Hamilton Beach Brands Holding Company — 2018 Q3 Form 10-Q
Business context and period. The filing reports unaudited results for the three and nine months ended September 30, 2018, compared with the same periods in 2017. The company operates Hamilton Beach Brands (HBB), a small-appliance business, and Kitchen Collection (KC), a kitchenware retailer. Both businesses are seasonal, with a majority of revenue and operating profit typically occurring in the second half of the year.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $196.9 million | $181.7 million | $501.5 million | $475.0 million |
| Gross profit | $50.4 million | $48.1 million | $129.0 million | $121.5 million |
| Operating profit | $11.0 million | $7.4 million | $11.3 million | $7.2 million |
| Net income | $8.0 million | $4.3 million | $6.8 million | $4.1 million |
| Diluted EPS | $0.59 | $0.31 | $0.49 | $0.30 |
- Q3 revenue grew 8.4%; operating profit rose 48%, and net income rose 89%. Nine-month revenue increased 5.6%; operating profit increased 57% and net income increased 63%.
- Gross margin was approximately 25.6% in Q3 2018 versus 26.5% a year earlier, and 25.7% for the first nine months versus 25.6%. Operating margin improved to 5.6% from 4.1% in Q3 and to 2.2% from 1.5% year to date.
- Income tax expense was $2.2 million in Q3 and $1.7 million year to date. The effective tax rate was 21.3% for Q3 and 20.2% year to date, versus 38.9% and 39.1% in 2017, primarily reflecting the lower federal corporate tax rate and prior-year spin-off expenses.
- Cash used in operating activities was $46.6 million for the first nine months, compared with $7.7 million in 2017. The principal working-capital uses included a $49.1 million increase in inventory and a $7.6 million increase in receivables. Investing activities used $7.2 million, including $7.2 million in capital expenditures.
- Cash was $2.1 million at September 30, 2018, down from $10.9 million at year-end 2017. Revolving borrowings totaled $99.9 million, up from $51.3 million at year-end; total liabilities were $324.5 million and stockholders’ equity was $54.5 million. Debt was 64.7% of total capitalization.
- HBB reported $25.8 million of excess availability under its facility; KC reported $5.2 million. Both subsidiaries reported compliance with financial covenants. Management stated available cash, credit facilities and expected operating cash flows should cover needs for the next 12 months.
Material changes and segment results
- HBB: Q3 revenue increased 12.3% to $172.5 million, primarily on higher sales volumes. Operating profit rose to $13.4 million from $9.0 million; improved gross profit and lower SG&A contributed, including the absence of $2.5 million of prior-year spin-off costs. Nine-month revenue rose 9.7% to $433.7 million and operating profit increased to $21.8 million. Higher employee, professional-services, warehouse and transportation expenses partly offset gains. Interest expense also increased with higher borrowings and rates.
- KC: Q3 revenue fell 9.6% to $25.9 million and operating loss widened to $2.4 million. Nine-month revenue declined 12.9% to $70.7 million; operating loss widened to $10.5 million and net loss to $8.5 million. Lower store traffic and transactions, plus closed stores, drove the revenue decline. KC operated 197 stores, versus 209 a year earlier.
- Cash dividends to shareholders were $3.5 million for the first nine months of 2018; no comparable shareholder dividends were reported in 2017. The company adopted ASC 606 in 2018 without a material effect on revenue timing or amount. It also early-adopted ASU 2018-02, reclassifying $1.2 million from accumulated other comprehensive income to retained earnings.
Outlook, risks and contingencies
- Management expected consolidated fourth-quarter and full-year 2018 net income to increase substantially over 2017, including the effects of a lower tax rate and the absence of the prior-year provisional Tax Act charge. The expected 2018 effective tax rate was 24%–26%. Consolidated net income was expected to increase in 2019.
- HBB expected modest Q4 revenue growth and moderate full-year revenue and operating-profit growth in 2018. Q4 operating profit was expected to decline year over year due to advertising investment, transportation costs and employee expenses. For 2019, HBB expected modest revenue growth, moderate increases in operating profit and net income, and significantly higher cash flow before financing activities.
- KC expected moderately lower Q4 revenue and comparable operating profit, assuming traffic and spending met expectations. Full-year 2018 revenue was expected to decline and operating and net losses to increase significantly. KC planned six additional closures by January 2019 and 25–35 more during 2019, targeting a smaller core of 100–150 profitable stores. It expected lower 2019 revenue but improved operating loss and cash flow before financing activities.
- HBB estimated that U.S. tariffs affected products representing about 10% of its purchases; further tariff actions, input and transportation costs, currency movements, online-shopping shifts, litigation and product risks could affect results. KC cited declining mall traffic, online competition and lease-renewal risks.
- Environmental remediation obligations were accrued at $8.6 million; additional reasonably possible costs were estimated at zero to $5.2 million. The company also disclosed ordinary-course legal and regulatory matters, including product liability, patent, asbestos and environmental claims; management said it would vigorously defend them. No legal proceedings were listed under Part II, Item 1.
Important facts for investors to verify
- Whether HBB’s seasonal holiday sales and cost pressures deliver the stated full-year and 2019 outlook.
- Whether inventory and receivables convert to cash as expected, given the substantial year-to-date operating cash outflow and increased revolving debt.
- Whether KC can improve store performance while executing planned closures, lease renewals and its smaller-store strategy.
- The effect of tariffs, transportation and product costs, interest rates, and foreign exchange on margins and borrowing costs.
- Potential changes in environmental remediation estimates and the ultimate outcomes of disclosed legal and regulatory matters.