Business Context and Reporting Period
Lifetime Brands, Inc. designs, sources and sells branded kitchenware, tableware and home products through U.S. Wholesale, International and Retail Direct segments. This unaudited Form 10-Q covers the three and nine months ended September 30, 2018.
The March 2, 2018 acquisition of Filament Brands materially changed the company’s scale and leverage. Filament contributed $38.6 million of third-quarter sales and $77.2 million of nine-month sales.
Key Financial Metrics
| Metric | Three Months Ended September 30 | Nine Months Ended September 30 |
|---|---|---|
| Net sales | $209.4 million, up 26.1% | $476.3 million, up 20.1% |
| Gross margin | $73.8 million; 35.2% versus 34.5% | $171.0 million; 35.9% versus 36.3% |
| Income from operations | $12.3 million versus $9.3 million | $(4.3) million versus $4.3 million |
| Net income (loss) | $5.9 million versus $4.3 million | $(11.7) million versus $0.9 million |
| Diluted earnings (loss) per share | $0.29 versus $0.29 | $(0.61) versus $0.06 |
| Cash flow from operations | Not separately provided | $(30.4) million versus $(20.9) million |
Third-quarter net sales growth was led by U.S. Wholesale, which increased 30.2% to $178.5 million, and Retail Direct, which increased to $8.5 million from $3.5 million. International sales declined 11.3% to $22.5 million. The nine-month U.S. Wholesale operating result declined to $15.1 million from $20.7 million, while International remained loss-making at $(6.1) million and Retail Direct improved to $1.5 million from a $(0.4) million loss.
At September 30, 2018, cash and cash equivalents were $5.8 million, accounts receivable were $147.5 million and inventory was $209.2 million, compared with $132.4 million at December 31, 2017. Working capital was $256.1 million. Total assets were $800.4 million, including $359.4 million of net intangible assets.
Debt included $87.2 million outstanding under the revolving ABL facility and $273.6 million under the Term Loan, with $3.1 million of letters of credit. ABL availability was approximately $59.6 million, and total reported liquidity, including cash, was $65.4 million. The company was in compliance with debt covenants at September 30, 2018. Term Loan interest was 5.7%, and ABL borrowing rates ranged from 2.5% to 6.0%.
Material Changes Versus the Prior Comparable Period
- Filament added significant revenue but also increased amortization, corporate costs, interest expense and debt.
- Third-quarter operating income increased despite a $2.2 million goodwill impairment charge and $0.6 million of restructuring expense. Nine-month operating income turned negative.
- Nine-month interest expense increased to $12.4 million from $3.1 million due primarily to acquisition financing.
- Nine-month gross margin declined to 35.9% from 36.3%, primarily because of product and customer mix; third-quarter gross margin improved to 35.2% from 34.5%.
- Operating cash use increased to $30.4 million, driven by the net loss, higher inventory purchases and working-capital timing.
- Investing cash use increased to $222.9 million, including $217.5 million paid for the Filament acquisition and $5.4 million of capital expenditures.
- Financing activities provided $251.7 million, primarily reflecting the new Term Loan and related ABL borrowings used to fund the acquisition.
- Common shares outstanding increased to 20.8 million from 14.9 million at year-end 2017, primarily reflecting 5.6 million shares issued as acquisition consideration.
Guidance, Outlook, Commentary, Risks and Unusual Items
The filing does not provide a clear quantitative revenue or earnings guidance range. Management expects continued seasonal borrowing and repayment under the ABL facility based on working-capital needs. Sales are highly seasonal, with the third and fourth quarters historically representing approximately 60% of annual sales, while inventory typically rises from June through October.
Management expects to introduce approximately 4,000 new or redesigned products globally in 2018 and described innovation, brands, sourcing capabilities and acquisition integration as key growth factors. The company incurred $1.4 million of restructuring expense during the first nine months of 2018 to integrate Filament and had approximately $0.8 million accrued at September 30.
Tariffs on certain products imported from China included 25% tariffs implemented in July and August 2018 and 10% tariffs implemented in September 2018, with the latter scheduled to increase to 25% in January 2019. Management may raise customer prices, which could reduce demand, or absorb costs, which could reduce gross margins.
The European tableware reporting unit generated a $2.2 million non-cash goodwill impairment charge after reduced expectations for future cash flows. The reporting unit’s estimated fair value was approximately 12% below carrying value. Management also identified $22.9 million of related long-lived assets as potentially impaired, although estimated undiscounted cash flows indicated that they remained recoverable at the reporting date.
The company entered into interest-rate swaps with an aggregate notional value of $125.0 million through March 2023. Approximately $235.9 million of debt carried variable interest rates before the effect of these swaps. Other principal risks include acquisition integration, leverage and liquidity, seasonality, customer concentration and practices, foreign exchange, international operations, supply-chain disruption, tariffs, competition, goodwill impairment and economic conditions.
A Puerto Rico environmental matter involving a leased facility remains unresolved. The company cannot estimate its potential share of liability; an adverse determination could be material. The company also reported $4.0 million of gross uncertain tax positions, of which $3.0 million is expected to be resolved within twelve months.
The company expects the adoption of the lease accounting standard in the first quarter of 2019 to materially increase reported assets and liabilities, with an immaterial expected effect on the income statement and cash flow statement.
Important Facts for Investors to Verify
- Whether Filament integration delivers projected synergies and improves operating profit after acquisition-related costs and amortization.
- Whether operating cash flow improves as seasonal inventory and receivables convert to cash.
- Available borrowing capacity, covenant compliance and leverage under the ABL and Term Loan facilities.
- The effect of China tariffs and any customer price increases on demand and gross margin.
- Whether the European tableware reporting unit or its $22.9 million of potentially impaired long-lived assets require additional write-downs.
- The sustainability of the quarterly dividend given negative year-to-date earnings and operating cash flow.
- The outcome and potential exposure from the Puerto Rico environmental matter and uncertain tax positions.
- The final purchase-price allocation for Filament and any resulting changes to goodwill or intangible assets during the measurement period.