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 inHong Kong andChina 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 inNorth 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. 26 -------------------------------------------------------------------------------- Table of Contents The following table presents the key results of our operations for the three- and nine months endedDecember 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 EndedDecember 31, 2019 Compared to Three Months EndedDecember 31, 2018 Net sales for the three months endedDecember 31, 2019 decreased to$112,932,000 from$133,231,000 for the three months endedDecember 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, andValentine's Day products. Gross profit for the three months endedDecember 31, 2019 decreased to$29,987,000 from$33,463,000 for the three months endedDecember 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 theU.S. International Trade Commission and theU.S. Department of Commerce . Selling, general and administrative ("SG&A") expenses of$21,654,000 for the three months endedDecember 31, 2019 decreased from$28,718,000 for the three months endedDecember 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 endedDecember 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 endedDecember 31, 2018 were associated with the Company's strategic business initiative and the consolidation of the Company's operations in theUnited Kingdom andAustralia . 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 endedDecember 31, 2019 slightly increased from$784,000 for the three months endedDecember 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 endedDecember 31, 2019 increased from$154,000 for the three months endedDecember 31, 2018 primarily due to the sale of a distribution facility inDanville, 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 endedDecember 31, 2019 and 2018, respectively. The change was primarily attributable to the impact of a valuation allowance recorded as ofDecember 31, 2018 that fully offset the Company'sU.S. net deferred tax assets. The Company continues to maintain the valuation allowance as ofDecember 31, 2019 . The net income for the three months endedDecember 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 endedDecember 31, 2018 . Nine Months EndedDecember 31, 2019 Compared to Nine Months EndedDecember 31, 2018 Net sales for the nine months endedDecember 31, 2019 decreased to$266,443,000 from$310,259,000 for the nine months endedDecember 31, 2018 . This decrease was driven by decreases in craft, gift and seasonal net sales of$8,172,000 , 27 -------------------------------------------------------------------------------- Table of Contents$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 endedDecember 31, 2019 decreased to$66,812,000 from$69,791,000 for the nine months endedDecember 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 theU.S. International Trade Commission and theU.S. Department of Commerce . SG&A expenses of$65,140,000 for the nine months endedDecember 31, 2019 decreased from$85,995,000 for the nine months endedDecember 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 endedDecember 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 endedDecember 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 endedDecember 31, 2018 were associated with the Company's strategic business initiative and the consolidation of the Company's operations in theUnited Kingdom andAustralia . 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 endedDecember 31, 2018 associated with the acquisition of Fitlosophy onJune 1, 2018 . See further discussion in Note 6 to the consolidated financial statements. There was no such impairment recorded for the nine months endedDecember 31, 2019 . Interest expense, net, of$2,447,000 for the nine months endedDecember 31, 2019 increased from$1,480,000 for the nine months endedDecember 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 endedDecember 31, 2019 increased from$437,000 for the nine months endedDecember 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 inDanville, 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 endedDecember 31, 2019 and 2018, respectively. The change was primarily attributable to the impact of a valuation allowance recorded as ofDecember 31, 2018 that fully offset the Company'sU.S. net deferred tax assets, and a difference in the mix of domestic and foreign pretax income as ofDecember 31, 2019 . The Company continues to maintain the valuation allowance as ofDecember 31, 2019 . The net loss for the nine months endedDecember 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 endedDecember 31, 2018 . LIQUIDITY AND CAPITAL RESOURCES As ofDecember 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 endedDecember 31, 2019 compared to$34,513,000 in the nine months endedDecember 31, 2018 . Net cash used for operating activities during the nine months endedDecember 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 endedDecember 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 endedDecember 31, 2018 reflected our working capital requirements which resulted in an increase in accounts receivable of$60,718,000 primarily 28 -------------------------------------------------------------------------------- Table of Contents 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 endedDecember 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 theUnited 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 endedDecember 31, 2019 , consisting of capital expenditures of$6,966,000 primarily related to information technology and other integration projects. In the nine months endedDecember 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 endedDecember 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 endedDecember 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 ofDecember 31, 2019 , there was$38,805,000 outstanding under the Company's ABL Credit Facility. OnMarch 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 onMarch 7, 2019 . OnMay 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 beginningAugust 20, 2019 toSeptember 10, 2019 ,$11,000,000 for the period beginningSeptember 10, 2019 toSeptember 24, 2019 , and$12,500,000 for the period beginningSeptember 24, 2019 toOctober 4, 2019 . OnNovember 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 ofOctober 2019 throughMarch 2020 . The Limited Consent also increased the availability block from$15,000,000 to$20,000,000 fromNovember 13, 2019 untilNovember 30, 2019 , and it provides for further increases thereof in increments of$1,000,000 beginning onDecember 1, 2019 and every two weeks thereafter until the availability block reaches$25,000,000 onFebruary 1, 2020 and remains at that level thereafter unless and until the Company demonstrates compliance as ofMarch 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 onNovember 11, 2019 . OnFebruary 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) 29 -------------------------------------------------------------------------------- Table of ContentsFebruary 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 ofDecember 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 ofDecember 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 endedMarch 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 inHagerstown, Maryland , which totaled 82 employees as ofDecember 31, 2019 , CSS employees are not represented by labor unions. The collective bargaining agreement with the labor union representing theHagerstown -based production and maintenance employees remains in effect untilDecember 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 inthe 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 endedMarch 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 endedMarch 31, 2019 . 30
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Table of Contents 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 theU.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 theSecurities 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 theSEC onMay 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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