what you are doing. The road show is being prepared and as we get through the process of the spin and all the required approvals that are necessary and the time that is required to do it, we will end up setting the spin date, announcing it and there will be a road show where Bob and his management team will go out and basically present that, answer those questions for the investors and the analysts. At the same time there will be a parallel road show with The Brink’s Company. All that will be announced in due course.

[Jeff Kessler:]

Moving over to Brink’s, can you give the number of CompuSave sites that are out there at this point?

[Michael Dan:]

I think it’s just about 7,000 units but we’ll make sure that we confirm that. It’s about 7,000 units.

[Jeff Kessler:]

With regard to the growth drivers, particularly in North America, realizing all the headwinds that you are going through, are you doing things like increasing the amount of Brink’s global services offered to clients or are you increasing the amount of other types of logistics, special logistic services offered to clients to offset the basic cash in transit hit that you have to be taking because they just don’t want as many pick-ups anymore?

[Michael Cazer:]

There are a variety of initiatives Jeff and as you know, it is a very complex business unit with a lot of lines of business cutting through a single asset base. We continue to see reasonable growth at the top line in a very tough economic environment. My concern isn’t the revenue growth rate because I know the pipeline is full. My concern is operating efficiently and getting those margin dollars to fall to the bottom line. That’s my major focus. I’m not worried about the growth.

[Operator:]

Our next question comes from Jerome Lande - Millbrook Capital.

[Jerome Lande:]

By my count I think this makes 12 quarters in a row that you have beat The Street, I understand those aren’t your numbers, but it is an impressive record nonetheless. Can I ask a question on the investments in people and IT around the higher value-added offerings, particularly in North America? Can you quantify what impact that had on the quarter and then maybe tell us a little bit about the timing of payback that you expected and how you quantified the return on those investments?

[Michael Dan:]

We have a long, strong internal process before we make any investments when we do that, Jerome. I would tell you that our capital expenditures are increasing year-over-year and are reflective of the increased spend on IT as we invest in these new products. But they are the products that are more value-added and differentiate ourselves from the competition because that’s where our future is which is getting value-added solutions to not only the financial sector but the retail sector. They are gaining a lot of traction and we are pleased; we are never happy with the efficiency of those investments. They always can be better. But we have teams of very smart people working on them every day to make sure we have a more than adequate return on our investment.

[Jerome Lande:]

Can you qualify the SG&A impact in the quarter of the new people or marketing spend you did?

[Michael Dan:]

I don’t have it broken out. Most of that expense is embedded in the U.S. business unit. I would say the only increases we have other than inflationary increases around the world would be the U.S. SG&A and the spin expenses having to do with Brink’s Home Security.

[Jerome Lande:]

A couple of questions of a long term, strategic nature. There was a recent ruling, I think it was the Appellate court, about U.S. currency in sizes and shapes as opposed to the way the rest of the world does it and it’s fairness under the disabilities act to people who are blind. So obviously this is a long-term issue. But do you have any view other whether that actually yields any potential currency policy changes in the future and how that would affect the company?

[Michael Dan:]

Of course, that’s a geopolitical issue and a very sensitive one and for people who are affected by it, it is a very personalized one. The reality is the U.S. currency is evolving continually to stay ahead of counterfeiting at the current time. If they decided to change the shape, color, size of currency to allow disabled people to more easily function in our society that would be a tremendous expense for the industry and a tremendous opportunity for us to change out machines and to change out the currency. So it’s a positive one way or the other for us.

[Jerome Lande:]

Some of your competitors are going through a more asset-light model, particularly in densely populated urban areas. Here in New York we obviously see it quite a bit, but it is apparently happening elsewhere in the country. People running two man teams instead of three man teams, running armored vans instead of armored trucks in areas where -- I don’t know, one could differ on the risks involved but the notion being the busy streets are a less imminent risk of assault. Do you have any comment on that? Is there any change in your analysis about the size of trucks you are running in urban areas, particularly with fuel where it is?

[Michael Dan:]

We are always looking for ways to have the most efficient long-term capital investment in our vehicle fleet. We are very cognizant of the life cycle costs. I can assure you that the soft sided vehicles, armored or unarmored, life cycle costs are a negative compared to the model we have. You can imagine the amount of damage that takes place to a soft-skinned vehicle versus a hard-skinned vehicle, et cetera, et cetera. As far as security goes, the fact of the matter is the lower the security standards become the higher the risk of robbery and injury to our people. I think you know, Jerome, that’s something that’s just not going to happen at Brink’s.

[Operator:]

Our next question comes from David Hancock - Morgan Stanley.

[David Hancock:]

First on France, can you say what drove the improved performance in the quarter compared to the first quarter? How much of that was the market environment getting better and how much of it was driven by Brink’s own initiatives? Second question is on Canada. You said you have taken some share there. Is there any pricing softness in that market or is pricing holding up in what I think has been quite a tough market? Thirdly on the currency conversion, it looks like the margins on that business were well into double-digits. Can you be a bit more specific about that and say what happened on underlying margins in Latin America, please? Thank you.

[Michael Dan:]

First of all in France we had some adjustments on employee costs which helped the quarter. Management has some very, very strong initiatives in place to deal with the marketplace issues that we highlighted last quarter which we are very pleased to say are totally offset in the second quarter. We expect those pressures to continue with France. The fact of the matter is it is a competitive environment and it is heating up. We have also had a spike in tax and robberies in France which we have to be very cognizant of to make sure we protect our people, employees and raise our security barriers. But our management team in France is first class and we’ll find a balance to that. I don’t expect France to have an improved year over year but fortunately the other initiatives in Europe and improvements in European countries such as the UK and Holland and Poland and on and on and on is more than offsetting the shortfall in Europe and in France. As far as Canada goes, we have taken share. It’s been a six year battle here with low cost people underbidding us on contracts and service quality has suffered. In the recent round I would describe it as we have improved our share but more importantly we have improved our pricing levels. I can assure you that the competition as usual decided to cut the prices to take share but the banking community decided that quality service was more important and so we are very, very pleased not only with the rate of increases we had on a contract over contract basis, but in the percentage of share we gained. So I’m very pleased. We still have a ways to go in Canada, but the returns are now finally approaching the average of the company. I think we have great areas for further improvement. As far as the margins on the currency conversion project, yes they were very, very strong. We don’t quantify them, but they were very, very strong. We’re able to put a substantial amount of additional revenue through our fixed asset base. It was a credit to the management team down there they were able to seize those opportunities.

[Operator:]

Our final question comes from Jeff Kessler - Imperial Capital.

[Jeff Kessler:]

Thank you, Michael, on the asset light comment because as you know twice before the industry has tried to go to cut costs for a so-called asset light model and they have been disastrous with freight loss every single time, and actually the brand reduction of whoever did that. The question I have for you is on the timing of all the investments that you are making in the U.S. to improve the margins beyond just cost reductions in overtime and things like that. Can you give some idea of when do you think the timing of those efficiencies and that investment that you are putting in is going to be able to hit the P&L? We are talking about a process that we are looking forward to sometime in the first half of 2009?

[Michael Dan:]

Hopefully, you’ll start to see some of it at the end of this year, but no question about 2009. Remember, the U.S. is the largest operating unit in the Brink’s world and so we also leverage those investments over time around the world. We really are excited about the progress we’re making and the differentiation we are creating and that’s why I am so confident that these are the right investments. Sometimes they all end up in one bucket in the beginning on the developmental side, that’s what you are seeing a little bit, Jeff.

[Jeff Kessler:]

You are going to export the U.S. model or the U.S. model of efficiencies to international about when?

[Michael Dan:]

The reality is we export great ideas from Latin America to the U.S., Europe to the U.S. and vice versa. We share best practices everywhere to strengthen the Brink’s organization. We learn from each other everyday.

[Operator:]

Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time.