CSS Industries, Inc. Second Quarter Fiscal 2019 Earnings Conference Call November 2, 2018
C O R P O R A T E P A R T I C I P A N T S Keith W. Pfeil, Executive Vice President, Finance, and Chief Financial Officer Christopher J. Munyan, President and Chief Executive Officer C O N F E R E N C E C A L L P A R T I C I P A N T S Linda Bolton Weiser, D.A. Davidson P R E S E N T A T I O N Operator: Good morning, my name is Melissa, and I will be your conference Operator today. At this time, I would like to welcome everyone to CSS Industries Fiscal 2019 Second Quarter Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers remarks, there will be a question and answer session. If you would like to ask a question at this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. Mr. Keith Pfeil, Chief Financial Officer, you may begin your conference. Good morning, and thank you for joining our conference call to discuss CSS Industries second quarter results for fiscal year 2019, and our outlook for the full year. Sitting with me today is Chris Munyan, our Chief Executive Officer and President. During the course of this call, we will be providing certain forward-looking information. We ask you to look at yesterday s press release and read through the forward-looking cautionary statement that we ve included there. In addition, we will use certain non-gaap measures in our discussion this morning and we ask you to read through the sections of our press release that address the use of these items. The press release and related tables can be found on the Investor Relations portion of our website at cssindustries.com. Chris will begin our discussion by providing some opening comments related to our quarter. Thanks, Keith. Good morning, everyone. Our second quarter results were as expected and in line with comments provided during our last call. Overall sales increased 11%, reflecting the contribution from Simplicity, which we acquired in November of 2017. Organically, our sales declined 10% year-over-year, which was the primarily the result of the timing of Christmas ribbon and bow sales. Sales for these 1
products shifted to our fiscal third quarter, when compared to last year, due to the re-shoring of certain plastic decorative ribbons and bows from China as a result of our anti-dumping case. We expected this shift to occur and commented on it during our last earnings call. Our Adjusted EBITDA was down $2.2 million from last year s second quarter results, driven primarily by the timing shift of Christmas ribbon and bow sales, as well as the slightly less profitable mix of Craft sales, partially offset by the contribution from Simplicity. Again, these results were anticipated, based on our comments from our last earnings call. The implementation of our strategy remains forefront within our business and we ve provided updates on several key initiatives in the press release. I d like to take a few minutes to comment further on a few of these. First, we completed another major integration activity with the combination of the McCall and Simplicity pattern marketing personnel located in New York City. This was a key integration activity planned with the acquisition of Simplicity and we are pleased to have implemented this in less than one year after acquiring Simplicity. This integration will drive collaboration between brands, bring additional innovation to the marketplace, while also driving significant cost savings for the Company. We now remain laserfocused on moving the personnel to a single office location, which we expect to have completed by the second quarter of fiscal 2020. Second, as we continue with the integration of recent acquisitions, we re seeking to drive additional improved profitability across the organization with revised systems and processes. To assist with the identification and implementation of potential opportunities, we ve engaged an international consulting firm to perform a comprehensive review of our operating structure, with the key goal focused on improving efficiencies. This is being done to optimize our business looking ahead as we reshape our portfolio. We re confident that this will position the Company to drive enhanced future profitability, while continuing to lead the market with innovation and on-trend designs. Third, we provided comments during our first quarter earnings call related to the U.S. Department of Commerce s investigation into Chinese producers relating to the dumping of plastic decorative ribbons into the U.S. market. We re pleased to provide an update that provisional trade remedies are now in place and will help address unfair competition from dumped and subsidized imports of decorative plastic ribbons and bows from China. Since August of 2018, imports of these products have been subject to cash deposits with respect to anti-dumping duties at rates ranging from approximately 45% to 370%, plus additional cash deposits relating to countervailing duties at ranges ranging from approximately 13% to 95%, which took effect in June 2018. These provisional trade remedies remain in effect pending final determinations by the U.S. Department of Commerce, expected in December 2018, and the U.S. International Trade Commission, expected in January 2019. Should these trade remedies remain in effect, we expect this to benefit our Company looking ahead into next year. Finally, during the quarter, the Company continued its ongoing review of potential tariff impacts as a result of goods imported from China. We ve identified the top product categories impacted as a result of tariffs and have implemented action plans to offset these cost increases. Our action plans are multi-faceted and reach across both our Sales and Operations Teams, to ensure cost increases are offset through price increases, additional cost negotiations with Chinese vendors, as well as efforts to resource imported products to non-china factories. We will continue to monitor the situation. We do not expect this issue to have any material impact to our fiscal 2019 net sales and Adjusted EBITDA guidance. To summarize, our second quarter performed largely in line with expectations and we remain on track to deliver our full year sales and Adjusted EBITDA guidance. Our key action steps looking ahead remain focused on driving actions to achieve our results, while continuing to execute on our strategic initiatives. 2
Keith will now take us through a review of our quarter. Thanks, Chris. This morning, we will walk through our overall sales results, sales performance by category, as well as the rest of the income statement, balance sheet and cash flow. Net sales for the quarter increased 11% over the prior year to $112.9 million. Sales related to Simplicity, which we acquired in November 2017, were $21.8 million. Excluding sales from Simplicity, net sales declined 10%, primarily due to the later timing of Christmas ribbon and bow shipments, which will shift to our fiscal third quarter of 2019. We had commented on this shifting of sales during our Q1 earnings call, noting an expected significant decline in Q2 seasonal sales. In our Craft category, net sales of $42.5 million in the second quarter represented a 110% increase over the prior year quarter. Excluding sales from Simplicity, our net sales increased 3%, compared to the prior year, driven by the timing of a button reset, as well as higher Craft ribbon replenishment orders. Coming off of a soft quarter due to destocking and timing shifts, we were encouraged to see a small lift in organic sales during the quarter. Looking ahead, our retailers are looking to win the season and ensure adequate levels of inventory at store level. As a result, we are encouraged about the sales activity as we enter our fiscal third quarter. On a full-year basis, we expect Craft sales growth of approximately 50%, as compared to the prior year, driven by the full year contribution of Simplicity sales. We expect our base Craft business to be essentially flat with the prior year. Turning to our Gift category, net sales were $30.6 million in the quarter, down 3% from the prior year quarter. The key driver of this year-over-year decline was the permanent loss of the infant category sales with a major retailer, as we noted in Q1. Partially offsetting this decline were higher sales of social giftable products due to the placement of a new program within the drug channel. For the full year, we expect sales in this category to be essentially flat with the prior year. Share gains within all-occasion ribbon and social stationery will offset the loss of the previously mentioned infant program with a major retailer. Our seasonal net sales declined 20% versus the prior year quarter, due to the expected later timing of Christmas ribbon and bow sales, driven by the reshoring of certain ribbon and bow items as a result of our polyribbon anti-dumping case, which will result in these sales shifting to our third quarter. Those sales, however, will be partially offset by the permanent reduction of Valentine and Easter sales, due to buy-downs with several major retailers, as well as a share loss within these categories. As a result, we expect full year sales in this category to be down approximately 5% to 7%, again, mainly due to Valentine and Easter, as well as lower sales of seasonal gift card holders. Moving further into our income statement, our consolidated gross profit on a GAAP basis was $24.7 million in the second quarter, compared to $26.7 million in the prior year quarter. There are several key drivers contributing to the year-over-year decline, which are as follows: First is the gross profit contribution from Simplicity, which was not included in our prior year second quarter. Second is the impact of the timing shift of Christmas ribbon and bow volume from our fiscal second quarter to the fiscal third quarter, as previously discussed. This timing shift is the primary driver of the year-over-year gross margin decline in the base business and, to a lesser extent, lower Craft gross margins due to product mix. 3
Next is the impact of the exit of our licensed back-to-school business and SKU reduction within our Gift business, which we discussed on our first quarter earnings call. As a result of this change, we booked $2.1 million of inventory write-down and licensing guarantee charges in connection with this change. Lastly, we incurred higher integration costs in the quarter versus the prior year as a result of the continued integration efforts around the Simplicity acquisition. Our adjusted gross profit was $30.9 million in the second quarter, compared to $30.5 million in the prior year quarter. Adjusted gross margin rate was 27.3% in the quarter, compared to 30.1% in the prior year quarter. The decline in adjusted gross margin percent is driven by the mix of lower base business volume, primarily Christmas ribbons and bows, as well as a less favorable product mix within the Craft category, partially offset by the contributions from Simplicity. Selling, general and administrative expenses were $28.3 million in the quarter, compared to $23.3 million in the prior year quarter, with the increase driven by the acquisition of Simplicity. Base business SG&A expense was essentially flat. During the quarter, we booked $2.1 million of restructuring expenses related to our previously announced U.K. consolidation. Of the $2.1 million expense, $1.6 million related to a non-cash write-down of fixed assets in connection with our Havant, England facility. The remaining restructuring expenses relate primarily to severance. The GAAP operating loss for the quarter was $5.8 million, compared to our operating income in the prior year quarter of $3.4 million. Our adjusted operating income was $4.5 million, compared to $8 million in the prior year second quarter, which primarily reflects the contributions from Simplicity, offset by the timing of Christmas ribbon and bow sales, a slightly less profitable mix of Craft products, and higher SG&A expenses as a result of the Simplicity acquisition. Our GAAP net loss for the second quarter was $4.9 million, compared to net income of $3 million in the prior year quarter. Adjusted net income was $2.9 million, compared to $5.9 million in the prior year quarter. GAAP loss per share this quarter was $0.54, compared to income per share of $0.33 in the prior year second quarter. Adjusted EBITDA was $7.9 million for the quarter, compared to $10.1 million in the prior year fiscal quarter. Turning now to the balance sheet and cash flow, we ended the quarter with $15.1 million of cash and cash equivalents, compared to $27.2 million at the end of the prior year quarter. The lower balance is primarily driven by the Company s use of cash to fund our November 2017 acquisition of Simplicity. Net inventory increased to $116 million from $107 million at the end of the prior year quarter, again, due to the addition of Simplicity; however, partially offset by lower base business inventories. The lower base business inventory is primarily due to the lower fair value step-up amortization related to McCall, partially offset by higher Christmas ribbon and bow inventories as a result of higher domestic volumes which will ship in our fiscal third quarter. Accounts receivable increased to $102 million from $95 million, mainly due to the Simplicity acquisition. Our past dues remain in line and we do not foresee any issues at this point. We ended the quarter with $61.5 million in total debt, of which $40.1 million relates to borrowings associated with the Simplicity acquisition, and the remainder primarily due to our seasonal working capital build. 4
Cash used for operating activities was $45.8 million for the six months, compared to $34.2 million in the prior year. A large driver of the higher cash used, compared to prior year, is the later timing of Christmas ribbon and bow shipments as a result of the re-shoring of goods to our U.S. plant. Included in cash from operating activities were $3.6 million of after-tax cash acquisition and integration-related costs, compared to $700,000 in the prior year. Capital expenditures were $5.9 million in the six months, compared to $2 million in the prior year, with the resulting growth driven by integration activities related to the Simplicity acquisition. The resulting free cash flow was the use of $52 million for the six months, compared to $36 million in the prior year six months. We ve returned $3.6 million to shareholders year to date through our normal quarterly dividend, which is consistent with prior year. Now, let me turn it back to Chris for a discussion around our outlook for the year, as well as some closing comments. Thanks, Keith. Our net sales and Adjusted EBITDA outlook remains unchanged. We expect full year net sales to be in the range of $398 million to $412 million, which is an increase of 10% to 14% over the prior year. The growth will be driven by the full year revenue contribution from Simplicity, partially offset by a small decline in our base business. We expect Adjusted EBITDA to be in the range of $26 million to $29 million, an increase of 7% to 19% over the prior year. The incremental Adjusted EBITDA is driven by the contributions of Simplicity, offset by the lower base earnings. The higher expected Adjusted EBITDA in Q3 and Q4, versus prior year, relates to three things: the shift of our Christmas sales, savings related to the Simplicity integration, the lower manufacturing variances versus prior year. We are revising our GAAP net loss guidance to be in the range of $10 million to $13 million, driven mainly by higher costs associated with our United Kingdom consolidation, higher costs related to our SKU rationalization within Gift, as well as higher acquisition and integration costs. To recap and close our call, we remain on track to achieve our full year sales and Adjusted EBITDA guidance; strategic initiatives remain a primary focus as we continue to integrate Simplicity, as well as drive additional operating efficiencies across our business; we remain committed to reshaping our portfolio and strengthening our market position with a focus on branded Craft and Gift products; our cash flow generation will remain strong on a full-year basis. Operator, let s open up for questions Operator: Thank you. At this time, I would to remind everyone, in order to ask a question, press star, then the number one on your telephone keypad. Your first question comes from the line of Linda Bolton Weiser from D.A. Davidson. Your line is open. Hi. Congratulations Good morning. 5
Hi. Congratulations, Keith, on your new role. Thank you. Can I just ask about you explained about the anti-dumping favorable ruling. Can you remind us on roughly what percentage of your revenue base that s affecting, and how soon will we start to see perhaps some favorable effect on your sales? Would it be right away or in a few quarters for that? Linda, this is Chris Munyan. Thank you for the question. The sales that are affected would be roughly 20%, and I think, from the standpoint of impact, we re really expecting to see some impact this year, because we actually have secured new business versus the prior year. Part of that is the reason we re seeing higher Christmas sales in the month of October and November, because they re re-shored goods that were produced in China last year. We also expect to receive opportunities to win new all-occasion business. So, some of that we re going to see this year, but most of the benefits we should see in the future year, into fiscal 20. Great. Then, just generally on this topic of tariffs, I mean, are there any I know you manufacture a lot of your own stuff, but is there anything that you import from China that you might be affected negatively on the whole tariff situation? This is Chris Munyan again, Linda. So, we do import several product categories from China. Paper goods are substantially impacted by the tariffs, journals, certain types of woven products, but our belief and what we re seeing is that we re going to take price up where we re going to re-shore products, and those are really the primary initiatives that we have to kind of mitigate the tariffs. We re operating under the basis that the tariffs are going to move to 25% and that they re not going to go away, and that s the way we re moving forward. Okay. Then, your results were very much as expected. You talked about the shifts and all of that. So, this is going to result in a pretty big third quarter revenue growth, I think, as far as my model has pretty big growth. Is there any way you can help me size kind of how the revenue falls out between third and fourth quarter, or the growth rates, or something? Is it much higher in the third quarter versus fourth quarter in terms of organic sales growth? 6
The trend for Q3, ribbon and bow is going to push into our third quarter, but we expect our fourth quarter to be up about 4% in our base business actually, between Q3 and Q4. Base business growth will be up in Q3 and Q4, but the big drive that we re going to see in Q3 is driven by ribbon and bow volumes. With most of that being seasonal. Yes. Okay, thanks. Just on the cash flow, I think you indicated it was some timing issues, but some of those will reverse, or whatever, in the second half, such that you expect to have similar type cash flow performance as in the prior fiscal year. Is that what you re expecting? We still feel good about our full year cash flow, but we do acknowledge that year to date obviously, ribbon and bow sales are lower year to date, which is driving lower income, as well as some higher integration expenses, when you look at kind of the core income, and the higher integration expenses are because we re trying to go faster, but when you look at the rest of the composition of cash flow, we have an inventory build as a result of the ribbon and bow volume. It s a timing shift that s going to push to Q3, but once we get through that, we do expect still to feel good about our cash flow for the full year. Linda, this is Chris Munyan. As we signaled earlier, our cap ex is going to be a little bit higher than last year, and so that cap ex is going to be kind of different year-over-year, and that cap ex is higher on 100% tied to integration activities. Yes, and we spoke before that our cap ex is roughly $4 million higher than prior year at this point through six months. A lot of our increased cap ex versus prior year is front-end loaded when you look at. So, we ve seen growth, but on a full-year basis, most of the spend is front-end. Right, got you. Then, you had alluded to some consulting work here. I guess that s something new, right? Can you just talk a little bit more about what areas are going to be looked at and what s the timing of when we might see actions taken, and then any effect on the financial performance? Sure, Linda, this is Chris. The prime area they re focusing on is our base business, not Simplicity. So, on Simplicity, just to let you know, we re making great progress on integration, so we didn t if we look at the end of this fiscal year, based on the accelerated integration activities on Simplicity, we re probably going to be looking at that acquisition at more like a low five multiple, so we feel great about the acquisition of Simplicity. Our base business, though, costs, we re only looking at a couple areas. The consultants are 7
looking at, you know, it spans the layers, where it s identifying kind of future organizational targets relating to do we have the layers, the right organizational structure. They re helping us look at active SKU management relating to rationalizing further complexity of SKUs within our portfolio. They re looking at kind of helping us look at further merging our shared services even though we ve done a lot of that over the years, there s further opportunities to do that as well as looking at Sales and Marketing, where we can share resources and capabilities across our teams, all with the intent to drive costs down in the base business. So, is there a timing for completion of the work? Yes. I mean, we ve not specifically announced that, but this is something that s been engaged in the past few months, and so our expectation is we re going to see absolutely tangible benefit of this to next year, with a small benefit to this year. It gets implemented between now and the end of this fiscal year. Okay, that sounds good. Then, just finally, you know, we follow the toy industry, as well, and in our store text about the expansions of the toy space at some of the mass retailers, we actually picked up that at one I think it was Walmart some of the space that they added toys, it was taken away from the arts and crafts section. Is it affecting you in terms of some losses of shelf space, or is it other areas, not the areas you re in, or can you can comment on have there been any shelf space changes at Walmart or Target? Linda, this is Chris again. I mean, no. I can only comment, first, all the craft chains. We ve seen no change at any of our space at any of the major craft chains, including Walmart, that relates to any kind of shift to toy, and at Target, we sell minimal craft products to Target, so none of our products have also been impacted by any expansion in toy. So, we ve had no effect. Okay, great. Well, thank you very much, I appreciate it. Thank you. Operator: Again, if you would like to ask a question, press star, then the number one on your telephone keypad. There are no further questions at this time. Mr. Pfeil, I turn the call back over to you. 8
Great, thank you. Thank you, everyone, for joining our fiscal second quarter call. If you have any additional follow-up questions, both Chris and I will be in the office today, feel free to reach out to us, and we look forward to finishing out our year on a strong note. Have a good day. Operator: This concludes today s conference call, you may now disconnect. 9