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Edited Transcript of CSS earnings conference call or presentation 8-Feb-19 1:30pm GMT

Q3 2019 CSS Industries Inc Earnings Call

Philadelphia Feb 13, 2019 (Thomson StreetEvents) -- Edited Transcript of CSS Industries Inc earnings conference call or presentation Friday, February 8, 2019 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christopher J. Munyan

CSS Industries, Inc. - CEO, President & Director

* Keith W. Pfeil

CSS Industries, Inc. - CFO & Executive VP of Finance

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Conference Call Participants

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* John Butler Walthausen

Walthausen & Co., LLC - CIO & Portfolio Manager

* Runxin Ding

D.A. Davidson & Co., Research Division - Research Associate

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Presentation

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Operator [1]

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Good morning. My name is Shelley, and I will be your conference operator today. At this time, I would like to welcome everyone to the CSS Industries' Fiscal 2019 Third Quarter Conference Call. (Operator Instructions) Thank you. Keith Pfeil, you may begin your conference.

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Keith W. Pfeil, CSS Industries, Inc. - CFO & Executive VP of Finance [2]

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Good morning, and thank you for joining our conference call to discuss CSS Industries' third quarter results for fiscal year 2019 and our outlook for the full year.

Sitting with me today is Chris Munyan, our President and Chief Executive Officer.

During the course of this call, we will be providing certain forward-looking information. We ask you to look at yesterday's press release and read through the forward-looking cautionary statements that we've included there.

In addition, we will use certain non-GAAP measures in our discussion this morning, and we ask you to read through those sections of our press release that address the use of these items.

The press release and related tables can be found on the Investor Relations portion of our website at cssindustries.com.

Chris will begin our discussion by providing some opening comments related to our quarter.

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Christopher J. Munyan, CSS Industries, Inc. - CEO, President & Director [3]

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Thanks, Keith. Good morning, everyone. Our third quarter did not perform as expected and we were disappointed with the results. Overall net sales for the third quarter increased 2%, driven by the contribution from Simplicity, which was acquired in November 2017.

Organic sales declined 4% year-over-year, driven primarily by lower craft and gift sales, partially offset by higher seasonal sales due to the later timing of Christmas ribbon and bow shipments as commented during our last earnings call.

Adjusted EBITDA for the quarter was down $4.8 million from last year's third quarter. The key driver of this was margin decline, driven by the mix of lower base sales volumes within our craft and gift categories, partially offset by the contributions from the Simplicity acquisition as well as higher seasonal sales.

Although our results for the third quarter did not meet expectations, I would like to take some time to provide insights and updates into our long-term strategy by discussing several key initiatives mentioned in yesterday's press release.

First and foremost, I'm pleased to announce that during the quarter, the company selected JPMorgan Chase Bank as the administrative agent to lead the new $125 million syndicated asset-based revolving credit facility. The team was heavily focused on commencing asset appraisals and diligence proceedings during the quarter.

More recently, the company executed a proposal letter with JPMorgan Chase and is actively marketing this new facility with additional lenders. We fully anticipate to close of this facility during our fiscal fourth quarter.

While we work towards finalization, we're aggressively paying down our debt. I want to highlight that we ended December with a total loan balance of $58.7 million and cash of $18.9 million. However, by January 31, our total loan balance decreased by $15.5 million to $43.2 million with $10.9 million of cash on hand.

As we move further into our fourth quarter, our plan is to continue to drive down debt levels with the goal of achieving a total loan balance between $25 million and $30 million by fiscal year-end.

The second topic I'd like to comment on relates to ongoing cost savings projects. Last quarter, we highlighted that our team was performing a detailed review of its operating structure to highlight areas for efficiency improvements.

I'm pleased to announce that we completed the first phase of this project in mid-December and initiated actions in early January, which have immediately impacted our business. These actions are expected to result in $1 million of cost savings in our fiscal fourth quarter and will drive approximately $4 million of savings on an annualized basis. We're still working to implement another $1 million to $2 million of annualized savings related to this initial phase prior to heading into fiscal 2020.

The second phase of our cost savings initiatives were planned in December and kicked off in early January. This phase will continue the evaluation of our operating structure, focusing specifically on product life cycle management as well as our new item development process with the goal of more clearly defining the drivers of profitability while driving out complexity within our base business.

This project will continue into our fourth quarter, and upon its completion, is expected to generate $8 million to $12 million of annualized run rate savings and an additional $8 million to $10 million of working capital improvements.

A key end result of this project will be significant permanent reduction in SKUs across our business. Actions around the second initiative will be implemented in a phased approach, starting in fiscal 2020 and expected to be fully realized within the next 2 years.

Overall, these 2 initiatives have the potential to generate $12 million to $18 million of ongoing annualized savings while also driving $8 million to $10 million of working capital improvements. Both of these will drive enhanced profitability as this retail environment continues to evolve.

The last area I'd like to comment on relates to our omnichannel initiatives. We continue to see atypical brick-and-mortar retail environment for our products as evidenced by the declining sales in our replenishment gift and craft business.

To offset this, we're aggressively pursuing new areas of investment, which will expand our direct-to-consumer presence within our omnichannel initiatives. Over the next 12 months, we will be aggressively moving to launch new services as well as drive additional investments in areas, which will seek to differentiate us in the marketplace.

We're set to launch Confetti Collection in fiscal 2020, which is a direct-to-consumer subscription service. This new service will enable us to immerse our customers with the broad portfolio of CSS products.

Following Confetti Collection launch, we will next roll out our new mobile selling app called Sew the Look. This app will include features for visual search where consumers can use an image to identify similar products across our vast portfolio of products. This will ultimately drive higher online sales, while also expanding our presence on social media as users share their creativity while using our products.

As these exciting launches roll out, we will continue to invest in driving the digitization of our content. Bringing together the McCall and Simplicity pattern businesses has allowed us to access and combine vast archives of hand-drawn artwork, fashion art and pattern art, some of which dates back to the mid-1800s.

Our goal is simple: we want to archive these images and art in a digital manner. It is our belief that this content is one of the largest collections of Western fashion art in the world. By doing so, we'll be able to further commercialize and drive exciting new product lines such as our Simplicity Vintage line, and drive additional market differentiation for CSS as we ideate how to further monetize these assets through additional product and format introductions.

In summary, though our third quarter missed expectations, we remain upbeat as we continue to effectively compete within the markets. We continue to address issues around our core business and drive investments towards the future. In short, we're implementing our long-term strategy.

Keith will now take you through a more detailed review of the quarter.

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Keith W. Pfeil, CSS Industries, Inc. - CFO & Executive VP of Finance [4]

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Thanks, Chris. Turning your attention to the financial results, we will walk through our overall sales performance and results by category as well as comment on the rest of the income statement, balance sheet and cash flow.

Net sales for the quarter increased 2% over the prior year to $133.2 million. Sales related to Simplicity, which we acquired in November 2017, were $22 million. Excluding sales from Simplicity, net sales in the third quarter declined 3.8% to $111.3 million from $115.7 million in the prior year quarter. The erosion in sales is driven primarily by declines within our craft and gift businesses, partially offset by the timing of later seasonal sales as we had expected and commented on during our fiscal second quarter earnings call.

Net sales in our craft category were $39.8 million in the third quarter, representing a 9.2% increase over the prior year quarter. Excluding sales from Simplicity, our net sales decreased $3.7 million, representing a 17.2% decline for the quarter, driven by lower button sales due to a customer not repeating a program reset, which occurred in the prior year quarter, as well as lower replenishment ribbon sales with a major mass market retailer and also a leading craft chain.

On a full year basis, we expect craft sales growth of approximately 40% as compared to the prior year, driven entirely by the full year contribution of Simplicity sales. Our base craft business is expected to be down roughly 6% to 9%, driven by lower expected replenishment sales within ribbons and buttons. We note these declines as reflective of retail store traffic around our products and do not represent competitive share losses.

Shifting next to our gift category. Net sales were $29.5 million in the quarter, down 13.1% from the prior year quarter. The year-over-year decline is led by lower sales of infant and social stationery as well as gift card holders, partially offset by higher sales of everyday trim and package products with a major retailer.

For the full year, we expect sales in this category to be down 5% to 8% as compared to the prior year. Share gains within our everyday trim and package business will be offset by lower sales within infant and social stationery and our wholesale floral business.

We note the decline in sales within this category to be primarily the result of a buy-down of an infant program with a major retailer as well as lower demand for wholesale floral ribbon products.

Our seasonal net sales increased 6.2% versus the prior year quarter, driven primarily by the later timing of Christmas ribbon and bow shipments, partially offset by lower Valentine and Easter sales as previously discussed during our second quarter earnings call.

On a full year basis, we expect seasonal sales to be down approximately 4% to 6%, driven almost entirely by lower sales of Valentine and Easter products as well as seasonal gift card holders. These declines will be partially offset by gains within seasonal stationery and school stationery with a major mass market retailer.

Moving further into our income statement. Our consolidated gross profit on a GAAP basis was $33.5 million in the third quarter compared to $37.5 million in the prior year quarter. Our third quarter reflected the incremental contribution from the Simplicity acquisition as we realized a full quarter of sales and profits in this year's third quarter compared to our partial quarter based on the timing of the acquisition in the prior year.

Despite that, our base business experienced lower profitability driven by 2 primary factors: first, the mix impact on lower base business volumes drove a significant impact to gross profit as the business loss represented higher-margin items during the quarter; secondly, we incurred significant operational costs as a result of reshoring poly ribbon products to our U.S. manufacturing locations. We attribute this to the timing of customer commitments relative to our production schedule and requested customer shipment dates. As a result, we incurred significant increases in the manufacturing cost of these products, primarily driven by higher labor expenses.

Our adjusted gross profit was $37.6 million in the third quarter compared to $42.7 million the prior year quarter. Adjusted gross margin rate was 28.1% in the current quarter compared to 32.7% in the prior year quarter. The resulting decline in profitability was driven directly by the product and customer mix of lost volume across our base business within craft, gift and seasonal.

Selling, general and administrative expenses were $28.7 million compared to $29.1 million in the prior year quarter. The decline in spending relates to lower acquisition and integration spending as well as cost savings initiatives. These savings are partially asset by the timing of the Simplicity acquisition as Simplicity is included in our results for the full quarter this year compared to our partial quarter in the prior year. Excluding Simplicity, our base business SG&A spending was essentially flat to the prior year quarter.

During the quarter, we booked an additional $1.1 million of restructuring expenses, primarily related to severance costs associated with cost savings initiatives, which Chris commented on earlier across our base U.S. locations as well as our Australia operations.

The GAAP net loss for the quarter was $6.8 million compared to income of $6 million in the prior year quarter. I want to highlight that during the quarter, we booked a noncash $7.6 million tax valuation allowance as well as a $1.5 million noncash reversal of a year-to-date tax benefit. The recording of the valuation allowance was a result of our valuation of the U.S. deferred tax assets on our balance sheet with respect to our 3-year cumulative pretax book loss. This allowance does not affect the company's ability to use tax attributes on future tax returns as we will unwind the valuation allowance when future U.S. taxable income is generated.

Adjusted net income was $6.5 million compared to adjusted net income of $11.3 million in the prior year. Our diluted net loss per share in the third quarter was $0.77 per share compared to diluted net income per share of $0.65 in the prior year quarter.

Adjusted EBITDA was $14.7 million for the quarter compared to $19.5 million in the prior year quarter.

Moving next to the balance sheet and cash flow. We ended the quarter with $18.9 million of cash and cash equivalents compared to $30.3 million in the prior year quarter. The lower balance was primarily due to acquisition integration efforts, higher spending related to our poly ribbon antidumping case and lower levels of income within our base business.

Net inventory decreased to $94.9 million from $110.8 million at the end of the prior year quarter related mainly due to lower fair value stepped-up inventory from McCall and Simplicity. Excluding the effect of lower stepped-up inventory, inventory levels are essentially flat. Accounts receivable was essentially in line to prior year at $119.6 million versus $120.6 million in the prior year quarter.

Assets held for sale were $2.5 million compared to 0 in the prior year quarter. This was the result of classifying our Havant, England facility as held for sale related to the previously announced consolidation of the Simplicity and McCall U.K. facilities. We expect to sell this facility within the next 12 months and we'll use the proceeds to further reduce our debt level.

Accounts payable increased to $36.7 million compared to $27.6 million the prior year quarter driven by improved working capital management.

We ended the quarter with $59 million in total debt, of which $40 million relates to borrowings associated with the acquisition of Simplicity, $300,000 relates to McCall capital leases and $18.7 million in borrowings associated with funding our seasonal working capital requirements.

Cash used for operating activities was $34.5 million for the 9 months compared to $10.4 million for the first 9 months of the prior year. Included in cash from operating activities were $9.8 million of noncash inventory step-up costs, $7.6 million of noncash tax valuation adjustments as well as $6.4 million of pretax acquisition costs compared to $4 million in the prior year.

Capital expenditures were $7.8 million in the 9 months compared to $4 million in the prior year, driven by system enhancements to further streamline and improve our information technology environment.

The resulting free cash flow was a use of $42.3 million in the 9 months compared to a use of $14.4 million in the prior year 9 months.

We've returned $5.4 million to shareholders through our normal dividend, which is consistent with prior year.

Now let me turn it back to Chris for a discussion around our outlook for the year as well as closing comments.

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Christopher J. Munyan, CSS Industries, Inc. - CEO, President & Director [5]

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Thanks, Keith. As a result of our third quarter performance, the company is revising its guidance for the full year of fiscal 2019, which is reflective of the ongoing erosion within our replenishment craft and gift business.

We now expect net sales to be in the range of $390 million to $400 million, representing an increase of 8% to 11% as compared to the prior year. Again, the growth is driven by the Simplicity acquisition, partially asset by lower base business sales.

We are revising our adjusted EBITDA guidance to be in the range of $21 million to $23 million compared to $24.3 million in fiscal 2018. Our previous adjusted EBITDA guidance was in the range of $26 million to $29 million. The expected decline in adjusted EBITDA reflects the continued base business erosion within craft and gift, partially offset by the contributions from the Simplicity acquisition.

We're revising our GAAP net loss guidance to be in the range of $29 million to $31.4 million compared to a net loss of $36.5 million in the prior year. The decrease from our previous provided guidance of a net loss of $10.2 million to $12.5 million is driven mainly by the mix of lower sales volumes, higher manufacturing costs, additional restructuring expense and the noncash tax valuation allowance.

To recap and close our call, we're disappointed with our third quarter results and a revision of our full year guidance. Our strategic initiatives will continue to reshape our portfolio and better position us to compete in this changing retail environment.

We remain focused in the near term on closing on our new ABL credit facility; cost cutting efforts, especially within our base business; working capital improvements; and aggressive debt paydown, which will better position us to move forward.

Operator, let's open up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Linda Bolton-Weiser from D.A. Davidson.

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Runxin Ding, D.A. Davidson & Co., Research Division - Research Associate [2]

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This is Cindy in for Linda. So in terms of your cost savings initiatives that started in January, I wonder, when will the benefits flow through? And what is the split between cost of goods sold and SG&A?

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Keith W. Pfeil, CSS Industries, Inc. - CFO & Executive VP of Finance [3]

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This is Keith Pfeil. The cost savings initiatives that were -- that we reviewed in December were implemented in January. We expect to realize $1 million of those savings in our fiscal fourth quarter. Looking ahead to next year, we expect that -- this action to generate about $4 million of cost savings. From the split between COGS and SG&A, I would say roughly 75% is within SG&A, 25% is within cost of goods sold.

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Runxin Ding, D.A. Davidson & Co., Research Division - Research Associate [4]

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And in terms of your gross margin, which was affected by higher manufacturing, flat and labor costs, what are some steps you've taken or you could take to offset these costs? And should we expect a similar level of gross margin going forward?

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Christopher J. Munyan, CSS Industries, Inc. - CEO, President & Director [5]

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This is Chris Munyan. I think you're referencing that the impact of what we would call our -- impact relating to the antidumping action. And so, no, we do not expect those to continue next year. We expect commitments to come in, in normal course from major retail chains, which were delayed this last year because of this case. And we expect to get back to normal levels of production. Historically, we've produced our seasonal domestic production without any substantial variances. So we're building good plans to have these not repeat.

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Runxin Ding, D.A. Davidson & Co., Research Division - Research Associate [6]

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Good. And in terms of a lower ribbon and button orders of some of your customers, do you see some of the orders coming back? Or do you see this as an ongoing issue for next year?

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Christopher J. Munyan, CSS Industries, Inc. - CEO, President & Director [7]

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I mean, right now with what we're seeing is, we're seeing orders consistent with the prior year. In the third quarter, there was an expectation from a few major chains, as well as us, that they were going to see lift in the third quarter and they were even forecasted by these chains and forecasted by us. And that lift just did not come. And we believe that it's tied to store traffic. I mean, there's a shift certainly going on between in-store product purchasing and online.

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Runxin Ding, D.A. Davidson & Co., Research Division - Research Associate [8]

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Great. And what kind of performance are you seeing right now for sewing pattern? Do you see some flattish growth? Or are you seeing some moderate growth?

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Christopher J. Munyan, CSS Industries, Inc. - CEO, President & Director [9]

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I think it varies by chain. But I think if we count online sales as well as -- most of it comes from in-store sales. I would say it's flat to up.

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Runxin Ding, D.A. Davidson & Co., Research Division - Research Associate [10]

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Okay. And my last question, so your working capital was negative in this quarter compared to the prior year. Is there something that will reverse in there? And what is your view on cash flow for the year and going forward?

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Keith W. Pfeil, CSS Industries, Inc. - CFO & Executive VP of Finance [11]

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Number one, we're not guiding on full year cash flow. However, I do want to call out that cash flow was negative for the quarter. However, we need to take a look at a lot of the noncash information going on within our cash flow, number one. And number two, we're actively working with integration costs. We announced last quarter the changes we made to our gift and specialty line with our C.R. Gibson division, our gifts division, as well as restructuring costs that we're incurring. So when I look at the components of our cash flow, there's a lot of, what I would call, activities that are unique and onetime. And I don't really foresee the result of the cash flow this quarter continuing to happen well into the future. I think that just some of the comments we've talked about here is, getting back and focusing on fundamentals. And one of those fundamentals is driving down working capital, number one; taking out costs of the business, number two; three, improving levels of profitability to drive stronger free cash flow in Q4 as we look ahead.

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Operator [12]

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Your next question comes from the line of John Walthausen from Walthausen & Co.

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John Butler Walthausen, Walthausen & Co., LLC - CIO & Portfolio Manager [13]

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Can you talk about where you're having success and where you're having challenges in developing these alternative channels of sales away from the traditional retail channels?

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Christopher J. Munyan, CSS Industries, Inc. - CEO, President & Director [14]

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Sure, John. Thank you for the question. I mean, I think even within traditional retail, we're having really good success, as I mentioned earlier, with sewing patterns, but also other branded craft products, especially coming out of the recent acquisition of Simplicity. In terms of online, I mean, we're seeing certainly online sales growing at a nice rate as well as our Amazon sales growing at a nice rate. I think next year, we're going to start calling out what those dollars are so we can kind of track against it. And these initiatives that we laid out relating to Sew the Look and the subscription service, we'll be launching pretty early into next fiscal year and we expect them to be successful, because we have a substantial list of consumers relating to some of our branded products that we can immediately market to.

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John Butler Walthausen, Walthausen & Co., LLC - CIO & Portfolio Manager [15]

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In terms of the direct sales or where you're, I guess, in some cases, you may be fulfilling for Amazon, do you have the costs in line so that you could make, say, a reasonable margin on those sales? Or is that still a challenge that has to be overcome?

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Christopher J. Munyan, CSS Industries, Inc. - CEO, President & Director [16]

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I think relating to one selling, let's call it, the online retailers like Amazon, those margins are consistent with kind of our regular brick-and-mortar margin. Any kind of direct-to-consumer margin is going to be much higher and it needs to be higher to cover the cost of marketing online. But we have, especially relating to patterns and other categories we're selling online, we have effective abilities to pick and ship those products as well as large enough margins to be able to be profitable going forward.

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John Butler Walthausen, Walthausen & Co., LLC - CIO & Portfolio Manager [17]

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Okay. I wasn't quite sure whether I got the -- in terms of overcoming the additional selling and fulfillment costs, whether you were there or whether it's something that you have to build up volume to get the margins that we think are appropriate?

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Christopher J. Munyan, CSS Industries, Inc. - CEO, President & Director [18]

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No, I think we're -- I think, relative to those categories now, we're there now.

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John Butler Walthausen, Walthausen & Co., LLC - CIO & Portfolio Manager [19]

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Okay, good. I guess, the other question that sort of surprised me that you highlighted both in the release and in your comments, first, the negotiations about a new line of credit has you also focused on your ability to generate cash flow and pay down debt, which has certainly been a hallmark over the years of CSS. Is that signaling that you're looking for more substantial acquisitions?

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Christopher J. Munyan, CSS Industries, Inc. - CEO, President & Director [20]

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John, I think that our plans -- our long-term strategic plans are still to grow through acquisitions. We're looking at, over this next year, to really focus on driving costs out of the base business, realizing the benefits of the integration that we have with Simplicity. So this line of credit is really going to -- it'll go to our seasonal working capital, which is pretty standard. I think longer term, it'll be there to certainly better support acquisitions going forward.

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Keith W. Pfeil, CSS Industries, Inc. - CFO & Executive VP of Finance [21]

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And I think just when you look at the facility, commenting on paying down debt, I think Chris talked a lot about some of the strategic initiatives that are out there as we're working to integrate the -- our current business with the volatility that exists in brick-and-mortar, we think that it's prudent to pay down some of this debt while we work to reshape the portfolio and really go after some of these strategic initiatives.

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John Butler Walthausen, Walthausen & Co., LLC - CIO & Portfolio Manager [22]

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It's -- am I correct that the scope of this is more than I would generally expect for your needs for seasonal working capital?

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Christopher J. Munyan, CSS Industries, Inc. - CEO, President & Director [23]

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It's really a bigger baseline than what we would need for seasonal working capital, absolutely. But we think, again, in negotiating this, the larger capacity will benefit us in the future.

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John Butler Walthausen, Walthausen & Co., LLC - CIO & Portfolio Manager [24]

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Okay. I mean, I'm not meaning to keep kicking this, is that because the terms of sale are changing so you need to have more availability to support the working capital as terms with retailers change?

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Christopher J. Munyan, CSS Industries, Inc. - CEO, President & Director [25]

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John, really, our terms with all of our major retailers have been pretty consistent over the past few years. We're not really seeing any changes in that.

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John Butler Walthausen, Walthausen & Co., LLC - CIO & Portfolio Manager [26]

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So there's an anticipation then that you feel that you could, in spite of the most recent quarter, that you can grow your sales?

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Christopher J. Munyan, CSS Industries, Inc. - CEO, President & Director [27]

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I mean, the expectation is that with these online initiatives as well as some of these other -- the new brands we've acquired that we should be able to get our sales over time, I would say, to some low level of growth. That would be to plan.

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Operator [28]

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There are no further questions at this time. I turn the call back over to the presenters.

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Keith W. Pfeil, CSS Industries, Inc. - CFO & Executive VP of Finance [29]

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I'd like to thank everyone for joining our fiscal third quarter call. If there's any additional questions, feel free to reach out to either Chris and I, and we look forward to closing on our fourth quarter. Thank you for attending.

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Operator [30]

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This concludes today's conference call. You may now disconnect.