Lifetime Brands Inc (LCUT) 2010 Q3 法說會逐字稿

Welcome to the Lifetime Brands third quarter 2010 earnings conference call. At this time, all participants are in a listen-only mode. Following Management's prepared remarks, we'll hold a Q&A session. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded November 4, 2010.

I would now like to turn the conference over to Harriet Fried of LHA. Please go ahead, ma'am.

Good morning, everyone, and thank you for joining Lifetime Brands' third quarter call. With us from Management are Jeff Siegel, Chairman, President and Chief Executive Officer; and Larry Winoker, Senior Vice President and Chief Financial Officer.

Before we begin, I'll read the Safe Harbor statement under the Private Securities Litigation Reform Act of 1995. The statements that are about to be made in this conference call that are not historical facts are forward-looking statements and involve risks and uncertainties, including the Company's ability to comply with the requirements of its credit agreement; the availability of funding under that credit agreement; the Company's ability to maintain adequate liquidity and financing sources and an appropriate level of debt; changes in general economic conditions, which could affect customer payment practice or consumer spending; changes in demand for the Company's products, shortages of and price volatility for certain commodities; the effect of competition on the Company's markets; and other risks detailed in Lifetime's filing with the Securities and Exchange Commission. The Company undertakes no obligation to update these forward-looking statements.

The Company's earnings release contains non-GAAP financial measures within the meaning of Regulation G promulgated by the SEC. Included in this morning's release is a reconciliation of these non-GAAP financial measures to the comparable financial measures calculated in accordance with GAAP.

With that introduction, I'd like to turn the call over to Mr. Siegel. Please go ahead, Jeff.

Thanks, Harriet. Good morning and thank you for joining us as we review our third quarter 2010 results. While some indicators signal a strong economy, I think it's clear that higher stock prices and data don't mean a lot to a factory worker who has been unemployed for two years or to anyone whose livelihood is tied to the construction industry.

I know that some analysts have looked at recent retail sales numbers and concluded that they point to a good holiday season. However, I think it's significant that strength in sales of food and other necessities has not spilled over to appliances, furniture or other household goods.

All of this makes the performance that Lifetime Brands' reported this morning even more noteworthy. Moreover, we foresee the Company's business and profitability continuing to improve in Q4 and barring some exogenous event as well into 2011.

As noted in our release, the gains we posted in sales, pretax profit, net income, earnings per share and EBITDA were the result of our continuing focus on executing the key elements of this strategic plan we put into place in 2009.

As you recall, these were, one, to increase market share in each of our product categories by expanding our offerings at each of our key customers; two, to tightly control or even reduce SG&A and distribution expenses; and, three, to strengthen our balance sheet.

I take great pleasure in congratulating all of our employees for the dedication and effort in helping the Company to execute its strategic plan. It's truly a team effort, which was rewarded with a 30% increase in diluted per common share on a 12% net sales gain.

In addition, over the summer, we completed a comprehensive refinancing of our bank debt and the repurchase of approximately two-thirds of our outstanding convertible senior notes last quarter.

My only disappointment is that we were not able to bring out inventory at September 30, 2010, down below the level of a year earlier. However, as I previously noted, earlier this year we foresaw several factors that we thought could cause production issues in China, and correctly anticipated container shortages on the major ocean freight routes. As a route, we determined to place orders early and to bring goods into our distribution centers sooner than we normally would.

While our concerns were show to have been accurate, we are pleased that our foresight has enabled us to ship our customers' holiday merchandise in a timely manner.

Whenever production cycles and transportation return to normal, I'm confident that we can be-- once again, be able to successfully resume our inventory reduction efforts.

Our Chief Financial Officer, Larry Winoker, will go through these results in detail in a few minutes.

I'd like to give you some color this morning on the progress we've been making in increasing market share.

In our wholesale segment, we've been expanding our presence at key retailers through broad-based gains in our food preparation, tabletop and home dcor products. We've long emphasized innovation as an important contributor to sales growth, and our focus on product development has paid off as consumers responded to exciting new designs, as well as to products with improved functionality that we offer at compelling price points.

As I had mentioned before, this is one area where we have not cut spending. In fact, we have an ongoing program in place to further grow our design capabilities, both by increasing the number of in-house designers by expanding our network of independent designers and engineers.

Much has been said in the news about increasing cost of products due to increases in raw materials, labor, transportation and exchange rates. Our advanced design capabilities have enabled us to greatly temper the effects of these increases.

It is our expectation that course will continue to increase, which makes it that much more important for us to continue to lead the innovation.

In our direct to consumer segment, where our business is done mostly over the internet, we now have four websites through which we sell to consumers-- Mikasa.com, Pfaltzgraff.com, LifetimeSterling.com and HousewaresDeals.com.

In addition, this infrastructure has enabled us to efficiently provide drop-shipped services directly to consumers for 31 of our customers. This has been, and we expect will continue to be, a rapidly expanding part of our business. We continue to expect that each of our wholesale businesses will have sales increases and be profitable this year. And we expect that the direct-to-consumer business will show great progress and be close to profitable by the end of the year.

In fact, if we achieve the 9% to 10% increase in wholesale sales we currently expect, full-year net wholesale sales will be about 6% above last year's. Equally important, we believe the strategic plan we've put in place can produce further performance improvements in 2011 and beyond.

I'd like to remind everyone that next Wednesday we'll be holding Lifetime's first ever Investor Day at our headquarters in Garden City. We want to show the financial community the full scope of our innovative products and how we develop them. We'll also take institutional investors and analysts through our showroom and introduce them to key members of our senior management team.

I think it will be a very interesting day, so I hope you can join us. If you haven't already RSVP'd, please call Harriet Fried at our Investor Relations firm at 212-838-3777 for details and assistance with transportation.

I'd like to now turn over the call to Larry.

Thanks, Jeff. As we reported earlier this morning, net income for the quarter was $6.6 million or $0.52 per diluted share as compared to net income of $4.9 million or $0.40 per diluted share in 2009.

Income from operations was $10.2 million in 2002 compared to $8.3 million excluding restructuring charges in the 2009 period.

EBITDA, which is a non-GAAP measure and is defined in our release, was $40.9 million for the trailing 12-month period ended September 2010 versus $20.6 million for the comparable period in 2009. For the 2010 quarter, EBITDA was $13.5 million versus $11.6 million in 2009.

Looking at our wholesale segment, net sales in the third quarter were $118.8 million, an increase of $12.5 million or 11.8%. The increase reflects volume growth across our product categories and to several of our major retail customers.

Wholesale segment gross margin remained approximately the same as 35.6% in the current period versus 35.7% last year.

Wholesale distribution expense as a percentage of net sales was 8% in the 2010 period, compared to 7.8% last year. Current period includes certain expenses related to the upgrading of the warehouse management system at our West Coast facility.

Wholesale SG&A in the third quarter was $18.4 million, an increase of 1.7% from $18.1 million last year. As a percentage of net sales, SG&A was 15.5% in 2010 versus 17% last year.

This improvement, as a percentage of net sales, reflect the benefit of the 2009 restructuring activities and our continuing effort to maintain tight control over expenses. The 2010 period reflects an accrual for incentive compensation for which there was no expense accrued in the 2009 period.

Turning to our direct-to-consumer segment, net sales was $6.1 million in 2010 versus $5.1 million last year. The increase is primarily attributable to the success of targeted sales promotions on the Company's Pfaltzgraff and Mikasa websites and sales from our new Lifetime Sterling and Housewares Deals websites. The increase was partially offset by lower shipping revenue from free shipping promotions.

Direct-to-consumer gross margin decreased to 63.3% from 72% last year primarily due to these promotional activities, including free shipping.

Merchandise margins, which excludes shipping revenue, was 60.7% and 65.9% in the 2010 and 2009 periods respectively.

Distribution expenses for the segment were approximately 30% for the current quarter compared to 39.3% last year. This significant improvement is due to the efficiencies realized from exiting the York, Pennsylvania distribution center during July of last year.

The segment's SG&A in the 2010 period increased to $2.6 million from $2.4 million. In support of sales growth, specifically employee and web-related search expenses.

With respect to non-segment items, unallocated corporate expenses were $3.6 million compared to $2.6 million last year. The 2010 period reflects an accrual for incentive compensation for which there was none in the 2009 period.

Interest expense declined to $2.1 million from $3.3 million last year. The decrease is due to lower average borrowings and lower interest rates. The rate reduction reflects the benefit of the debt refinancing completed in the second quarter.

The effective income tax rate for the 2010 quarter was 29.4% versus 3.6% in 2009. Both periods reflect a reduction in the valuation allowance related to our deferred cash assets. Please note that the effective tax rate for the nine-month period in 2010 was approximately 40%, and that is the rate we expect for the full year.

Grupo Vasconia, our 30%-owned investee, continued its strong operating performance. Its results, and to a lesser extent, the strength of the Mexican Peso added to our earnings increase.

Now turning to our financial position. We have not included the balance sheet in this morning's release as we are finalizing some account classifications, so I will note a few key balance sheet amounts.

At September 30, accounts receivable was $88.7 million and inventory was $126.3 million. Our bank debt was $52.7 million and the convertible notes were carried at $23.3 million.

In August, we drew down in full our $40 million second lien term loan. As of September 30, which is approximately our seasonal working capital peak, our leverage ratio, that is total debt to EBITDA, was 2.8 times, and available under the revolving credit facility was $47.1 million.

Looking at the fourth quarter, as we've said, we expect wholesale and sales volumes to be up 9% to 10% versus the fourth quarter of last year, or 6% on a full-year basis.

Wholesale gross margin for the fourth quarter is expected to be approximately 36%. Wholesale distribution expenses as a percent of sales are expected to be approximately 7.5%, reflecting the anticipated volume increases. Wholesale SG&A should be higher then for the third quarter, also reflecting the anticipated higher sales volume.

And as I mentioned, our estimated effective income tax rate is 40%, but as we stated last quarter, it could change based upon an assessment of a valuation allowance against (inaudible) assets.

Additionally, the seasonal inventory decline in the fourth quarter will be less than in past years as Chinese New Year falls earlier than normal. During this holiday period, factories are closed, so we have ordered some goods to arrive in late December.

And lastly, capital expenditures, which were $2.3 million through September, should be approximately $3 million for the full year.

Operator, we're ready for questions.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Per Ostlund with Jefferies & Company.

Thanks. Good morning, Jeff and Larry. Congratulations. Question on gross margins. The wholesale gross margin is hanging in quite well here. It was about flat it looked like in the third quarter. Can you talk about, you know, kind of looking ahead fourth quarter next year, I think you might have alluded to it a little bit, but some of the puts and takes in there, be it shipping, which doesn't seem to have really abated as an issue yet or raw materials? And then, you know, sort of what you have availability on the pricing front to combat that.

You know, as far as the raw materials, we believe we'll hold pretty steady in the fourth quarter-- we're not-- Larry gave you the number, and we're pretty confident of that number, so I'm not as concerned about that.

We have been able to temper the increases in raw material, labor, transportation and so forth, and I'm pretty confident that we can continue to do that.

As far as the free shipping, that will continue in the DTC business because that's just something that's very important right now on any internet sales is free shipping, so that will continue.

Okay. That makes sense. What about looking out to next year? Are you kind of prepared to go there yet, or is it too early to say?

You know, right now it looks like-- I don't see any continuing great increases in raw materials and transportation, I think they'll maintain the high level they are now, and if they do we can certainly live with it. So we'll see where it goes.

Over time-- I think over time there will be continuing increases in labor costs out of China. Transportation will probably hold steady, go up maybe very slightly from where it is. The exchange rate probably will, you know, worsen a bit. But I think with the way we're developing new products aggressively and in such large numbers, I think we can temper that to a large degree.

Okay. That makes sense. One other question. Jeff, you mentioned you didn't get inventory levels at the end of the quarter down where you might have liked. How are inventory levels at retail right now?

At retail they're hold-- you know, retailers have not become that aggressive. They are still very conservative on their inventories, and I expect that's going to continue. So the inventories are low. They're about the same as last year, which were low already, and I don't anticipate that going up.

But, you know, I'm disappointed, but I think we did the right-- I'm sure we did the right thing. I think we wouldn't be delivering properly if we didn't do the right thing.

And our inventory's in a very healthy condition, so I'm not nervous abut it at all. I think it will be-- right now it is coming down, which was natural for it to come down now. But we're still anticipating, you know, shortages of some materials and so forth and also transportation issues. So we are bringing in goods earlier than we normally do-- would have in the past and where we would like to go.

I think things will stabilize a bit with that, and I think sometime in 2011 we will be able to continue our inventory reduction. We're pretty sure we can take out another 10% to 15% of the inventory, reduce it by 10% to 15% further as long as things are a little more normalized with the issues of getting the merchandise.

Okay. Great. Thank you.

Your next question comes from the line of Gary Giblen with Quint Miller. Please go ahead with your question.

Good morning and congratulations.

Thanks, Gary.

Thank you.

On the DTC promotionality, I mean, if I look at it simplistically in the second quarter, your gross margin was down year over year 400 basis points, and now you're down 810 basis points. So did the-- did, you know, price promotionality, apart from free shipping, get more pronounced, or, you know, how do you explain the greater year-over-year decline in gross margin?

It's a combination of both, Gary. It's-- the free shipping certainly had a very big part of that, but there were also-- there's a bit more promotional activity. One of the sites that we have launched, the Housewares Deals site, is a lower margin site. It's basically a vehicle for us to sell off a lot of discontinued merchandise, and we tend to work on a lower margin on that.

Okay. That makes sense. And what led to the genesis of HousewaresDeals.com? I mean, evidently it's a-- kind of a replacement for the outlet stores you used to have.

Well, it's only one. It's a single item every day, so it's not that much of a replacement, but it is a business that we think can develop over time into much more than it is. It's doing fairly well from its first launch, so we're very comfortable with it.

You know, the nice thing about the DTC business, it's-- we use the same infrastructure to keep on launching additional sites, and the additional costs of that are rather minimal, so it's something that we're going to do.

We will be launching in the first quarter of 2011 a B2B site, which is really-- more than anything else, it will give us an entre into the approximately 1,000 independent retailers that we're not doing business with that we want to do business with. These are more smaller stores or very small chains of two or three stores that we don't currently do business with, and we intend to do it through the internet.

Oh, that's interesting. Okay. And then on the gross margin on wholesale, you know, I was modeling a little higher, in the high 30%s there. Is there a trade-down mix thing going on there, or is it really the costs coming from the Far East?

No, it's not a cost issue. In that case-- in the case of the gross margin, we had a dramatic increase in the number and the amount of direct shipments in the third quarter versus the third quarter of last year. And when we ship directly from the Orient to our customers, we bypass our warehouses; and, therefore, we don't have that expense, so it's a-- it shows us a lower margin, but frankly the operating margin is wonderful, so we don't-- it's-- for us it's a washout doing it either way.

Okay. Yes, that explains that. Sure.

It is-- so, you know, it is a dramatic increase. Larry, what are the numbers?

Yes. Well, the third quarter of this year, the direct imports from the Far East was almost 25%. Last year it was only about 17%. So it's actually about $10 million more of shipments.

Yes. Okay. Sure, that helps a lot. And-- oh, yes, the-- on distribution expense, can you roughly quantify the warehouse system upgrade cost there that-- and is it-- has it gone away for the fourth quarter, or did it continue somewhat?

You know, it was probably about $0.5 million. It's going to go away. In fact, one of the reasons to upgrade the system is to make it more efficient, so we should-- you know, certainly going to be a payback, and we should see improvements going forward.

Yes, we'll get the payback in 2011, but the excess costs are going away now.

And again, just simplemindedly looking at it, distribution expense was 15 basis points better in the-- or, you know, has been running a stronger improvement year over year in recent quarters than in the third quarter, so the-- in other words, it was only 20 basis points down. So some of it's accounted for by the warehouse system upgrade. Is there anything else that produced, you know, good but not incredibly stellar leverage on (inaudible), I mean, given sales increases as you've had?

That's the thing, Gary. Since we put almost $10 million direct, not through the warehouse, it's certainly-- we get tremendous leverage by putting more merchandise through the warehouse. The percentage comes down. And when we don't do that, the percentage doesn't come down as much.

Yes, I guess that affects all the line items. That's a funny thing.

Okay. And then just directionally, you know, broadly, do you think the, you know, consumer takeaway for the holiday is going to be, you know, okay or good or, you know, quite a bit better than last year? I mean, what's your sense?

I think the-- in general, no, I don't think it's going to be that much better than last year. I think the reason that we're doing well is because of the increased placement we have. We've gained a tremendous amount of market share. It's been a tremendous focus here for more than 18 months.

It's really like a mantra that-- with a weekly meeting to discuss market share gains. So our gains are market share gains. It's not that the retailers are doing that much better. They're certainly not, at least not in the categories that we're in. They're certainly-- where you see improvements, I mean, if someone's out of work they're still buying food, and they're buying other true necessities, but they're not necessarily buying our stuff if they're out of work.

Okay. Thanks. And look forward to seeing you guys next Wednesday.

Thank you.

(OPERATOR INSTRUCTIONS) There are no further questions at this time. I'd like to turn the call back to Jeff for any closing remarks.

Thanks again for joining us on this conference call. And we hope that you can make the time to come visit us next week. If not, we look forward to talking to you again with our yearend call. Thank you.

Ladies and gentlemen, that concludes your conference call for today. We thank you for your participation and ask that you please disconnect your lines.