STRATEGIC OVERVIEW
The Company's near-term strategy is to return to profitability by focusing on
its previously announced restructuring and cost savings initiatives. After
completion of such initiatives, the Company will continue to focus on profitable
sales growth through five strategic pillars. These strategic pillars include:
*Defend the base business - Design, product innovation, category leadership
*Expand to adjacent categories with a focus on brands - Focus on fragmented
markets, brands, omni-channel
*Build an omni-channel business model - Dedicated resources, leverage technology
*Improve ROIC by maximizing margins while minimizing capital investment -
Streamline and focus on economic value add and working capital
*Build a collaborative, One CSS culture - Communication, accountability,
diversity
Approximately 70% of the Company's annual net sales for fiscal 2019 were
attributable to products within our craft and gift categories, with the
remainder attributable to products in the seasonal category. The craft product
category reflects products used for craft activities and includes ribbons,
trims, buttons, sewing patterns, knitting needles, needle arts and kids' crafts.
Craft products are sold to mass market, specialty, and online retailers and are
generally ordered on a replenishment basis throughout the year. The gift product
category is defined as products primarily designed to celebrate certain life
events or special occasions such as weddings, birthdays, anniversaries,
graduations, or the birth of a child. Gift products are primarily sold to mass,
specialty, and online retailers, floral and packaging wholesalers and
distributors, and are generally ordered on a replenishment basis throughout the
year. The seasonal product category is defined as products designed, produced
and sold to mass market and online retailers for holidays and seasonal events,
including Christmas, Valentine's Day, Easter and back-to-school. Production
forecasts for these products are known well in advance of shipment.
The Company has relatively high market share in many products across its
categories. Most of these markets have declined in recent years. The Company
continues to confront significant price pressure as its competitors source
certain products from overseas and its customers increase direct sourcing from
overseas factories. Increasing customer concentration has augmented customers'
bargaining power, which has also contributed to price pressure. In recent fiscal
years, the Company has experienced lower sales in certain Christmas product
lines, craft ribbon product lines, gift stationery product lines, its infant
product line, and in its non-retail packaging and floral product lines due to
factors such as continued price pressure, inventory destocking, as well as a
decline in brick and mortar retail traffic.
The Company has taken several measures to respond to sales volume, cost and
price pressures. The Company believes it continues to have strong core product
offerings which have allowed it to operate effectively in this competitive
market. In addition, the Company is pursuing new product initiatives related to
craft, gift and seasonal products, including new licensed and non-licensed
product offerings, as well as increased investment in omni-channel offerings.
CSS continually invests in product and packaging design and product knowledge to
assure that it can continue to provide unique added value to its customers. In
addition, CSS maintains purchasing offices in Hong Kong and China to be able to
provide foreign-sourced products at competitive prices. CSS continually
evaluates the efficiency and productivity of its production and distribution
facilities and of its back office operations to maintain its competitiveness.
The Company seeks to build on existing relationships with craft, gift and
seasonal customers by expanding and diversifying its product lines and thereby
growing its presence in the largest retailers in North America. As the Company
continues to execute on existing cost containment plans, it will consider
additional improvement plans to stimulate profitability.
RESULTS OF OPERATIONS
The seasonal nature of CSS' business has historically resulted in lower sales
levels and operating losses in the first and fourth quarters and comparatively
higher sales levels and operating profits in the second and third quarters of
the Company's fiscal year, thereby causing significant fluctuations in the
quarterly results of operations of the Company.
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The following table presents the key results of our operations for the three-
and nine months ended December 31, 2019 and 2018 (in thousands):
                                                                                                               Nine Months Ended
                                                Three Months Ended December 31,                                   December 31,
                                                    2019                   2018               2019                 2018
Net sales                                    $       112,932           $ 133,231          $ 266,443          $   310,259
Gross profit                                          29,987              33,463             66,812               69,791
Selling, general and administrative expenses          21,654              28,718             65,140               85,995
Restructuring expenses                                   604               1,050              3,399                3,177
Impairment of goodwill                                     -                   -                  -                1,390

Interest expense (income), net                           798                 784              2,447                1,480
Other expense (income), net                             (649)               (154)            (1,725)                (437)
Income tax expense                                       339               9,835              1,076                8,342
Net income (loss)                            $         7,241           $  (6,770)         $  (3,525)         $   (30,156)


Three Months Ended December 31, 2019 Compared to Three Months Ended December 31,
2018
Net sales for the three months ended December 31, 2019 decreased to $112,932,000
from $133,231,000 for the three months ended December 31, 2018. This decrease
was driven by decreases in craft, gift and seasonal net sales of $1,072,000,
$4,373,000 and $14,854,000, respectively. The decrease in craft sales was
primarily due to lower replenishment orders of needle arts and kids' crafts. The
decrease in gift sales was primarily due to lower replenishment orders of social
stationery products, infant products, and packaging and wholesale products. The
decrease in seasonal sales was primarily due to lower sales of Christmas
ribbons, bows, cards, and gift card holders, and Valentine's Day products.
Gross profit for the three months ended December 31, 2019 decreased to
$29,987,000 from $33,463,000 for the three months ended December 31, 2018. The
decrease in gross profit was primarily driven by the impact of lower sales
volume and mix of sales of $8,435,000 which was partially offset by $941,000 of
lower inventory step-up amortization, $824,000 of lower distribution costs,
$689,000 of lower operational variances, and the absence of incremental costs of
$2,544,000 related to operational inefficiencies associated with the Christmas
2018 ribbon and bow production in connection with the now complete trade remedy
petition with the U.S. International Trade Commission and the U.S. Department of
Commerce.
Selling, general and administrative ("SG&A") expenses of $21,654,000 for the
three months ended December 31, 2019 decreased from $28,718,000 for the three
months ended December 31, 2018 primarily due to lower personnel related costs of
$3,630,000, lower consulting costs of $2,225,000 and lower travel and
entertaining costs of $424,000.
Restructuring expenses of $604,000 were recorded for the three months ended
December 31, 2019 associated with the Company's resource alignment initiative
and the Company's location consolidation initiatives. Restructuring expenses of
$1,050,000 for the three months ended December 31, 2018 were associated with the
Company's strategic business initiative and the consolidation of the Company's
operations in the United Kingdom and Australia. See further discussion of these
restructuring initiatives in Note 3 to the consolidated financial statements.
Interest expense, net, of $798,000 for the three months ended December 31, 2019
slightly increased from $784,000 for the three months ended December 31, 2018
primarily due to the Company's increased borrowings, and the related borrowing
rate, under the Company's ABL Credit Facility.
Other income, net, of $649,000 for the three months ended December 31, 2019
increased from $154,000 for the three months ended December 31, 2018 primarily
due to the sale of a distribution facility in Danville, Pennsylvania. See
further discussion in Note 1 to the consolidated financial statements.
Income tax expense, as a percentage of income (loss) before income taxes, was 4%
and 321% for the three months ended December 31, 2019 and 2018, respectively.
The change was primarily attributable to the impact of a valuation allowance
recorded as of December 31, 2018 that fully offset the Company's U.S. net
deferred tax assets. The Company continues to maintain the valuation allowance
as of December 31, 2019.
The net income for the three months ended December 31, 2019 was $7,241,000, or
$0.81 per diluted share compared to net loss of $6,770,000, or $0.77 per diluted
share for the three months ended December 31, 2018.
Nine Months Ended December 31, 2019 Compared to Nine Months Ended December 31,
2018
Net sales for the nine months ended December 31, 2019 decreased to $266,443,000
from $310,259,000 for the nine months ended December 31, 2018. This decrease was
driven by decreases in craft, gift and seasonal net sales of $8,172,000,
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$15,568,000 and $20,076,000, respectively. The decrease in craft sales was
primarily due to lower replenishment orders of ribbons, buttons, needle arts and
kids' crafts. The decrease in gift sales was primarily due to lower
replenishment orders of social stationery products, infant products, packaging
and wholesale products, and everyday trim-a-package products. The decrease in
seasonal sales was primarily due to lower sales of Christmas ribbons, buttons,
cards, bags, and gift card holders, Valentine's Day products and the previously
announced exit of the Company's sports-licensed back-to-school product line.
Gross profit for the nine months ended December 31, 2019 decreased to
$66,812,000 from $69,791,000 for the nine months ended December 31, 2018. The
decrease in gross profit was primarily driven by the impact of lower sales
volume and mix of sales of $20,476,000, which was partially offset by $9,830,000
of lower inventory step-up amortization, $1,698,000 of lower operational
variances, $1,655,000 of lower licensing costs, a non-recurring write-down of
inventory and royalty guarantees of $2,053,000 in the prior year related to the
restructuring of the Company's specialty gift product line, and the absence of
incremental costs of $2,544,000 related to operational inefficiencies associated
with the Christmas 2018 ribbon and bow production in connection with the now
complete trade remedy petition with the U.S. International Trade Commission and
the U.S. Department of Commerce.
SG&A expenses of $65,140,000 for the nine months ended December 31, 2019
decreased from $85,995,000 for the nine months ended December 31, 2018 primarily
due to lower personnel related costs of $12,406,000, lower consulting costs of
$4,987,000, lower travel and entertainment costs of $1,412,000, and a benefit
related to the remeasurement of the Fitlosophy contingent earn-out consideration
of $1,366,000 for the nine months ended December 31, 2019. See further
discussion of the remeasurement in Note 9 to the consolidated financial
statements.
Restructuring expenses of $3,399,000 were recorded for the nine months ended
December 31, 2019 associated with the Company's performance improvement
initiative, strategic business initiative, resource alignment initiative, and
location consolidation initiatives. Restructuring expenses of $3,177,000 for the
nine months ended December 31, 2018 were associated with the Company's strategic
business initiative and the consolidation of the Company's operations in the
United Kingdom and Australia. See further discussion of these restructuring
initiatives in Note 3 to the consolidated financial statements.
An impairment of goodwill of $1,390,000 was recorded for the nine months ended
December 31, 2018 associated with the acquisition of Fitlosophy on June 1, 2018.
See further discussion in Note 6 to the consolidated financial statements. There
was no such impairment recorded for the nine months ended December 31, 2019.
Interest expense, net, of $2,447,000 for the nine months ended December 31, 2019
increased from $1,480,000 for the nine months ended December 31, 2018 primarily
due to the Company's increased borrowings, and the related borrowing rate, under
the Company's ABL Credit Facility, and the write-off of deferred financing
transaction costs of $344,000.
Other income, net, of $1,725,000 for the nine months ended December 31, 2019
increased from $437,000 for the nine months ended December 31, 2018 primarily
due to the sale of certain Internet Protocol (IP) addresses which the Company
determined were not needed for its ongoing business operations and the sale of a
distribution facility in Danville, Pennsylvania. See further discussion of the
sale of the distribution facility in Note 1 to the consolidated financial
statements.
Income tax expense, as a percentage of income (loss) before income taxes, was
(44%) and (38%) for the nine months ended December 31, 2019 and 2018,
respectively. The change was primarily attributable to the impact of a valuation
allowance recorded as of December 31, 2018 that fully offset the Company's U.S.
net deferred tax assets, and a difference in the mix of domestic and foreign
pretax income as of December 31, 2019. The Company continues to maintain the
valuation allowance as of December 31, 2019.
The net loss for the nine months ended December 31, 2019 was $3,525,000, or
$0.40 per diluted share compared to net loss of $30,156,000, or $3.35 per
diluted share for the nine months ended December 31, 2018.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2019, the Company had working capital of $86,540,000 and
stockholders' equity of $186,987,000. Operating activities used net cash of
$8,586,000 during the nine months ended December 31, 2019 compared to
$34,513,000 in the nine months ended December 31, 2018. Net cash used for
operating activities during the nine months ended December 31, 2019 reflected
our working capital requirements which resulted in an increase in accounts
receivable of $33,768,000 primarily reflecting seasonal billings of current
fiscal year Christmas shipments, net of current fiscal year collections; a
decrease in inventory of $8,984,000; a decrease in prepaid expenses and other
assets of $2,929,000; an increase of accounts payable of $2,216,000 and an
increase in lease liabilities of $6,013,000. Included in net loss for the nine
months ended December 31, 2019 were non-cash charges such as depreciation and
amortization of $9,863,000, amortization of operating lease right-of-use assets
of $7,518,000, amortization of inventory step-up of $284,000, amortization of
financing transaction costs of $421,000, write-off of financing transaction
costs of $344,000, provision for accounts receivable allowances of $2,470,000,
and share-based compensation of $669,000. Net cash used for operating activities
during the nine months ended December 31, 2018 reflected our working capital
requirements which resulted in an increase in accounts receivable of $60,718,000
primarily
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reflecting seasonal billings of current year Christmas accounts receivable, net
of current year collections and an increase in inventory of $2,222,000,
partially offset by an increase in accounts payable of $15,865,000 and an
increase in accrued expenses and long-term obligations of $4,093,000 due to
increased accruals for freight, royalties, and contingent earn-out consideration
associated with the acquisition of Fitlosophy. Included in net income (loss) for
the nine months ended December 31, 2018 were non-cash charges for depreciation
and amortization of $10,264,000, deferred tax provision of $10,050,000,
amortization of inventory step-up of $9,830,000, provision for accounts
receivable allowances of $4,386,000, share-based compensation of $1,694,000,
impairment of property, plant and equipment of $1,398,000 related to a
restructuring plan to combine its operations in the United Kingdom and
impairment of goodwill of $1,390,000 associated with the acquisition of
Fitlosophy.
Our investing activities used net cash of $5,941,000 in the nine months ended
December 31, 2019, consisting of capital expenditures of $6,966,000 primarily
related to information technology and other integration projects. In the nine
months ended December 31, 2018, investing activities used net cash of
$13,507,000 consisting of capital expenditures of $7,757,000 primarily related
to information technology and other integration projects, the purchase of
Fitlosophy of $2,500,000, the final payment of purchase price of $2,500,000
related to the Simplicity business previously acquired, and the purchase of a
company-owned life insurance policy of $750,000.
Our financing activities provided net cash of $9,881,000 in the nine months
ended December 31, 2019, consisting primarily of net borrowings of $12,666,000,
partially offset by payments of financing transaction costs of $2,425,000. In
the nine months ended December 31, 2018, financing activities provided net cash
of $8,361,000 consisting primarily of net borrowings of $18,695,000, partially
offset by payments of cash dividends of $5,401,000 and purchases of treasury
stock of $4,372,000.
Historically, a significant portion of the Company's revenues have been
seasonal, primarily Christmas related, with approximately 64% of sales
recognized in the second and third quarters. As payment for seasonal products is
usually not received until just before or just after the holiday selling season
in accordance with general industry practice, working capital has historically
increased in the second and third quarters, peaking prior to Christmas and
dropping thereafter. As such, the Company relies on seasonal borrowings under
its ABL Credit Facility, cash on hand and cash generated from its operations to
meet its liquidity requirements throughout the year. As of December 31, 2019,
there was $38,805,000 outstanding under the Company's ABL Credit Facility.
On March 7, 2019, the Company entered into a $125,000,000 asset based senior
secured credit facility with three banks (the "ABL Credit Facility"). The
Company used the proceeds from borrowings under the ABL Credit Facility to repay
in full the Company's prior credit facility with two banks (the "Prior Credit
Facility"), under which the maximum credit available to the Company at any one
time (the "Committed Amount") was $50,000,000 at the time the Prior Credit
Facility was repaid and terminated on March 7, 2019. On May 23, 2019, the
Company entered into a Second Amendment (the "Amendment") to the ABL Credit
Facility. The Amendment reduced the maximum amount available under the revolving
credit facility from $125,000,000 to $100,000,000. Availability under the
Amendment is equal to the lesser of $100,000,000 or a Borrowing Base (as defined
in the Amendment), in each case minus (i) revolving loans outstanding and (ii)
$15,000,000 until the Agent's receipt of a compliance certificate demonstrating
compliance with the amended financial covenants.
The $15,000,000 availability block mentioned above was reduced to $10,000,000
for the period beginning August 20, 2019 to September 10, 2019, $11,000,000 for
the period beginning September 10, 2019 to September 24, 2019, and $12,500,000
for the period beginning September 24, 2019 to October 4, 2019. On November 13,
2019, the Company and the lenders under the ABL Credit Facility entered into a
Limited Consent and Waiver (the "Limited Consent") which reduced the minimum
cumulative EBITDA (as defined in the ABL Credit Facility) levels required to be
attained by the Company as of the end of each calendar month for the months of
October 2019 through March 2020. The Limited Consent also increased the
availability block from $15,000,000 to $20,000,000 from November 13, 2019 until
November 30, 2019, and it provides for further increases thereof in increments
of $1,000,000 beginning on December 1, 2019 and every two weeks thereafter until
the availability block reaches $25,000,000 on February 1, 2020 and remains at
that level thereafter unless and until the Company demonstrates compliance as of
March 31, 2020 with each of the financial covenants contained in the ABL Credit
Facility. Under the Limited Consent, the lenders waived any events of default
that may have resulted from the Company's adoption of the Rights Plan on
November 11, 2019.
On February 4, 2020, the Company and the lenders under the ABL Credit Facility
entered into a Limited Consent (the "Additional Limited Consent") which
temporarily reduces the availability block imposed under the ABL Credit Facility
from $25,000,000 to $23,000,000. The Additional Limited Consent permits the
Company, in accordance with the terms of the Additional Limited Consent, to
exercise two additional reductions of the availability block, each in $1,000,000
increments. In the event that the Company exercises both of the foregoing
additional availability block reductions in accordance with the terms of the
Additional Limited Consent, the availability block would be temporarily reduced
to $21,000,000. The Additional Limited Consent further provides that the
availability block will be reinstated to $25,000,000 on the earliest of: (i) the
Merger Effective Time (as defined in the Merger Agreement), (ii) the Termination
Date (as defined in the Merger Agreement) or (iii)
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February 28, 2020. For information concerning the ABL Credit Facility, see Note
7 and 13 to the consolidated financial statements.
The Company is currently in compliance with its debt covenants under its ABL
Credit Facility discussed in Note 7 to the consolidated financial statements;
however, it is probable, based on our forecasts, that the Company will not be in
compliance with these covenants at certain future measurement dates in the
following twelve-month period. In connection with the transactions contemplated
by the Merger Agreement discussed in Note 13 to the consolidated financial
statements, the Company expects that its obligations to the lenders under the
ABL Credit Facility described in Note 7 to the consolidated financial statements
will be discharged at the time the merger contemplated by the Merger Agreement
is consummated. However, there can be no assurance that the transactions
contemplated by the Merger Agreement will be consummated on the contemplated
timeline or at all. If a debt covenant violation under the ABL Credit Facility
were to occur prior to the consummation of the transactions contemplated by the
Merger Agreement and if the Company was unable to agree to amended financial
covenant measures with its lenders before such time or obtain a waiver in the
event of subsequent non-compliance, the Company would not be able to repay the
entirety of the outstanding debt in the event the lenders were to call the debt,
thus leading to substantial doubt about the Company's ability to continue as a
going concern until such amendments or waivers are in place.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern and do not include any adjustments that
might result from the outcome of this uncertainty.
As of December 31, 2019, the Company's letter of credit commitments are as
follows (in thousands):
                      Less than 1        1-3        4-5       After 5
                          Year          Years      Years       Years        Total
Letters of credit    $     2,582          -          -            -       $ 2,582


The Company has a reimbursement obligation with respect to stand-by letters of
credit that guarantee the funding of workers compensation claims and a lease
security deposit. The Company has no financial guarantees with any third parties
or related parties other than with respect to certain obligations of its
subsidiaries.
As of December 31, 2019, the Company is committed to pay guaranteed minimum
royalties attributable to sales of certain licensed products. Reference is made
to contractual obligations included in the Company's annual report on Form 10-K
for the fiscal year ended March 31, 2019. There have been no significant changes
to such contractual obligations.
In the ordinary course of business, the Company enters into arrangements with
vendors to purchase merchandise in advance of expected delivery. These purchase
orders do not contain any significant termination payments or other penalties if
cancelled.
LABOR RELATIONS
With the exception of the bargaining unit at the ribbon manufacturing facility
in Hagerstown, Maryland, which totaled 82 employees as of December 31, 2019, CSS
employees are not represented by labor unions. The collective bargaining
agreement with the labor union representing the Hagerstown-based production and
maintenance employees remains in effect until December 31, 2020. Historically,
the Company has been successful in renegotiating expiring agreements without any
disruption of operating activities.
CRITICAL ACCOUNTING POLICIES
The consolidated financial statements are prepared in conformity with accounting
principles generally accepted in the United States. The preparation of these
financial statements requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
The significant accounting policies of the Company are described in the notes to
the consolidated financial statements included in the Annual Report on Form 10-K
for the fiscal year ended March 31, 2019. Judgments and estimates of
uncertainties are required in applying the Company's accounting policies in many
areas. Following are some of the areas requiring significant judgments and
estimates: revenue; the assessment of the recoverability of other intangible and
long-lived assets; the valuation of inventory and accounts receivable and
resolution of litigation and other proceedings. With the exception of leases
(see Note 5 to the consolidated financial statements), there have been no
material changes to the critical accounting policies affecting the application
of those accounting policies as noted in the Company's Annual Report on Form
10-K for the fiscal year ended March 31, 2019.
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ACCOUNTING PRONOUNCEMENTS
See Note 12 to the consolidated financial statements for information concerning
recent accounting pronouncements and the impact of those standards.
FORWARD-LOOKING STATEMENTS
Any statements contained in this report that do not describe historical facts,
including estimates and other statements regarding matters that are to occur in
the future, as well as statements regarding future operations, are neither
promises nor guarantees and may constitute "forward-looking statements" as that
term is defined in the U.S. Private Securities Litigation Reform Act of 1995.
Such forward-looking statements may include words such as "may," "might,"
"will," "should," "expects," "plans," "anticipates," "believes," "estimates,"
"predicts," "potential" or "continue," the negative of these terms and other
comparable terminology. Any such forward-looking statements contained herein are
based on current assumptions, estimates and expectations, but are subject to a
number of known and unknown risks and significant business, economic and
competitive uncertainties that may cause actual results to differ materially
from expectations. Numerous factors could cause actual future results to differ
materially from current expectations expressed or implied by such
forward-looking statements, including the risks and other risk factors detailed
in various publicly available documents filed by CSS from time to time with the
Securities and Exchange Commission (SEC), which are available at www.sec.gov,
including but not limited to, such information appearing under the caption "Risk
Factors" in this report and in CSS' Annual Report on Form 10-K filed with the
SEC on May 31, 2019. Any forward-looking statements should be considered in
light of those risk factors. CSS cautions readers not to rely on any such
forward-looking statements, which speak only as of the date they are made. CSS
disclaims any intent or obligation to publicly update or revise any such
forward-looking statements to reflect any change in Company expectations or
future events, conditions or circumstances on which any such forward-looking
statements may be based, or that may affect the likelihood that actual results
may differ from those set forth in such forward-looking statements.

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