Edited Transcript of SUMR earnings conference call or presentation 13-Nov-19 2:00pm GMT

Even in such a tough environment, however, we generated $6.3 million in cash from operations with notable reductions in inventory, receivables and payables from second quarter levels. Using this cash, we paid down $6 million on our credit facilities, reducing debt to its lowest level since the beginning of 2019.

We ended the period with borrowing availability of nearly $7 million, and we’re pleased once again to have the full support of our bank group in providing flexibility as we navigate through these near-term headwinds. At the same time, we reported inventory turns of 3.8 and days sales outstanding of 64, both consistent with our announced goals this year. Such operational achievements underscore our commitment to improving the company’s fundamental performance and adapting to current industry conditions.

Now let me discuss some product and marketing trends in detail. I’ll start by saying what a great turnout we had at this year’s Kind + Jugend trade show in Cologne, Germany, where we met with numerous channel partners and discussed the outlook for 2019 and beyond. We had very productive meetings with all major customers, during which we received positive feedback about new and existing products and were praised for areas of particular strength in our core categories and brands.

We also confirmed additional placement with some key European retail establishments and channel partners. All in all, we received upbeat reviews about our entire product portfolio and strong interest in Summer’s new innovative travel system and infant car seat, which remain on track for introduction early next year. We’re excited for the launch of these products, not only due to the customer opinions expressed thus far, but also for the potential for margin enhancement as they are exempt from tariff regulations. We believe such innovative offerings will bolster both growth and profitability next year.

That said, we have decided to restructure our international business starting this November to better focus on core markets and further streamline our operations. We plan to change our distribution model by increasing shipments out of our third-party logistics center in China, phasing out our U.K. distribution facility by the end of March. This new distribution model will greatly improve the company’s overall profitability.

With Brexit and other currency issues impacting the company, we are making a concerted effort to streamline this part of our business. In the same vein, we will purposely walk away from expanding in certain product areas in order to enhance overall bottom line results, focusing on those categories with greater price integrity and margin expansion opportunity.

Before turning the call over to Paul, I want to say in closing that we’re working hard at SUMR Brands to reduce costs, strengthen the balance sheet and invest in innovative products that drive top line growth. Margins remain a priority even as we continue to face headwinds on a variety of fronts related to trade disputes with China.

Managing costs is tantamount. We’re operating in a very fluid environment where changes in production, warehousing and shipping are the new normal as we analyze consumer trends and negotiate price points with our channel partners. We’re attacking these problems head-on but acknowledge tariffs will continue to be disruptive.

In that light, SUMR Brands has recently engaged Baird to assess strategic alternatives that can unlock value for our shareholders. We do not know as of yet what recommendations will be forthcoming, but we owe it to this company, our staff, customers and investors to look at all possible ways to strengthen and support SUMR Brands and its portfolio of products. We’ll report back in the future as to what potential opportunities are open to us.

With that, I’ll turn it over to Paul to review our financial results in detail. Paul?

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Paul Francese, Summer Infant, Inc. – Senior VP & CFO [4]

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Thank you, Mark, and good morning, everyone. As a reminder, our 10-Q and related press release were issued last night. In addition to listening to this conference call, I encourage you to review our filings.

Third quarter net sales were $41.5 million compared to $43.8 million for the third quarter of 2018. As Mark mentioned, the company’s top line performance was negatively impacted by the ongoing 25% tariffs on certain goods imported from China, and to a lesser extent, by a separate 15% tariff imposed September 1 on additional imported products. While incremental 5% tariffs were not imposed October 15 as originally anticipated, the uncertain environment is a challenge for any company in our space, impacting both revenue and margins.

We are doing everything possible, working hand-in-hand with our channel partners to manage through this difficult time while enticing customers with attractive, innovative products at many price points. We are also going to restructure overseas activities, as Mark discussed, to streamline the distribution process.

Gross profit was $12.6 million for the third quarter of fiscal 2019 versus $13.6 million in 2018. And our gross margin as a percent of sales was 30.3% in 2019 versus 31% last year. The margin decline year-over-year was primarily due to product mix and the impact from tariffs on goods imported from China.

However, even with the higher tariffs, we continue to actively manage our inventory levels and increase inventory turns. The impact of tariffs going forward is hard to predict. Although discussions with our channel partners are ongoing, it takes time for price changes to flow through to our customers and some adjustments are difficult within competitive product lines.

Selling expense was $3.6 million in the third quarter of 2019 versus $3.7 million last year. As a percent of net sales, selling expense was 8.7% in fiscal 2019 versus 8.3% in 2018. The increase in selling expense was due to an increase in e-commerce marketing to support the quickly changing retail environment.

General and administrative expenses were $8.4 million in the third quarter versus $7.6 million in the prior year period, and G&A as a percent of sales was 20.1% this year versus 17.4% in 2018. The year-over-year change primarily reflects the fact that last year, the company booked a $0.5 million positive adjustment to decrease allowances for bad debt due to a partial recovery from the Toys “R” Us bankruptcy. This year’s G&A did not have such a positive adjustment but did include a $0.3 million in legal settlement costs.

Interest expense was $1.2 million in fiscal 2019 versus $1.1 million last year.

The company reported a net loss of $1.7 million or $0.09 per share in the third quarter of 2019 compared with net income of $0.1 million or $0.01 per share in 2018. Adjusted EBITDA for the third quarter of 2019 was $0.8 million versus $2 million for the third quarter of 2018. Adjusted EBITDA in 2019 included a $0.1 million in bank-committed add-back charges compared with a credit reduction of $0.4 million in the prior year period. The adjusted EBITDA as a percent of net sales was 2% in fiscal 2019 versus 4.6% last year.

Now turning to the balance sheet. As of September 28, 2019, Summer Infant had approximately $0.7 million of cash and $48.6 million of bank debt compared with $0.7 million of cash and $47.9 million of bank debt as of December 29, 2018. Our debt was reduced by $6 million this period versus the second period of fiscal 2019 as the company generated approximately $6.3 million in cash from operations for the 3 months ended September 28, 2019. Most of our capital spending on new products has already been incurred, and we expect a reduction in capital spending for the remainder of 2019 and into 2020.

Inventory at the end of the third quarter was $30.2 million compared with $36.1 million as of December 29, 2018, reflecting ongoing working capital management. And inventory turns were 3.8. Our goal was to reduce inventory to around $30 million, which has been accomplished.

Trade receivables at the end of September were $29.7 million compared to $31.2 million at the beginning of fiscal 2019. Days sales outstanding, or DSO, was 64, under our goal of 70.

Accounts payable and accrued expenses were $30.9 million as of September 28, 2019 compared with $37.1 million at the beginning of the fiscal year.

The company generated approximately $6.3 million of cash from operations during the quarter, as I mentioned a moment ago, compared to $1.7 million use of cash in the prior year period.

At the end of the third quarter, we had approximately $7 million of availability under our line of credit. As Mark mentioned, we recently completed an amendment with our bank group, which provides additional liquidity as we work through the impact of tariffs. We thank them for their commitment to SUMR Brands.

And with that, I’ll turn the call over to the operator and open it up to questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Eric Beder with SCC Research.

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Eric Martin Beder, Small Cap Consumer Research, LLC – CEO & Consumer Analyst [2]

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Let’s talk a little bit about the international changes here. So when you look at the shifts here, what should we be expecting in terms of the international business changing in terms of focus here? Are we looking at kind of — what’s the goal here in terms of the international, in terms of driving higher returns there?

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Mark Messner, Summer Infant, Inc. – President, CEO & Director [3]

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Yes. Good question. We’ll definitely walk away from some low-performing SKUs and just an overall focus on improving efficiency in logistics through distribution out of Hong Kong instead of off of the island. And the customers we’ve spoken to have reacted well to our new distribution model. But it’s all about efficiency and producing better profits in the international business, Eric.

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Eric Martin Beder, Small Cap Consumer Research, LLC – CEO & Consumer Analyst [4]

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Great. In terms of the tariff-driven items, are you trying to and are you able to reduce your dependence, I guess, on China as a manufacturer? And how — what has been the ability to pass on the price increases here in the U.S.?

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Mark Messner, Summer Infant, Inc. – President, CEO & Director [5]

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Yes. Well, good question. We are reshoring product and looking at tariff-exempt regions and move it — continuing to move products to tariff-exempt regions. That’s not a quick action, but it’s a continuous one that we’ve undertaken and we’ll continue to. I’d say, going through 4 different lists of tariffs, it’s laborious and — going back to retailers several times for increases, which we’ve been successful with. Of course, there’s sharing in the tariffs from time to time depending on the item, but we’ve been successful in getting price increases through. But it’s created lumpiness in the marketplace.

Retails have changed, and velocities on certain products change with those retail changes. So it’s a very dynamic environment relative to tariffs. But we continue to resource, like I mentioned. We’re redesigning products just to get cost efficiencies on those products, and we’re working with suppliers on those design changes to increase our efficiencies and lower our costs. And so we’re very active in the tariff mitigation process.

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Paul Francese, Summer Infant, Inc. – Senior VP & CFO [6]

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Eric, this is Paul. Just going back to — add a little bit more color on our international restructuring. Earlier this year, as we made the announcement that we had opened up a 3PL warehouse in China to service our international customers, we’ve tested that strategy and it’s worked out really well for us. And now we’re expanding that to service our customers in Europe and the U.K. as well. We feel that servicing customers from that warehouse in China will provide a significant improvement in profitability as we focus on servicing our key customers in the U.K. and Europe. The slow, I would say, closure of our warehouse in the U.K. will take several months. We believe that will be completed by end of March. And on an annual basis, we believe the gain in profitability will be about $1 million on an annualized basis.

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Eric Martin Beder, Small Cap Consumer Research, LLC – CEO & Consumer Analyst [7]

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No, that’s great. Last question here. In 2020, what should be — you have some interesting product rollouts coming up. Now what are you looking forward to the most? And how should we be thinking about how the mix shift between your different products is going to change as you kind of do these reorgs and new product entries that you talked about?

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Mark Messner, Summer Infant, Inc. – President, CEO & Director [8]

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Yes. Probably one of the biggest product launches we’re excited about is the launch of our new travel system, like I mentioned earlier, which starts shipments in the beginning of next year. The advocate response, we worked with safety advocates and work with them as we develop a seat has been fantastic. Very high reviews on our infant car seat. The retailer’s response is equally as large. It can seem like a crowded space, but we feel like we have a unique selling proposition that really will speak to consumers in ease of use and installation. So really excited about the car seat and travel system as an opportunity. But we continue to innovate in our current core categories as well, so categories like potty, bath and gates, to name a few. And certainly, we’ll stay active under our SwaddleMe brand as well.

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Operator [9]

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Our next question comes from Richard Hantke with Zacks Small-Cap Research.

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Richard Hantke, [10]

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I’m sitting in for Marla Marin, she’s our consumer products analyst, and we’re obviously new to the story so I’ll apologize in advance. I just had a few questions, and I’ll just ask a couple and then I’ll get back in the queue because I don’t want to hold up if there’s others that want to ask some questions. If there’s time at the end, I’ll ask a few more.

But starting with the tariff situation, and to be honest, I can say, and maybe you can’t say, it is absolutely crazy. I mean the uncertainty, I don’t know how you’re dealing with it because you don’t know what’s — one day, they’re on. Next day, they’re off. One day, they’re on. Next day, they’re off. But help me understand, so much of what’s going on is — the weakness in the business driven is by tariffs, but yet you’ve hired Baird to do some — evaluate strategic options. Can you kind of talk a little bit about the tariffs and Baird and what they’re doing? They can’t do anything about the tariffs, but can you give me a little more color there, please?

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Mark Messner, Summer Infant, Inc. – President, CEO & Director [11]

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Sure. Well, I mean, the tariffs and how they affect our performance, I mean, obviously, as retailers are getting price increases, their buying routines change. And the lumpiness in the market is — some changes might go through for 1 brand and not the other. So the playing field is choppy right now.

In terms of strategic opportunities, we’re investigating with Baird. I mean, obviously, we have leadership in many categories. We have strong brands. And there’s good opportunities with those product lines and those brands to possibly further unlock shareholder value, maybe through the sale of a product line or a brand or maybe more than that. So now we just want to do our due diligence and provide what we need to drive shareholder value.

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Richard Hantke, [12]

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Now the — you did say that you don’t know what they’re going to recommend, but when, it will be sometime in the future. Can you narrow that down a little bit? Would the future be 3 months out, 6 months out? Any sense for us as to when you think they’ll come back to you and when you’ll come to us?

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Paul Francese, Summer Infant, Inc. – Senior VP & CFO [13]

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Yes. Yes, we — as a management team, we believe it’s very prudent for us to engage an outside financial adviser to really explore the opportunities that may be there to look — to really bring value to our assets. When I look at SUMR Brands, we have tremendous value in our brands. We have tremendous value in our placement at retail. We have tremendous value in the innovative products that we bring to customers. And so Baird’s goal is to look for maximizing those values either through a transaction of some sort, whether or not selling off a product line, looking for a merger, but looking to how do we exploit those values that we don’t really see being valued by the market today. So they’re going to — they have the task of advising us, see what is the best option for us to maximize shareholder value in the future. Now we expect that to happen in a relatively short period of time, but we don’t have a specific time period for them to get back to us.

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Richard Hantke, [14]

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Got it. Now with respect to — you can — I’ll ask the question in maybe 2 different ways. Maybe it will be the same answer, but I’ll let you answer however you like. The decline in sales from the year ago period, a little over $2.3 million, and I think your gross margins also declined. I mean what — ex the impact of tariffs, I guess, what would you think — what’s the normalized gross margin we should be looking at for this business? I understand it’s seasonal. But I mean, can you kind of quantify a little bit the impact of the tariffs? Or what would you think your sales would have done ex tariffs? Is there any way you can kind of give me a little color?

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Paul Francese, Summer Infant, Inc. – Senior VP & CFO [15]

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Yes. The best way of quantifying that, Richard, is that we do a rather detailed bottoms-up budget every year. And the mix of what we had budgeted to sell this year has been pretty consistent. So when I look at the change in gross margin, the only true variable that I see versus how we budgeted would be the impact of the tariffs. And the impact on our margins are about 173 basis points. So yes, the tariffs have had a significant impact on our margins. 133 — 173 basis points is pretty significant. Here again, we’re doing everything we can to mitigate that. We’re doing it on several fronts. We’ve asked for concessions from our suppliers, which they’ve been very supportive, and we’ve gotten some concessions from them. We’ve gotten price increases at retail, and we moved some production outside of China. But I believe that the impact on our gross margins due to the tariffs are about 173 basis points.

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Operator [16]

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(Operator Instructions) Our next question will be a follow-up from Richard Hantke with Zacks Small-Cap Research.

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Richard Hantke, [17]

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Okay. Just — Eric had asked you a few questions on your international components and things like that. I — just so I understand a little better, I think last quarter, you mentioned that 16%, I believe, of your sales are internationally based. And I think half of that is in Canada, and half, rest of the world. And you expected that to grow. Now based on what we’re talking about today, how do I look at the international component of your, I guess, of your business?

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Mark Messner, Summer Infant, Inc. – President, CEO & Director [18]

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Yes. Like we mentioned previously, I mean, the focus will be on profitability. So the growth might be hampered through that effort. I mean we’re changing the distribution model to deliver to customers. And as we change that model, let’s face it, the retail landscape is changing pretty rapidly, too. Again, the goal is for improved profitability, and Paul highlighted what we expect there. So I mean, with retailers like Mothercare, which is a pretty big retailer in the baby space, announcing administration last week, that’s going to challenge some growth and we have to shift sales to other channel partners.

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Paul Francese, Summer Infant, Inc. – Senior VP & CFO [19]

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Yes. If — we look at international 2 ways. We look at Canada and then we look at the rest of the world. Canada, next year, we will be predicting growth in Canada next year. The rest of the world, we expect a decline in sales but an increase in profitability. And that profitability increase is coming from the efficiencies that we’re gaining by servicing all of our customers from the Chinese warehouse and also focusing on a key group of customers that we believe provides us more of an ability to have a reasonable margin.

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Richard Hantke, [20]

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Okay. Got it. Now speaking of margin, looking at some of your presentation materials earlier in the year, one of your goals you laid out was you want to have sustained profitability. Now I realize all things on the table now. But when you made that comment, what do you define as profitability? Is it going to be gross margin? Is it going to be adjusted EBITDA? And when you say sustained, that’s year-on-year, over a certain period of time? Is there any — is that still a valid goal? And how do you kind of look at it?

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Mark Messner, Summer Infant, Inc. – President, CEO & Director [21]

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Yes. Well, I mean, moving into some of the categories that I mentioned earlier, the average sell price is much higher, and the opportunity for margin dollars is certainly higher as well. I mean so we focus on gross margin and then the projects that we’re talking about to increase the company’s efficiency, for profitability to increase as well to just work its way to bottom line EBITDA. So it’s a mix of things.

We’re in some pretty competitively priced categories right now, which, when you’re getting down into some lower retails, take an even heavier impact from tariffs if the retail price positioning moves. So our focus will be on pushing retails higher with the feature sets to entice consumers to move there. Part of the travel system launch as well, I mean, will help us with our entry in connection with first-time expectant parents. So once we delight those folks, we’re going to keep them with us and with the brand for the long haul. So that’s a little bit of a mix of the overall product strategy and just company efficiency improvement strategy.

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Richard Hantke, [22]

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Yes. Got it. All right. Excellent. Just one final kind of macro question. I’ll leave it at that. I mean your stock has been under a lot of pressure year-to-date. For a lack of a better way to ask the question, how much of that is deserved versus things out of your control versus maybe the investment community not really understanding what you’re up to and a little — some misconceptions or whatever the case may be? Can you kind of talk a little bit about it in terms of the stock decline and how much is on you and how much is on us and how much is on the rest of the world, something like that?

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Mark Messner, Summer Infant, Inc. – President, CEO & Director [23]

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Yes. Okay. Well, nobody likes excuses. I mean our performance certainly isn’t great. We’re not proud of the results we’re delivering this quarter. But I mean, it is a dynamic space, the baby space, in particular. You’ve had consolidation of retail and tariffs and just some dynamics that are outside factors that you need to deal with. And you need to step up to the challenge and mitigate tariff issues. So I’d say there’s a good mix of outside influences that make the business challenging. But I’d say our team is pretty nimble and adept, and we’ll step up and meet those challenges and mitigate tariffs. And we have a trough in profitability because of tariffs and just overall product mix, selling products that might be higher — more products that might be higher tariffed. And we just need to work through this soft period and continue pushing forward with a good mix of products that entice consumers. We do have retailers that support our brand and our company and I think we have good partnerships to allow us to grow, but it is a very challenging environment and I have to point that out.

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Paul Francese, Summer Infant, Inc. – Senior VP & CFO [24]

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Yes. I think that there’s a little bit of investor fatigue right now. When I look back over the last 2 years, in 2018, this company needed to adjust after the liquidation of Toys “R” Us, which was actually a very large customer for us. We have adjusted well after their liquidation. We’ve grown with our top 4 — or actually our top 5 accounts very well to replace Toys “R” Us. This year, we’ve had to adjust to the uncertainty of tariffs, which we’re battling every day here.

So I think that when you look at the last 2 years, they have been very challenging. Here, again, we’re not making excuses. But to overcome the loss of a major customer in 2018, to overcome the uncertainty and the impact of large tariffs against our products, we’re doing everything we can to try to bring value to our shareholders. And I think that we also need to make sure that we are very attentive to reducing our debt as well. So I think that — looking at those challenges, I think that we’re doing everything we can. I think we’ve made some good inroads in replacing Toys “R” Us, and I think we’re doing everything we can to mitigate the impact of the tariffs in our products.

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Operator [25]

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As we have no further questions, this will conclude our question-and-answer session. I would like to turn the conference back over to Mr. Messner for any closing remarks.

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Mark Messner, Summer Infant, Inc. – President, CEO & Director [26]

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Thank you, everybody, for joining our call and your support of SUMR Brands, and we look forward to speaking with you next quarter.

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Operator [27]

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The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.