Chief Executive Officer's address - 24 November 2015 Annual Meeting of shareholders

Thank you, Sarah. Good morning, everyone.

First, a quick reminder of the Group's operations and principal activities, comprising:

  • Broadloom carpets – sold under the Cavalier Bremworth and Norman Ellison brands
  • Until recently, carpet tiles under the Ontera brand
  • The Elco Direct wool procurement business
  • The Radford felted yarn operation, and
  • A 50% interest in Cavalier Wool Holdings, a commission wool scouring business

 
The focus of my address to you today will be:

  • 2015 performance
  • The abnormal costs incurred during that year
  • Our focus for the last few months, and
  • Our future plans

2015 PERFORMANCE

NZD $m 2015 2014 Change
Sales 215.7 200.5 7.6%
Normalised profit after tax (non-GAAP) 1.2 5.8 -79.4%
Abnormal items -26.9 -  
Reported (loss)/profit -25.7 5.8  
Net bank debt 56.8 61.2 -7.3%

 

This table shows the key performance indicators for 2015.

 
The Group reported an audited after tax loss of $25.7 million for the year ended 30 June 2015, compared with an audited after tax profit of $5.8 million in 2014. The loss included abnormal items of $26.9 million.

 
Excluding these abnormal items, the normalised profit after tax was $1.2 million, compared with $5.8 million in 2014. We refer to normalised profits as a better year on year comparison of underlying operating performance. This is particularly relevant for the 2015 financial year with large abnormal costs during the period.

 
I will cover sales, profit, abnormal items and debt in more detail over the next few minutes.


Sales

 
Total sales were up 7.6% from 2014.

 
In our core business, broadloom carpets, we have had 5% growth in volume in each of the last two years.

 
It was not so long ago when wool carpet sales represented over 70% of the NZ market. We believe this is now less than 20%.

Normalised profit (non-GAAP)

 
While total sales increased 7.6% from the prior year - normalised profit was down $4.6 million to $1.2 million.

 
Ontera, Cavalier's tile manufacturing business in Australia, contributed to most of the profit short fall with a large loss for the year. Other contributing factors were the strong NZD against the AUD and high wool prices, and we were unfortunately not able to convert the increased broadloom sales volume into bottom line profit.


NZD/AUD

 
With over 50% of our sales generated in Australia the unexpected spike in the NZD/AUD through 2015 hit our profitability. Significant foreign exchange cover limited our exposure, but any uncovered sales were adversely impacted. Every 1 cent movement in this cross rate represents approximately $600k impact on profit per annum. So without this, our year would have turned out much better. At high cross rates, it is difficult to make good margins in Australia but Australia remains our most important market for sales growth


Wool price

 
Over 50% of broadloom carpet sales are wool based. So wool price movement still has a large impact on profitability with every $1 movement representing between $3 and $4million per annum.

 
The current long run wool price is now $5.50/kg or more compared to $3.50/kg during our best years. The increased wool price is a structural change which we do not expect to reverse and we have to manage our business accordingly. Longer term, our exposure will reduce with increasing volumes of synthetic products.


Ontera

 
The major contributor to the year-on-year decline in normalised earnings came from the Australian tile business. Ontera was a big drain on the company in 2015 - making a large loss.

 
In the past, Ontera has generated healthy profits while its high quality printed product had a place in the market at a premium price well able to cover relatively high manufacturing costs. All this has changed as the flood of imported alternatives now shows much improved quality at much lower prices. Ontera had a high cost product that was trapped in the declining premium end of the market. As a result, Ontera was losing share in a growing market.

 
The decision to sell Ontera was one the Directors considered carefully and determined was in the Group's best interest. Milliken was the obvious and natural purchaser – they own the technology and have a much stronger interest in supporting their product in the market. At the same time, it represented a significant de-risking of our business where we were potentially exposed to considerable losses either on an ongoing basis or as a result of closure.

 
Exiting the business with a $6.5m cash flow was a good outcome.


Cavalier Wool Holdings

 
The proposed rationalisation of wool scouring through the merger of Cavalier Wool Holdings (CWH) and New Zealand Wool Services International has once again been approved by the Commerce Commission. This is the fifth time an approval has been given.

 
The Commerce Commission process has been very long and unnecessarily costly with CWH spending over $1.0 million in professional fees in 2015. CWH has persevered with the merger as this will secure the long-term future of scouring in NZ and we are hopeful that the process will conclude sometime in 2016.

 
Our share of CWH profits, excluding the significant costs associated with the Commerce Commission process, was unchanged on the previous year.

 
An appeal against the latest Commerce Commission approval is expected, but in the interim we still receive good dividends and returns on our investment.


Wool procurement business

 
The wool procurement business, Elco Direct, has had its third straight year of strong results. It is a well-managed self-contained business.


Felted yarn operation

 
The felted yarn operation performed well with revenues similar to the previous year – the demand for this unique product is strong and we will be increasing capacity in the near future.


Abnormal costs

 
In 2015, there were significant one-off or abnormal costs which impacted our reported results.

  $m  
Impairment of carpet tile assets in Australia 9.1 Ontera making losses. Businees sold - Asset values written down to scale price
Impairment of fixed assets in New Zealand 4.3 NZ assets supporting Ontera business also written down
De-recognition of deferred tax assets 5.4 Unlikely to use siginificant tax losses in Ontera in forseeable future
Impairment of intagible assets 5.4 Brands/Trademarks/Goodwill in Ontera ($1.7m) and Norman Ellison ($3.7m)
Restructuring Costs 1.2 Share of CWH one-of costs and employee termination costs from restructure
Total $26.9m  

Apart from the last item in the table, restructuring costs, the other abnormal items had very little cash impact on the business.

 
Most abnormal costs are in respect of Ontera and the impairment of assets that business had to write down to net realisable value. There is also the impairment of associated assets for yarn production at Wanganui and writing down deferred tax and intangible assets.

 
While we do see a future in the Norman Ellison brand, volume and margin pressure have impacted profitability and the decision was made to write off its goodwill and trademarks.

 
The last item, restructuring costs, represents our share of scour merger costs and restructuring costs.


Strategy

 
We accepted some time ago that wool was in a declining market and in order to regain market share, expansion of our non-wool range was essential. We also accepted that our debt levels were too high for the current level of earnings.

 
In the early part of 2015, the board approved an amended and more focused strategic plan – we had to address the problem of having no headroom for investment. Our focus needed to come back onto our core broadloom carpet and soft flooring business where the majority of our capital is invested. We will exploit our brand strengths with new products and gain market share by improving productivity to be more price competitive.


Focus for last six months

 
For the last six months, we have focused on reducing debt and overheads and where the market allowed, we recently increased our selling prices to partially offset the increased price of wool and other input costs.

 
As mentioned earlier we have sold our loss-making business Ontera – netting approximately $6.5 million in the process.

 
In addition to freeing up our Sydney premises for sale, the outsourcing of our Australian broadloom carpet warehousing and distribution will result in a net reduction in costs within the next year or so. The outsourcing of Australian logistics will be complete once we exit our leased warehouse in Queensland.

 
We have also made good progress with inventory rationalisation – but there's still some more work to do here.

 
After a review of NZ operations - headcount has been reduced by approximately 20 with savings to accrue in 2016 and onwards.

 
The savings through merging the scouring operations will come through progressively over time.

 
We have not finished yet and clearly there is more work to be done on efficiencies and improving productivity.


Debt reduction

 
The completed initiatives I have just described have resulted in a net bank debt position of $35 million at the end of October 2015. This is the lowest level of bank debt that Cavalier has had for many years and there are further initiatives in play that should reduce debt further.

 
Of course, the debt reduction itself leads to improved profits through significant reduction in interest costs but more importantly giving us vital headroom to invest in our core business.


Future focus

 
So - what is our future strategy – what are we doing to increase sales and profitability?

 
Increasing productivity is a top priority. It is clear that we need to be more efficient – to produce more output for less input. A number of initiatives are under consideration that will make a difference - we hope to be able to share more information with you early in the new year.

 
Cavalier, with significant investment in wool-related assets, was perhaps the last major carpet company to introduce synthetic products across its entire range of product offerings. However, the strength of our brand has seen us move to over 40% synthetics in a little over two years. The introduction of the Habitat Collection range has exceeded expectations and we are planning to expand the range to meet the market's product expectations. More synthetic products will hit the market in the new year.

 
Exclusive yarns are critical to maintaining premium prices and focused product development is an ongoing function of our business. Some exciting new developments are emerging through our research and development programme.

 
Tiles are a growing part of the market showing 30% growth in Australia in five years. An imported, Cavalier branded, range of tiles will be introduced to the NZ market in the new year – these are currently being compliance tested. As soon as we have completed a successful launch in NZ we will repeat the process in Australia.

 
Based on current market research Cavalier is still the most recognised brand in the NZ market and we will leverage this more effectively by adopting a more direct and modern approach. Work is currently being completed on refreshing our marketing focus and strategy.

 
Australia represents Cavalier's biggest opportunity to grow broadloom sales. The market is large and Cavalier is currently a small player. A more competitive product offering will be critical to success and depends on improving productivity and efficiency in the NZ manufacturing operation.

 
Cavalier has a very diverse and overly complicated product portfolio. One of our key productivity improvements is simplifying the range by carefully selecting low volume or low margin ranges for deletion and allowing room for new products that will drive incremental volume and profit. The simplification project is already in progress.

 
We cannot and will not forget wool. Wool carpets are still an important part of our business and there are new specialised wool products being developed to satisfy our customers' requirements.

 
Overall – watch out for new things from us!

 
Our dedicated team of people continues to work very hard for you. We have introduced a flatter management structure, shortening communication lines to enable quicker decision making. The new management team is starting to work very well together and there is full buy in to what we need to do.

 
Our IT/reporting systems are old and need replacing to better support product planning and production and meet our customer and reporting needs. Replacement systems have been evaluated and we expect to get this project underway next year.

 
Our Rest of World volume was about the same as the prior year. Most of our Rest of World programmes are focused on leveraging our unique wool products at the premium end of the market. Getting to the sharp end of sales in the US business has been slower than anticipated – in addition to our existing US customers, products are now in the process of being sampled in Mohawk stores under the Karastan brand. With financial support from New Zealand Trade and Enterprise, wool carpet programmes are underway in Canada and the UK.

 
We need to manage the business within the current economic environment (wool prices and exchange rates) and we cannot keep doing things as we always have. The focus is to improve productivity and lift sales. Together with clear measurable goals and objectives I expect to see continuous improvement across the entire organisation and my staff will be empowered and held accountable to make sure we achieve this. I look forward to seeing you again next year and reporting on the progress we have made.

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