Hamilton Beach Brands Holding Co: Form 10-Q for the period ended Sep 30, 2023

(Dollars in thousands, except as noted and per share data)

Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based upon management’s current expectations and are subject to various uncertainties and changes in circumstances. Important factors that could cause actual results to differ materially from those described in these forward-looking statements are set forth below under the heading “Forward-Looking Statements.”

HBB is the Company’s single reportable segment and intercompany balances and transactions have been eliminated.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

For a summary of the Company’s critical accounting policies, refer to “Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies and Estimates” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022, as there have been no material changes from those disclosed in the Annual Report.

RESULTS OF OPERATIONS

The Company’s business is seasonal, and a majority of revenue and operating profit typically occurs in the second half of the year when sales of small electric appliances and kitchenware historically increase significantly for the fall holiday-selling season.

Third Quarter of 2023 Compared with Third Quarter of 2022

Effective income tax rate 21.6 % 22.8 %

The following table identifies the components of the change in revenue:

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Revenue - Revenue increased $2.8 million, or 1.9% compared to the prior year, primarily due to increased unit volume partially offset by lower average sales price. Sales increased in the Latin American and Mexican Consumer markets, while sales decreased in the U.S. and Canadian Consumer markets. The Global Commercial market had decreased sales as demand normalized compared to the third quarter of 2022, when revenue grew 35.8% due to strong post-pandemic demand in the food service and hospitality industries.

Gross profit - As a percentage of revenue, gross profit margin increased from 23.1% in the prior year to 26.1% in the current year as lower average sales price was offset by lower product costs and lower distribution and warehousing costs.

Selling, general and administrative expenses - Selling, general and administrative expenses were flat compared to the third quarter of 2022. An increase in personnel-related expenses was offset by a non-recurring insurance recovery.

Interest expense - Interest expense, net decreased $0.7 million due to a significant decrease in average debt compared to September 30, 2022, partially offset by higher interest rates compared to the prior year.

Other expense (income), net - Other expense (income), net was flat compared to 2022 and includes currency losses of $0.4 million in the current year.

Income tax expense (benefit) - The effective tax rate on income was 21.6% and 22.8% for three months ended September 30, 2023 and 2022, respectively. The effective tax rate was lower in the three months ended September 30, 2023 due to a discrete benefit on foreign income in the current year.

First Nine Months of 2023 Compared with First Nine Months of 2022

Effective income tax rate 19.7 % 21.0 %

The following table identifies the components of the change in revenue:

Revenue - Revenue decreased by $25.7 million or 5.8% over the prior year due to a combination of lower average selling price and lower sales volume in the U.S., Canadian, and Latin American Consumer markets and the Global Commercial market. The decrease in volume is related to softer consumer demand and inventory rebalancing by many retailers. Partially offsetting these revenue decreases was an increase in the Mexican Consumer market.

Gross profit - Gross profit margin decreased to 21.1% from 21.4% due to a decrease in average sales price almost entirely offset by lower product costs and lower distribution and warehousing costs.

Selling, general and administrative expenses - Selling, general and administrative expenses increased $10.8 million due primarily to the $10.0 million insurance recovery recognized during the first quarter of 2022 which did not recur. Additionally, there was an increase in employee-related costs in the current year that was partially offset by a decrease in outside services.

Interest expense - Interest expense, net decreased $0.3 million due to decreased average borrowings outstanding under the HBB Facility, partially offset by higher interest rates.

Other expense (income), net - Other expense (income), net includes currency gains of $0.1 million in the current year compared to currency losses of $2.2 million in the prior year. The net change is driven by the liquidation of the Company’s Brazilian subsidiary, which resulted in $2.1 million of accumulated other comprehensive losses being released into other expense (income), net during the first quarter of 2022. The decrease in other expense (income), net was offset by lower pension income during the nine months ended September 30, 2023.

Income tax expense (benefit) - The effective tax rate was 19.7% compared to 21.0% in the prior year. The effective tax rate was lower for the nine months ended September 30, 2023 due to increased tax benefits from foreign income and credits in the current year. The prior year rate was driven by the reversal of interest and penalties on unrecognized tax benefits partially offset by a valuation allowance on certain foreign deferred tax assets related to the Company’s decision to wind down the Brazilian subsidiary which qualified for substantial liquidation in 2022, which did not recur.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity

HBBHC cash flows are provided by dividends paid or distributions made by HBB. The only material assets held by it are the investments in HBB. As a result, certain statutory limitations or regulatory or financing agreements could affect the levels of distributions allowed to be made by HBB. HBBHC has not guaranteed any of the obligations of HBB.

HBB’s principal sources of cash to fund liquidity needs are: (1) cash generated from operations and (2) borrowings available under the HBB Facility. HBB’s primary use of funds consists of working capital requirements, operating expenses, payment of dividends, repurchase of shares, capital expenditures and payments of principal and interest on debt.

The HBB Facility expires on June 30, 2025. HBB believes funds available from cash on hand, the HBB Facility and operating cash flows will provide sufficient liquidity to meet its operating needs and commitments arising during the next twelve months.

The following table presents selected cash flow information:

Operating activities - Net cash provided by operating activities was $68.7 million compared to cash used for operating activities of $40.2 million in the prior year primarily due to the Company’s focus on net working capital improvement. Net working capital provided cash of $64.3 million in 2023 compared to a use of cash of $62.1 million in 2022. Net cash provided by accounts payable was $54.0 million in 2023 compared to $20.2 million used in 2022. Net cash used for inventory was $3.4 million in 2023 compared to $63.3 million used in 2022. This net change was driven by slowed inventory purchases during the fourth quarter of 2022, as the Company effectively managed elevated inventory levels during the second half of 2022. Trade receivables provided net cash of $13.7 million during 2023 compared to $21.4 million provided in the prior year due to timing of collections.

Investing activities - Net cash used for investing activities in 2023 increased compared to 2022 related primarily to internal-use software development costs.

Financing activities - Net cash used for financing activities was $65.7 million in 2023 compared to net cash provided by financing activities of $42.3 million in 2022. The change is due to a decrease in HBB’s net borrowing activity on the HBB Facility to fund net working capital.

Capital Resources

The Company expects to continue to borrow against the HBB Facility and make voluntary repayments within the next twelve months. The obligations under the HBB Facility are secured by substantially all of HBB’s assets. As of September 30, 2023, the borrowing base under the HBB Facility was $148.2 million and borrowings outstanding were $51.3 million. As of September 30, 2023, the excess availability under the HBB Facility was $96.9 million.

The maximum availability under the HBB Facility is governed by a borrowing base derived from advance rates against eligible trade receivables, inventory and trademarks of the borrowers, as defined in the HBB Facility. Borrowings bear interest at a floating rate, which can be a base rate, SOFR or bankers’ acceptance rate, as defined in the HBB Facility, plus an applicable margin. The applicable margins, effective September 30, 2023, for base rate loans and SOFR loans denominated in U.S. dollars were 0.0% and 1.55%, respectively. The applicable margins, effective September 30, 2023, for base rate loans and bankers’ acceptance loans denominated in Canadian dollars were 0.0% and 1.55%, respectively. The HBB Facility also requires a fee of 0.25% per annum on the unused commitment. The margins and unused commitment fee under the HBB Facility are subject to quarterly adjustment based on average excess availability. The weighted average interest rate applicable to the HBB Facility for the nine months ended September 30, 2023 was 4.49% including the floating rate margin and the effect of the interest rate swap agreements described below.

To reduce the exposure to changes in the market rate of interest, HBB has entered into interest rate swap agreements for a portion of the HBB Facility. Terms of the interest rate swap agreements require HBB to receive a variable interest rate and pay a fixed interest rate. HBB has interest rate swaps with notional values totaling $50.0 million as of September 30, 2023 at an average fixed interest rate of 1.47%. HBB also entered into delayed-start interest rate swaps. These swaps have notional values totaling $25.0 million as of September 30, 2023, with an average fixed interest rate of 1.78%.

The HBB Facility includes restrictive covenants, which, among other things, limit the payment of dividends, subject to achieving availability thresholds. Dividends are not to exceed $7.0 million during any calendar year to the extent that for the thirty days prior to the dividend payment date, and after giving effect to the dividend payment, HBB maintains excess availability of at least $18.0 million. Dividend amounts are discretionary to the extent that for the thirty days prior to the dividend payment date, and after giving effect to the dividend payment, HBB maintains excess availability of at least $30.0 million. The HBB Facility also requires HBB to achieve a minimum fixed charge coverage ratio in certain circumstances, as defined in the HBB Facility. As of September 30, 2023, HBB was in compliance with all financial covenants in the HBB Facility.

In December 2015, the Company entered into an arrangement with a financial institution to sell certain U.S. trade receivables on a non-recourse basis. See Note 2 of the unaudited consolidated financial statements.

Contractual Obligations, Contingent Liabilities and Commitments

For a summary of the Company’s contractual obligations, contingent liabilities and commitments, refer to “Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Contractual Obligations, Contingent Liabilities and Commitments” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022, as there have been no material changes from those disclosed in the Annual Report.

Off Balance Sheet Arrangements

For a summary of the Company’s off balance sheet arrangements, refer to “Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Off Balance Sheet Arrangements” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022, as there have been no material changes from those disclosed in the Annual Report.

FORWARD-LOOKING STATEMENTS

The statements contained in this Form 10-Q that are not historical facts are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements are made subject to certain risks and uncertainties, which could cause actual results to differ materially from those presented. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Company undertakes no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date hereof. Such risks and uncertainties include, without limitation: (1) the Company’s ability to source and ship products to meet anticipated demand; (2) the Company’s ability to successfully manage constraints throughout the global transportation supply chain; (3) uncertain or unfavorable global economic conditions; (4) changes in the sales prices, product mix or levels of consumer purchases of small electric and specialty housewares appliances; (5) changes in consumer retail and credit markets, including the increasing volume of transactions made through third-party internet sellers; (6) bankruptcy of or loss of major retail customers or suppliers; (7) changes in costs, including transportation costs, of sourced products; (8) delays in delivery of sourced products; (9) changes in or unavailability of quality or cost effective suppliers; (10) exchange rate fluctuations, changes in the import tariffs and monetary policies and other changes in the regulatory climate in the countries in which the Company operates or buys and/or sells products; (11) the impact of tariffs on customer purchasing patterns; (12) product liability, regulatory actions or other litigation, warranty claims or returns of products; (13) customer acceptance of, changes in costs of or delays in the development of new products; (14) increased competition, including consolidation within the industry; (15) shifts in consumer shopping patterns, gasoline prices, weather conditions, the level of consumer confidence and disposable income as a result of economic conditions, unemployment rates or other events or conditions that may adversely affect the level of customer purchases of HBB products; (16) changes mandated by federal, state and other regulation, including tax, health, safety or environmental legislation; and (17) other risk factors, including those described in the Company’s filings with the Securities and Exchange Commission, including, but not limited to, the Annual Report on Form 10-K for the year ended December 31, 2022. Furthermore, the future impact of unfavorable economic conditions, including inflation, rising interest rates, availability of capital markets and consumer spending rates remains uncertain. In uncertain economic environments, the Company cannot predict whether or when such circumstances may improve or worsen, or what impact, if any, such circumstances could have on its business, results of operations, cash flows and financial position.

INTEREST RATE RISK

HBB enters into certain financing arrangements that require interest payments based on floating interest rates. As such, the Company’s financial results are subject to changes in the market rate of interest. There is an inherent rollover risk for borrowings as they mature and are renewed at current market rates. The extent of this risk is not quantifiable or predictable because of the variability of future interest rates and business financing requirements. To reduce the exposure to changes in the market rate of interest, HBB has entered into interest rate swap agreements for a portion of its floating rate financing arrangements. The Company does not enter into interest rate swap agreements for trading purposes. Terms of the interest rate swap agreements require HBB to receive a variable interest rate and pay a fixed interest rate.

For the purpose of risk analysis, the Company uses sensitivity analysis to measure the potential loss in fair value of financial instruments sensitive to changes in interest rates. The Company assumes that a loss in fair value is an increase in its receivables. The fair value of the Company’s interest rate swap agreements was an asset of $5.9 million as of September 30, 2023. A hypothetical 10% relative decrease in interest rates would cause a decrease of $0.2 million in the fair value of interest rate swap agreements. Additionally, a hypothetical 10% relative increase in interest rates would cause an increase of $0.2 million in the fair value of interest rate swap agreements. Neither would have a material impact to the Company’s interest expense, net of $2.6 million for the nine months ended September 30, 2023.

FOREIGN CURRENCY EXCHANGE RATE RISK

HBB operates internationally through its foreign operating subsidiaries and enters into transactions denominated in foreign currencies, principally the Canadian dollar, the Mexican peso and, to a lesser extent, the Chinese yuan and Brazilian real. As such, HBB’s financial results are subject to the variability that arises from exchange rate movements. The fluctuation in the value of the U.S. dollar against other currencies affects the reported amounts of revenues, expenses, assets and liabilities. The potential impact of currency fluctuation increases as international expansion increases.

HBB uses forward foreign currency exchange contracts to partially reduce risks related to transactions denominated in foreign currencies and not for trading purposes. These contracts generally mature within twelve months and require HBB to buy or sell the functional currency in which the applicable subsidiary operates and buy or sell U.S. dollars at rates agreed to at the inception of the contracts.

For the purpose of risk analysis, the Company uses sensitivity analysis to measure the potential loss in fair value of financial instruments sensitive to changes in foreign currency exchange spot rates. The Company assumes that a loss in fair value is either a decrease to its assets or an increase to its liabilities. The fair value of the Company’s foreign currency exchange contracts was a net payable of $0.2 million as of September 30, 2023. Assuming a hypothetical 10% weakening of the U.S. dollar as of September 30, 2023, the fair value of foreign currency-sensitive financial instruments, which represents forward foreign currency exchange contracts, would be decreased by $2.0 million compared with its fair value as of September 30, 2023.

Evaluation of Disclosure Controls and Procedures

Company management, with the participation of the Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures as of September 30, 2023. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2023.

Changes in Internal Control Over Financial Reporting

There were no changes in the Company’s internal control over financial reporting identified during the quarter ended September 30, 2023, in connection with the evaluation by the Company’s management required by paragraph (d) of Rules 13a-15 and 15d-15 under the Exchange Act, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II

OTHER INFORMATION

There are no material changes to the risk factors for the Company from those disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022.