Summer Infant, Inc. (NASDAQ:SUMR)
Q3 2016 Results Earnings Conference Call
November 03, 2016 09:00 AM ET
Chris Witty - IR
Mark Messner - CEO
Bill Mote - CFO
Bryan Caronia - Wunderlich
Dave King - ROTH Capital Partners
Good morning and welcome to the Summer Infant Third Quarter 2016 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please also note today’s event is being recorded.
I would now like to turn the conference over to the moderator, Chris Witty. Please go ahead.
Hello, and welcome to the Summer Infant 2016 third quarter conference call. With me on the call today is Summer Infant’s CEO, Mark Messner; CFO, Bill Mote.
I would now like to provide a brief Safe Harbor statement. This call may include forward-looking statements that relate to Summer Infant’s outlook for 2016 and beyond. These forward-looking statements are subject to various risks and uncertainties that could cause actual results and events to differ materially from these statements. Please refer to the Risk Factors contained in the Company’s Annual Report on Form 10-K, for the year ended January 2, 2016, and in our other filings with the Securities and Exchange Commission.
During the call, management may make references to adjusted EBITDA, constant currency sales, adjusted net income, and adjusted earnings per share. These metrics are non-GAAP financial measures, which the Company believes help investors gain a meaningful understanding of changes in Summer Infant’s operations. For more information on non-GAAP financial measures, please see the table for a reconciliation of GAAP results to non-GAAP measures, included in today’s financial release.
And with that, I’d like to now turn the call over to Mark Messner. Mark?
Thanks, Chris, and good morning, everyone. We appreciate you joining on our third quarter conference call. I’m pleased to report that with more time under my belt at Summer Infant compared to last quarter, more excited than ever to be part of this organization and feel confident about its future.
As noted in our press release, we again posted positive earnings this period, which after the past few years is very welcome news and testimony to the many quarters dedicated to streamlining our operations, focusing our brands and cleaning up the balance sheet. Bill Mote and our entire team deserve a great deal of product for getting Summer Infant back on track.
Even with flat revenue, we achieved strong gross margins and a penny per share of earnings. Our administrative expenses were down 25% year-over-year including legal expenses of just $0.1 million versus $3.7 million in 2015, and we reduced inventory to the lowest level in recent memory.
As Bill will review in a moment, our balance sheet is strong and we are in a great position to drive revenue growth and improve bottom line performance in the quarters to come. We are pleased to see great enthusiasm for our brands at the recent ABC Show in Las Vegas and during the past quarter continued to experience solid demand across a number of product lines.
Of particular note, store sales were up by double digits versus 2015, and we also saw extremely strong growth across boosters and potties. Overall, our gear and safety categories are doing very well, and we believe there is plenty of room for further expansion. In fact, we are looking at ways to capitalize on our My Size Potty success with ancillary products and will also be launching a variety of new gates that cater to different fashion tastes and complement home décor.
For example, we will be launching our rustic home gate in the very near future and have already received preorders from a variety of key customers. This is a great new gate and features are step easy to use installation system suitable for almost any door frame, and stylish contemporary design. Likewise, with our Pop sub brand our successful Pop ‘n Sit Portable Booster is now coming to retail stores after being sold over the internet since April. It’s a great example of innovative product development and strategic marketing, and we definitely believe there’re additional opportunities for Pop applications as well as channel expansion.
Across our store category, we see further room for growth. In reviewing existing sales channels, we’re looking to more strategically placed merchandise to maximize customer satisfaction as well as margins for Summer Infant and our retail partners. One way to do this may involve reducing a number of third party wholesalers thus strengthening the direct bond between us and the retailers we serve. Strollers are just one area where we’re planning to do this to both increase retail responsiveness and avoid market saturation, which can cause unnecessary price competition between our channel partners. We’ll also be launching several new stroller products in the near future including the 3Dtwo and we expect sales within this category to continue on an upward trend.
The 3Dtwo’s unique frame design provides three times more storage room than any other light weight model and includes specially designed clips to safely hang a diaper bag on the back. We know our parents want enough space, convenience, ease of use, storage and durability. And we’ll continue to research new ways to offer these attributes at a compelling price.
We also remain a leader in the swaddling space and are looking to expand here as well, developing a sleeper model to be used next to the parents in bed as well as one that can be positioned next to the bed and uses a rocker. There’re many avenues to grow our leading SwaddleMe brand, and we’ve only just scratched the surface.
In general, we’re looking at ways to refocus our growth strategy and change the way we can tuck business across our leading channel partners. In some cases, as I just mentioned, this means reducing a number of third-party wholesalers, but it’s more than just that. We’ve done some significant market research in the categories to better understand and connect with end users. In doing so, we found that our revolutionary Summer Smart suite of products would serve a limited niche market that’d warrant the substantial development, capital expense and subsequent marketing costs required. The products appeal to a very small demographic and there was just no compelling demand for connected nursery in the way we envision. Don’t get me wrong, but technology is top notch and can be applied to future products and applications, but we need to take a step back and look at what areas could more quickly drive rapid growth and build brand recognition and loyalty.
It’s been a learning process, that’s for sure, but Summer Smart was never expected to be a large product company revenue to begin with. It makes more sense to stop going down the path anticipate it and instead look for more sensible attractive opportunities. In the meantime, we’re ramping up product development in our bread and butter highly successful radio frequency monitors. They’ll have a refreshed look, new price points and added features but stay easy to use and will leverage the position we’ve already built in the market. As of today, roughly 80% of our monitor business is in the RF space, and that’s what consumers like. So, we’ve plenty of room to accelerate growth without making something too complicated or expensive for the average millennial mom. We’re also looking at expanding our Pop line, bringing out new gates and strollers, as I mentioned, and basically focusing on products where we see the most potential for less seasonal, higher volume sales.
Our near-term initiatives are tied to both innovation and product breadth as well as channel development. We’re looking at ways to improve our relationships with Summer’s largest customers and create a brand map strategy that increases our value to them, which should in turn drive higher sales and stickiness to our brand as well as better margins for both of us and our retail partners.
We will use a more tailored promotional approach to benefit our brands and channels that serve them. So, while we have made great strides rightsizing the Company, strengthening our balance sheet and building our brands, we felt a need to take a step back from our product development perspective and review our current strengths to plan for the future.
The technology we brought to such innovative concepts as Summer Smart will not go to waste, but we knew that we had to access our product portfolio vis-à-vis customer acceptance and channel demand dynamics. We need to do a better job of quickly bringing quality, attractive products to the market at a price customers can afford. And we see a lot of potential for new applications heading into 2017. If items are not selling or firing up the retail base, we will rapidly move to other products, supported by market research that prove to be winners for our customers.
I remain very upbeat about the future for Summer Infant given our talented workforce, strong brands and great channel partners. I believe the Company is on sound footing for accelerated growth and improved operating performance next year and look forward to what the future brings.
Now Bill will review our financial results in detail. Bill?
Thanks, Mark, and good morning, everyone. Our 10-Q and related press release were issued last night. In addition to listening to this call, I encourage you to review our fillings. We are happy with our overall performance this quarter, as Mark mentioned.
Net sales for the third quarter were $48.6 million, versus $50.2 million for the same period a year ago. And if you exclude $1.7 million of sales in 2015 related to our inventory reduction plan, revenue was roughly flat year-over-year. The three months ended October 1, 2016 also included $0.5 million of unfavorable foreign exchange on a constant currency basis, primarily due to the decline in the value of the British pound.
Gross profit for the third quarter of 2016 was $15.5 million compared with $15.6 million for the third quarter of 2015. And gross margin was 32% this year versus 31.1% in the prior year period. The 2016 third quarter included $100,000 of unfavorable foreign exchange on a constant currency basis, again mainly due to a decline in the value of the British pound; and $300,000 in cost overages or the introduction of our filling [ph] products. Without these, gross margin would have been 32.5% in the current year third quarter.
The fiscal 2015 third quarter included $100,000 in losses on the sale of inventory below cost related to our inventory reduction plan, $200,000 of inventory charges tied to exiting the furniture business and $300,000 in temporary costs related to a West Coast distribution center. Excluding such items, gross margin for the three months ending October 3, 2015 would have been 33%. We continue to target gross margins in this range going forward.
Selling expenses were $3.7 million in the third quarter of 2016 compared with $4.1 million in the third quarter of 2015, reflecting customer mix and lower royalty cost. General and administrative expenses declined 25% to $9.7 million in 2016 from $13 million last year. In the third quarter of 2016 included just $100,000 of legal expenses versus $3.7 million of legal expenses in the prior year period. G&A as a percent of sales fell to 20% from 2016 from 25.8% last year.
Interest expense was $600,000 in the third quarter of 2016, roughly flat with 2015, while depreciation and amortization declined $1.1 million from $1.3 million last year due to lower capital expenses.
The Company reported net income of $200,000 or $0.01 per share in the third quarter of 2016 compared with a net loss of $1.8 million or $0.10 per share in the third quarter of 2015. This is our second sequential quarter of positive earnings, reflecting strong margins, sound operating execution and lower expenses.
Adjusted EBITDA for the third quarter of 2016 was $2.6 million versus $3.1 million for the third quarter of 2015. This year’s adjusted EBITDA included $300,000 in bank permitted add-back charges compared with $4.3 million of bank permitted add-back charges in the third quarter of 2015, primarily legal expense of $3.7 million.
Turning to the balance sheet, as of October 1, 2016, Summer Infant had approximately $1 million of cash and $49.7 million of debt compared with $900,000 of cash and $53.6 million of debt on January 2, 2016. Given the lower debt and improved operating performance this year, the Company’s bank leverage ratio was 4.6 times the trailing 12 months adjusted EBITDA at quarter end.
Inventory as of October 1, 2016 was $32.3 million, the lowest level in many years and down from $36.8 million at January 2, 2016. We continue to manage inventory aggressively while still having the highest quality of merchandise available for sale.
Trade receivables at the end of the third quarter were $37.3 million compared with $40.5 million at the beginning of the fiscal year. Accounts payable and accrued expenses were $33.1 million as of October 1, 2016 compared with $39.1 million at the beginning of the fiscal year.
Regarding cash flow, we generated $5.4 million in cash from operations this quarter versus $8.5 million in the prior year’s comparable period.
With that, I’ll turn the call over to the operator and open it up for questions.
Thank you. We will now begin the question-and-answer session. [Operator Instructions] And today’s first question comes from Eric Beder of Wunderlich; please go ahead.
Yes. Good morning, everyone. This is Bryan Caronia on for Eric. The first question we had was, obviously you spent some time in your prepared remarks talking about your continued development in the monitors segment. I would love any color you can provide in terms of the competitive environment in that segment and how sort of you are increasingly looking to differentiate against -- amongst your competitors, again as of course as you alluded to in the radio frequency segment of that market?
Just to talk to that a little bit, we’re going heavily into some research on some new concepts that we want to put in front of consumers. So, I mean, it’s a competitively -- fast pace competitive environment in monitors for sure. And we need to continue to strive to find those unique features that mom and dad are looking for. And I think the team has tremendous amount of creative vision for the category. We’re just going to refine our implementation strategy a little bit and backing that up with a little more consumer research to be a little more confident in some of the new products that we bring to the market. So, plenty of ideas in the funnel for sure, just going to be a little more focused on which of those make it to the market.
And then, I guess to take a step back and look at the business more holistically, obviously you’ve discussed a little bit more focused on sort of whittling down and providing greater operational and capital focus in terms of your main sort of product lines and sources of areas and competitive advantage. Any, I guess, greater insight you can provide in terms of as you look at your product fleet and your brand portfolio now, what sort of lines that you’re going to be increasingly focused on and perhaps which ones maybe sort of ones that you might need to look at a bit more strategically in terms of their long term value within Summer Infant?
Yes, for sure. We’ve had really great recent success in our stroller category, our geared category, and I see us investing more heavily in that for sure. That’s going to help drive up average selling prices and average retails within our fleet mix. Our safety category is doing tremendously well. We’ll continue to develop products there and introduce innovation and further grow that category. We won’t -- we’ll strategically continue to sell Born Free but I mean from a marketing spend point of view, the previous mentioned categories will be where we’re going to be doubling down as well as in the monitoring space. We still have very strong market share in monitors. And I think we can continue to gain some share back from recent entries of newcomers in the marketplace.
And then, last question I had and turning a bit more into the financials, obviously you guys have done great work in terms of lowering the inventory on hand as well as the margin breakdown within Summer Infant. Any insight you could give in terms of what you are looking for in terms of long term operating margins or any sort of internal goal that you are sort of looking at? And then, I guess the same goes for an inventory level, I think sort of last year, something around during a half time on an inventory term basis. Where you sort of see inventory looking sort of as you continue to finalize sort of optimizing the balance sheet?
Yes, those are all good questions. I’ll start with the kind of the short term or near term look for the financial performance from a margin perspective. We have said for the past 18 months, we would like to be in the 33 range on a gross margin basis. And we are bumping up against that. We’re within, in last couple of quarters within 80 basis points of that number. and we will continue to look for that to be our kind of target metric for the next few periods here. Long-term, we would like that number to be closer to 35% and that’s more aspirational, but that will come as long as we are doing exactly what we are saying we doing with some of the new categories or product categories that we are going to focus on.
G&A, we would love to see it continue to be around 18% of net sales; and selling expenses, we’d like to be around 8.5%. If you do the math on all that, it gets you to about 6.5% bottom line. That’s kind of our near-term tactical. And then as you increase margins that number would go up closer to 8%, but that’s more aspirational on a longer term basis.
Related to the inventory, yes, we are at 32 and change, and that’s one of -- that’s a historical low in the Company, I mean even looking back six years or so, we haven’t been that low. We have cleaned it up a lot which means we can facilitate our shipments fine at this level. Although we believe there is some strategic investments we would like to make in inventory in the certain seasonal items as well as continue to focus on direct import business, which takes product out of our inventory. So we’ve targeted and we’ve indicated we would like to be at four turns, we are at 4.1 turns this quarter, and in the recent past we have been at 3.8, 3.7. We think that range is probably realistic, although we will probably add a little bit of inventory here for the end of year, especially with Chinese New Year. So, you will see that go up a bit at the end of the year, but we will continue to focus somewhere in the high threes, low fours in terms of inventory turns.
Great. And not to continue to drag on here, but I guess as we’re on that topic, I guess turning to your debt balance at quarter end, I guess sort of the same question going forward. What are you sort of looking? Obviously you’ve taken it down about a turn over the past 12 months. But where you sort of seeing that over the long term, or are you sort of identifying any near term, or somewhat medium term opportunities to materially pay down debt or sort of how you reconcile what you are looking at from the capital structure perspective?
Absent any measure issues, we continue to run about mid to mid-high single digit operating cash flow on an annual basis and we use that cash primarily to pay down debt. So near-term I think that’s kind of the target for us. As you see margins increase and that operating cash flow continue go up, we’ll dedicate those moneys directly to paying down debt. Next year, we will have capital repayments of about $4 million, and that’s contractually. So, you’ll definitely see at least that because that’s what’s going to transpire just to do debt agreements. But we’ll continue to use as much cash as we can, pay down debt. We’re dedicated to that. Our turns are -- leverage ratio is at 4.5 now versus it’s been as high as 6. So that’s about 25% reduction in leverage ratio.
[Operator Instructions] Our next question today comes from Dave King of ROTH Capital Partners. Please go ahead.
I guess first off maybe following up on some of the prior line of questioning. Bill, in terms of the cash flow generation with sort of inventories being, trends being where you want them to be and just sort of the thoughts around contractual debt pay down. I guess what sort of the plan in terms of what you can do cash flow generation wise next year in order to then meet that 4 million or so contractually? And then, I guess how should we think about the opportunity and do more than that? Is that more -- it sounds like that might be more of a function of getting margins up and obviously as currencies weighing. But I guess just maybe just to step back, what is sort of -- how you are thinking about the capacity for cash generation over the near-term and maybe longer-term in the business? Thanks.
Yes, I think it’s mid to high single digits next year. And then, obviously as your grow sales and margins, you’ll see that cash flow generation continue to go up.
Okay. So, you are saying mid -- high single digits in terms of…
Okay, as a percentage of…
Dollars, it’s dollars, millions of dollars.
Okay. Now I get it. Thank you. And then in terms of the cost overages on new products, were both onetime in nature, I guess was that sort of development costs or are there…
We went in our Born Free line which we introduced earlier in the year, we had some start-up costs and those costs that came through and they are called out specifically in the numbers this quarter, those were related to those onetime start-up costs. We negotiated with our factory and guided down slightly but those were the costs that they will not reoccur as a result of just starting up our Born Free line. So that’s what I called them out specifically.
Okay. And then in terms of expenses, obviously the decline in legal fees was encouraging. I guess first, the question there, do you think it’s now substantially sort of out of the way, given kind of the numbers and where we are at? And then in terms of core expenses if I back those out, I think they are still little bit higher than what we modeled. Anything specific driving that particularly as we think about getting to sort of the guidance you’ve laid out for G&A?
We continue to push remediation and to be resolved on this litigation. So, hopefully we can see those costs continue to be lower as we move forward. You did see some G&A expenses higher and we did spend more money on marketing in the third quarter kind of ramping up what we’re trying to do on some of the items that Mark mentioned earlier in terms of our focus areas; that’s about 200,000 of incremental costs. We did in exiting Summer smart connected nursery, we had little over $100,000 in costs that were kind of write down costs that went through G&A as a result of deciding to exit that or put it in a refrigerator for now. So, those costs did come through as a bit higher thus driving us a bit over the 18% of net sales that we’d like to be at. So, legal, I wouldn’t -- I’m not going to give you a target, but I wouldn’t think you need to budget the $1 million per quarter that we have in the past. I think that number is going to be significantly lower going forward.
And then Mark, you’ve been on board now for call it three and a half months or so. Now that you’ve been there for a little while, any sense in terms of how you’re thinking about the strategy going forward? I think you shared a little bit in your prepared remarks in terms of pricing and some of that, but maybe you can just talk sort of high level in terms of sort of the big opportunities for Summer Infant as we look forward into 2017 and sort of beyond?
Yes. I’m really excited, there’s some really big opportunities. As I mentioned we had serious double-digit growth in strollers, and there’s no reason to believe we can’t get heavier oriented in gear. And to me those higher average retail items are going to help us drive the business forward. And the innovation that is seen from the team, they’re extremely innovative. And we’ve found the channel where we can grow the business. So, we just need to shift some resource to that area to nurture that a little bit more. So, I feel really good about that.
Getting out and talking to customers about kind of consolidating our distribution a little bit and getting rid of the third-party distribution model will help us to make those folks feel better about growing Summer as well. So, it’s been a fast and furious first 90 plus days but it’s been great. And we’ve gotten good reception from retailers as to some of the short term strategies that we’ve put in front of them. So, I think we’re well aligned for growth with our key retail and online partners. And you’re going to be excited to see what’s coming for Summer in 2017.
[Operator Instructions] Showing no further questions, I’d like to turn the conference back over to Mr. Messner for any closing remarks.
Well, thank you all for joining us for today’s call. We’ll look forward to speaking with you next quarter.
Thank you, sir. Today’s conference has now concluded and we thank you all for attending today’s presentation. You may now disconnect your lines and have a wonderful day.