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Edited Transcript of CSS earnings conference call or presentation 15-Nov-19 1:30pm GMT

Q2 2020 CSS Industries Inc Earnings Call

Philadelphia Dec 6, 2019 (Thomson StreetEvents) -- Edited Transcript of CSS Industries Inc earnings conference call or presentation Friday, November 15, 2019 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christopher J. Munyan

CSS Industries, Inc. - President, CEO, Principal Financial Officer & Director

* Jamie Rongone

CSS Industries, Inc. - VP of Accounting

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Conference Call Participants

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* John Butler Walthausen

Walthausen & Co., LLC - CIO & Portfolio Manager

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Presentation

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Jamie Rongone, CSS Industries, Inc. - VP of Accounting [1]

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Good morning, and thank you for joining our conference call to discuss CSS Industries' second quarter results for fiscal year 2020 and an update on our outlook for fiscal 2020.

Sitting with me today is Chris Munyan, our President and Chief Executive Officer.

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 statements 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 our Investor Relations portion of our website at cssindustries.com.

Chris will begin our discussion by providing some opening comments related to our second quarter.

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Christopher J. Munyan, CSS Industries, Inc. - President, CEO, Principal Financial Officer & Director [2]

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Thanks, Jamie. Good morning, everyone. Our second quarter results were slightly below our prior expectations. While the net sales decreased 15% to $96 million in the second quarter as compared to prior year quarter, the company had net income of $3.5 million in the second quarter compared to a net loss of $4.9 million in the prior year quarter. Our second quarter results reflect the impact of our previously announced cost savings initiatives, which we continue to focus on in order to maximize the cost containment plans we have implemented. We also expect to work on additional business improvement plans during the remainder of fiscal 2020.

Stepping back from the quarter 2 highlights, there are 2 things that I would like to underscore. First, we're very pleased with the financial results. We are tracking well ahead of prior year, even with lower sales. Second, we are confident in achieving our previously announced cost savings initiatives, which we evidenced by both our Q1 and our Q2 results.

Moving ahead, these 2 initiatives mentioned in yesterday's press release that I would like to take a moment to discuss. The first item I'd like to touch on relates to debt and liquidity. We ended the second quarter with $45.3 million compared to $46.4 million of debt at September 30, 2018. Despite operating at a net loss, free cash flow in the first 6 months of current fiscal year improved $17.4 million compared to the first 6 months of the prior fiscal year, which was driven by the cost savings actions.

This leads me to the second item I'd like to touch on, our continued cost savings initiatives. The company continues to implement and successfully execute its cost-savings actions and continue to seek to identify new areas of spending reduction. During the second quarter, we recorded $700,000 of restructuring expense relating to a resource alignment restructuring plan that is expected to drive expense reductions of approximately $6 million on an annualized basis. Additional cost savings efforts made during the second quarter included 2 location consolidation initiatives. One was ceasing the use of one of our New York City offices, and the other was shifting distribution of certain products from one facility toward technologically advanced and efficient facility. We also continue to review underperforming product lines, specifically focusing on profit improvement initiatives within the specialty components of our gift business. We plan to continue to develop and implement the plans to drive performance improvement within our gift business in fiscal 2020.

Now I'll turn it back to Jamie, who will cover the financials in detail.

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Jamie Rongone, CSS Industries, Inc. - VP of Accounting [3]

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Thanks, Chris. Turning attention to the financial results, we will walk through our overall sales performance and results by category as well as comment on our income statement, balance sheet and cash flow. Net sales for the second quarter were $96 million, which was $16.9 million or a 15% decrease over the prior year quarter, impacted by lower craft, gift and seasonal sales.

Looking at our sales by category, craft net sales were $35 million in the second quarter compared to $42.5 million in the prior year quarter, representing a 17.6% decline. The decline was driven by lower replenishment orders of ribbons, needle arts and kids crafts, further increased by lower button sales due to the timing of a button program reset from the prior year quarter. Our gift category net sales were $23.6 million in the second quarter compared to $30.6 million in the prior year quarter, representing a 22.8% decline. The decline was primarily due to lower replenishment orders of social stationery products within our specialty gift business as well as declines in packaging and wholesale products and everyday trim-a-package product. Additionally, the decline was impacted by a placement of a new program within the drug channel in the prior year quarter.

Our seasonal net sales were $37.3 million in the second quarter compared to $39.8 million in prior year quarter, representing a 6.2% decline. The decline was primarily due to lower sales of Christmas cards and bags and the previously announced exit of the company's sports-licensed back-to-school product line partially offset by higher sales of Christmas ribbons and bows.

Moving further into our income statement. Our consolidated gross profit on a GAAP basis was $24.7 million for both current year and prior year quarters. Gross margin was 25.8% in the quarter compared to 21.9% in the prior year quarter. The increase in gross margin was primarily related to lower inventory step-up amortization related to our Simplicity, McCall and Fitlosophy acquisitions and a nonrecurring write-down of inventory and royalty guarantees in the prior year quarter related to the restructuring of the company's specialty gift product line. These savings were substantially offset by the lower sales volume and the mix of sales.

Our adjusted gross profit was $25.3 million for the second quarter compared to $30.9 million in the prior year quarter. Adjusted gross margin was 26.4% in the quarter compared to 27.3% in the prior year quarter driven by the mix of sales.

Selling, general and administrative expenses were $20.4 million in the second quarter compared to $28.3 million in the prior year quarter. The decrease was attributable to lower costs, including consulting, salaries, medical benefits and travel expenses as a result of our cost savings initiatives.

In addition, the company also realized a benefit related to the remeasurement adjustment of the Fitlosophy-contingent earn-out consideration. Restructuring expenses were $700,000 for the second quarter, primarily attributable to severance expenses resulting from resource alignment related to the company's previously announced restructuring plan. The company had restructuring expenses of $2.1 million for the prior year second quarter attributable to the consolidation of operations in the United Kingdom and Australia, pursuant to the company's previously announced restructuring plan.

GAAP operating income for the second quarter was $3.5 million compared to an operating loss in the prior year quarter of $5.8 million. The adjusted operating income was $5.9 million for the second quarter and $4.5 million for the prior quarter. The GAAP net income was $3.5 million for the second quarter compared to a net loss of $4.9 million for the prior year quarter. Adjusted net income was $5.2 million compared to $2.9 million from the prior year quarter. Diluted net income per share was $0.39 compared to diluted net loss per share of $0.54 for the prior year quarter. Adjusted diluted net income per share was $0.59 compared to adjusted diluted net income per share of $0.32 for the prior year quarter. Adjusted EBITDA was $9.1 million for the second quarter compared to $7.9 million in the prior year quarter.

Turning to the balance sheet and cash flow. We ended the second quarter with $5.2 million of cash and cash equivalents compared to $15.1 million at the end of the prior year quarter. The lower balance was primarily due to funding of working capital needs for our overall business. Inventory decreased to $105 million at the end of the quarter from $116.4 million at the end of the prior year quarter partially related to lower fair value step-up adjustments of inventory relating to previously acquired inventories. Excluding the effect of the lower step-up inventory, inventory levels were $9.4 million lower at the end of the second quarter than at the end of the prior year quarter, which was driven by our inventory management improvements.

Accounts receivable decreased to $20.1 million from $101.8 million at the end of the prior year quarter to $81.7 million this quarter primarily attributable to the decrease in net sales.

Accounts payable decreased to $36.7 million compared to $37.7 million at the end of the prior year quarter. The company ended the second quarter with operating lease right-of-use assets and operating lease liabilities of $46.9 million and $46.2 million, respectively, which were recognized commencing in fiscal 2020 as a result of the adoption of the new lease accounting standard.

Cash used for operating activities was $28.4 million for the 6 months ended September 30, 2019, compared to $45.8 million for the first 6 months of the prior year. The decrease was primarily due to lower buildup of accounts receivable attributable to lower sales volume. Cash used for investing activities was $5.8 million for the first 6 months of the current year compared to $11.6 million for the first 6 months of the prior year.

Capital expenditures were $6 million compared to $5.9 million for the first 6 months of the prior year. Cash provided by financing activities was $22.2 million for the first 6 months of the current year compared to $14 million for the first 6 months of the prior year. Free cash flow was a use of $13.5 million for the current year second quarter compared to a use of $33.1 million for the prior year second quarter and $34.3 million for the first 6 months in the current year compared to $51.7 million for the first 6 months in the prior year.

Now I am going to turn it back to Chris to discuss our fiscal 2020 outlook as well as provide closing comments.

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Christopher J. Munyan, CSS Industries, Inc. - President, CEO, Principal Financial Officer & Director [4]

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Thanks, Jamie. The lower SG&A results of our first and second quarter demonstrate the company's commitment to driving cost out of our business. We move ahead, planning for continued declines in revenue as previously communicated, which will be partially offset by cost savings initiatives already implemented as well as additional cost-saving measures to improve overall results.

We acknowledge continued weakness in our gift business as well as ongoing pressure from China tariffs, and we'll be addressing this in fiscal 2020. Our domestic Christmas ribbon and bow production remains on track to ship on time, such that we do not expect to see the execution issues experienced in the prior fiscal year.

Lastly, we remain optimistic about our combined legacy and acquired craft businesses as we continue to bring newness and innovation to the marketplace. Overall message remains the same, which is to maximize cost cuts, drive working capital improvements, aggressively pay down debt and drive improved profitability and free cash flow. We expect full year fiscal 2020 net sales to be in the range of $346 million to $352 million, primarily driven by retail customer reducing orders as a result of the impact of U.S. tariffs imposed on certain goods imported from China. Our GAAP net loss is expected to be in the range of $2 million to $4 million compared to a net loss of $53.5 million in fiscal 2019, and adjusted EBITDA is expected to be in the range of $21 million to $23 million compared to $15 million in fiscal 2019.

The expected growth in adjusted EBITDA was driven by the realization of cost-saving initiatives partially offset by lower sales volumes. We're also reaffirming our guidance range on free cash flow for fiscal 2020, defined as net cash provided by operating activities minus the purchase of property, plant equipment. We expect free cash flow to be in the range of $14 million to $16 million driven by the combination of cost savings, working capital improvements and reduced capital expenditures. This expected range compares to our fiscal 2019 free cash flow of negative $9.6 million.

Lastly, I would like to touch on the short-term stockholder rights plan we announced earlier this week. On November 11, 2019, our Board of Directors adopted a short-term stockholder rights plan and declared a dividend distribution of 1 right for each outstanding share of common stock with a record date of November 22, 2019. The rights plan is similar to stockholder rights plans adopted by other publicly held companies and will expire without further action by our Board of Directors on the earlier of November 11, 2020, or the business day immediately following the company's next Annual Meeting of stockholders, absent any extension being approved by the company's stockholders.

The adoption of the right plan is intended to protect CSS and its stockholders from the actions of third parties that our Board of Directors determines may not be in the best interest of CSS and its stockholders, to enable all the stockholders to realize the full potential value of their investment in CSS and protect the interest of CSS and its stockholders by reducing the likelihood that any person or group gains control of CSS through open market accumulation or other tactics without paying an appropriate control premium.

In addition, the rights plan provides our Board of Directors with time to make informed decisions that are in the best long-term interest of CSS and its stockholders and does not prevent our Board of Directors from considering any offers that considers to be in the best interest of our stockholders. Further details are available in various publicly available documents filed by CSS with the Securities and Exchange Commission, which are available at www.sec.gov.

Operator, let's open it up for questions.

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Questions and Answers

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Operator [1]

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[Operators Instructions) Your first question comes from the line of John Walthausen with Walthausen & Co.

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John Butler Walthausen, Walthausen & Co., LLC - CIO & Portfolio Manager [2]

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Yes, Chris, well, first of all, thank you very much for the great details that you provided in the report this time. That makes it easier to understand what's going on. But on the faster-than-expected decline in sales, the part that really surprised me was the craft group falling that far. And it sounds by omission as though the sewing pattern business held in pretty well, but the ribbons and needle arts must have fallen quite, quite sharply. Can you talk about what's going in that market? What's the sell-through, and whether we're seeing an erosion of retailers who are carrying those lines.

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Christopher J. Munyan, CSS Industries, Inc. - President, CEO, Principal Financial Officer & Director [3]

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Yes, John, thank you for the question. And I mean, for one, we don't see anything that's endemic within the category that's causing problems. What we did experience this summer with a few retailers in that segment was as tariffs were starting to increase and affect those retailers, many of them who direct-buy from Asia, they were constrained with buy dollars. So retailers managed buy dollars based on retail buy dollars as well as physical dollars of inventory in their shelves. So as tariffs were coming in and being absorbed by the retail chains, they were constrained. So during the summer months until the early fall, we had several items that were actually recently shipped in where they turned off replenishment as they had to shift inventory dollars within their store. Now that has changed now, kind of, since late September into October, but we did experience that in core areas. Patterns were not affected because patterns are mostly pay by scans. Where we also...

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John Butler Walthausen, Walthausen & Co., LLC - CIO & Portfolio Manager [4]

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Okay. That's -- I am sorry. We're talking over each other. Sorry, I can't hear you.

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Christopher J. Munyan, CSS Industries, Inc. - President, CEO, Principal Financial Officer & Director [5]

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No, I'm sorry, John. I was just saying, we hold the pattern inventory because it's -- so we're able to make sure patterns are highly in stock. But there were definitely out-of-stocks that occurred. And I think that they were just really trying to manage what's happening in the tariff world and manage their inventory levels.

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John Butler Walthausen, Walthausen & Co., LLC - CIO & Portfolio Manager [6]

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So the fact that you can see that the patterns we're selling through suggest that the demand is there for the ribbons. And if I'm understanding you correctly, buying constraints caused the retailers' inventories to go on the low side, which should tend to be a plus for you in the next few quarters.

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Christopher J. Munyan, CSS Industries, Inc. - President, CEO, Principal Financial Officer & Director [7]

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I mean, over time, they have to -- they'll have to bring inventory in, but I think as everyone is trying to figure out really what's going on, I mean the expectation now is tariffs are here to stay. Earlier this year, before the G7, there was a lot of kind of managing inventory levels and try to figure out really what's happening with tariffs.

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John Butler Walthausen, Walthausen & Co., LLC - CIO & Portfolio Manager [8]

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Okay. I guess the bigger question that is, obviously, it's good to see you reaffirming your guidance on free cash flow and on adjusted EBITDA, but seeing the sales expectations decline again, I guess the real question is with the seasonal business largely completed by now and the other businesses largely being replenishment, where do you see the risks of falling short of your renewed guidance on sales and earnings for this year? And then as we look towards next year -- because obviously, we can't continue to suffer this rate of sales decline, what are you seeing that could rejuvenate sales to get back to a flat or growth pattern in sales?

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Christopher J. Munyan, CSS Industries, Inc. - President, CEO, Principal Financial Officer & Director [9]

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Yes. John, it's early. I can't -- thank you. But in terms of where we, kind of, took guidance down was really to account for potential further slower reorders. We still believe it's not tied to share change or item loss change at retail or even the fundamental weak consumer interest in those items as much as really the further risk of further tariffs and how that could impact retailer buys and further inventory management at the major chains. And that was really kind of what we build into that. I think eventually, that will have to all bounce back. But I still think there's further risk as we finish out our year. We have seen orders bounce back. We had a very nice October in orders for nonseasonal products. But we do think that's a risk going forward. And I think without guiding into next year, our expectation is we are certainly not going to repeat a year like we had this year at all. And that we have belief that with -- what we're seeing with the new placement that we see into next year, both in gift and craft and in seasonal that we're going to have a much different revenue outlook going into fiscal '21. That's going to -- our goal is to be at minimum at the flat level.

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John Butler Walthausen, Walthausen & Co., LLC - CIO & Portfolio Manager [10]

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Okay. And then my final question -- I don't know whether there's a congratulations on having another role as CFO or not. I am not sure the -- I guess, I welcome that. But could you talk about the reasoning behind that?

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Christopher J. Munyan, CSS Industries, Inc. - President, CEO, Principal Financial Officer & Director [11]

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Well, I mean, we are still recruiting for a CFO, and we're just being cautious to make sure we bring the right person in. So it's just Jamie Rongone, who's our Vice President Controller, is doing a great job for us and her team. But -- I have a CPA and a financial background so I felt that also do in-depth review of the financial statements every month as I have always done. And I felt that was better than putting Jamie in the position. So I'm very comfortable signing as Chief Financial Officer as well.

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John Butler Walthausen, Walthausen & Co., LLC - CIO & Portfolio Manager [12]

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Okay. And I guess there is another question because that reminds me of the monthly reports you have to do. The projections you're making suggest that you really will be at a net cash positive by the end of your fiscal year. Is there any reason to suspect that you will not be able to renegotiate your current credit agreement at that point?

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Christopher J. Munyan, CSS Industries, Inc. - President, CEO, Principal Financial Officer & Director [13]

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I mean I can't comment to the future. But I mean, I think as the business continues to improve, we're going to be in a better position to always work with our banks, right? And we're -- I think we're doing all of the right things and that in terms of driving costs down, getting out of assets we don't need, rationalizing our footprints and working to stabilize our sales that I think are going to be -- continue to be good for the banks and us.

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Operator [14]

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[Operators Instructions) There are no further question at this time. Thank you for your participation today. You may now disconnect.