Acme United Corp: Form 10-Q for the period ended Sep 30, 2023

Forward-Looking Information

The Company may from time to time make written or oral “forward-looking statements” including statements contained in this report and in other communications by the Company, which are made in good faith pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. Such statements are based on our beliefs as well as assumptions made by and information currently available to us. When used in this document, words like “may,” “might,” “will,” “except,” “anticipate,” “believe,” “potential,” and similar expressions are intended to identify forward-looking statements. Actual results could differ materially from our current expectations.

Forward-looking statements in this report, including without limitation, statements related to the Company’s plans, strategies, objectives, expectations, intentions and adequacy of resources, are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that such forward-looking statements involve risks and uncertainties that may impact the Company’s business, operations and financial results.

These risks and uncertainties include, without limitation, the following: (i) changes in the Company’s plans, strategies, objectives, expectations and intentions, which may be made at any time at the discretion of the Company; (ii) the impact of uncertainties in global economic conditions, including the impact on the Company’s suppliers and customers; (iii) the continuing adverse impact of inflation, including product costs, and interest rates; (iv) potential adverse effects on the Company, its customers, and suppliers resulting from the wars in Ukraine and the Middle East; (v) additional disruptions in the Company’s supply chains, whether caused by pandemics, natural disasters, or otherwise, including trucker shortages, port closures and delays, and delays with container ships themselves; (vi) labor related costs the Company has and may continue to incur, including costs of acquiring and training new employees and rising wages and benefits; (vii) currency fluctuations including, for example, the fluctuation of the dollar against the euro; (viii) the Company’s ability to effectively manage its inventory in a rapidly changing business environment; (ix) changes in client needs and consumer spending habits; (x) the impact of competition; (xi) the impact of technological changes including, specifically, the growth of online marketing and sales activity; (xii) the Company’s ability to manage its growth effectively, including its ability to successfully integrate any business it might acquire; (xiii) international trade policies and their impact on demand for our products and our competitive position, including the imposition of new tariffs or changes in existing tariff rates; and (xiv) other risks and uncertainties indicated from time to time in the Company’s filings with the Securities and Exchange Commission.

For a more detailed discussion of these and other factors affecting the Company, see the Risk Factors described in Item 1A included in the Company’s Annual Report on Form 10-K for the fiscal year December 31, 2022 and below under “Financial Condition”. All forward-looking statements in this report are based upon information available to the Company on the date of this report. The Company undertakes no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events, or otherwise, except as required by law.

Critical Accounting Policies

We discuss our critical accounting policies and estimates in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022.

Critical Accounting Estimates

There have been no material changes to the Company’s critical accounting estimates as previously reported in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022.

Results of Operations

Traditionally, the Company’s sales of its cutting, sharpening, and measuring products are stronger in the second and third quarters and weaker in the first and fourth quarters of the fiscal year, due to the seasonal nature of the back-to-school market.

Net sales

Consolidated net sales for the three months ended September 30, 2023 were $50,384,000 compared to $49,744,000 the same period in 2022, an increase of 1%. Net sales for the nine months ended September 30, 2023 were $149,559,000 compared to $149,849,000 in the same period in 2022.

Net sales in the U.S. for the three months ended September 30, 2023 increased 2% compared to the same period in 2022. The increase in sales was primarily related to higher sales of first aid and medical products partially offset by lower sales of school and office products. Net sales for the nine months ended September 30, 2023 remained constant compared to the same period in 2022. Net sales of school and office products for the nine months ended September 30, 2023 were negatively impacted by customer reduction of inventory in the first half of 2023.

Net sales in Canada for the three months ended September 30, 2023 decreased 9% (7% in local currency). The decrease in nets sales for the three months ended September 30, 2023 was due to lower sales of cutting, sharpening and measuring products. Net sales for the nine months ended September 30, 2023 decreased 2% in U.S. dollars but increased 3% in local currency, compared to the same period in 2022. The increase in net sales in local currency for the nine months ended September 30, 2023was mainly due to higher sales of first aid products.

European net sales for the three months ended September 30, 2023 increased 7% in U.S. dollars but decreased 1% in local currency compared to the same period in 2022. Net sales for the nine months ended September 30, 2023 decreased 2% in U.S. dollars (4% in local currency) compared to the same period in 2022. The declines in net sales in local currency for the three and nine months were mainly due to the economic weakness in Europe.

Gross profit

Gross profit for the three months ended September 30, 2023 was $19,503,000 (38.7% of net sales) compared to $15,925,000 (32.0% of net sales) in the same period in 2022. Gross profit for the nine months ended September 30, 2023 was $55,807,000 (37.3% of net sales) compared to $49,475,000 (32.0% of net sales) in the same period in 2022. The increases in gross profit for the three and nine months were primarily due to productivity improvements in the Company's manufacturing and distribution facilities, as well as lower in-bound freight costs.

Selling, general and administrative expenses

Selling, general and administrative ("SG&A") expenses for the three months ended September 30, 2023 were $15,846,000 (31.4% of net sales) compared with $14,972,000 (30.1% of net sales) in the same period in 2022, an increase of $874,000. SG&A expenses for the nine months ended September 30, 2023 were $44,711,000 (29.9% of net sales) compared with $43,176,000 (28.8% of net sales) in the same period in 2022, an increase of $1,535,000. The increases in SG&A expenses for the three and nine months ended September 30, 2023 were primarily related to higher personnel related expenses.

Operating income

Operating income for the three months ended September 30, 2023 was $3,657,000 compared with $953,000 in the same period of 2022. Operating income for the nine months ended September 30, 2023 was $11,096,000 compared with $6,299,000 in the same period of 2022.

Operating income in the U.S. segment increased by $2,653,000 for the three months ended September 30, 2023, compared to the same period in 2022. Operating income in the U.S. segment increased by $4,419,000 for the nine months ended September 30, 2023 compared to the same period in 2022. The increase in operating income for the three and nine months ended September 30, 2023 was primarily due to productivity improvements at our manufacturing and distribution facilities, cost savings initiatives which included lowering SG&A expenses as well as lower in-bound freight costs.

Operating income in the Canadian segment decreased by $320,000 and $219,000 for the three and nine months ended September 30, 2023, respectively, compared to the same periods in 2022. The decreases in operating income were primarily due to lower sales of cutting, sharpening and measuring products.

Operating income in the European segment increased by $371,000 and $597,000 for the three and nine months ended September 30, 2023, respectively, compared to the same periods in 2022. The increases in operating income for the three and nine months ended September 30, 2023 were primarily due to higher gross margins as a result of lower in-bound freight costs.

Interest expense, net

Interest expense, net for the three months ended September 30, 2023 was $784,000 compared with $714,000 in the same period of 2022, a $70,000 increase. Interest expense, net for the nine months ended September 30, 2023 was $2,517,000 compared with $1,443,000, in the same period of 2022, a $1,074,000 increase. The increases in interest expense for the three and nine months ended September 30, 2023 resulted from a higher average interest rate on the outstanding debt under the Company’s revolving loan agreement.

Other expense, net

Other expense, net was $55,000 in the three months ended September 30, 2023 compared to $209,000 in the same period of 2022. Other expense, net in the nine months ended September 30, 2023 was $9,000 compared to $354,000 in the same period of 2022.

Income taxes

The effective income tax rate for the nine months ended September 30, 2023 was 23% compared to 19% in the same period of 2022. The higher effective income tax rate for the nine months ended September 30, 2023 was primarily due to higher earnings in jurisdictions with higher tax rates.

Financial Condition

Liquidity and Capital Resources

During the first nine months of 2023, working capital decreased approximately $10.4 million. Inventory decreased approximately $8.8 million during this nine-month period. The decline in inventory was due to planned reductions as the risk of supply chain disruptions has diminished. Inventory turnover, calculated using a twelve-month average inventory balance, was 2.1 at September 30, 2023 compared to 2.0 at December 31, 2022. Receivables increased approximately $1.3 million at September 30, 2023 compared to December 31, 2022. The average number of days sales outstanding in accounts receivable was 57 days at September 30, 2023 compared to 62 days at December 31, 2022. Accounts payable and other current liabilities increased by approximately $3.3 million at September 30, 2023 compared to December 31, 2022.

The Company's working capital, current ratio and long-term debt to equity ratio are as follows (dollar amounts in thousands):

Long-term debt consists of (i) borrowings under the Company’s revolving loan agreement with HSBC Bank, N.A. and (ii) amounts outstanding under the fixed rate mortgage on the Company’s manufacturing and distribution facilities in Rocky Mount, NC and Vancouver, WA. The revolving loan agreement provides for borrowings of up to $65 million, at an interest rate of SOFR plus 1.75%; interest is payable monthly. The loan agreement has an expiration date of May 31, 2026. The Company must pay a facility fee, payable quarterly, in an amount equal to one eighth of one percent (.125%) per annum of the average daily unused portion of the revolving credit line. The facility is intended to provide liquidity for growth, share repurchases, dividends, acquisitions, and other business activities. Under the revolving loan agreement, the Company is required to maintain specific amounts of funded debt to EBITDA, a fixed charge coverage ratio and must have annual net income greater than $0, measured as of the end of each fiscal year.

On November 8, 2022, the revolving loan agreement was amended to increase the ratio of funded debt to EBITDA. The increase was in effect during the four quarters commencing in the third quarter of 2022 and ending with the three months ended June 30, 2023. The increase for those four quarters ranged from a low of 4.75 to 1 to a high of 5.75 to 1. The amendment also modified the interest rate from SOFR +1.75% to range from SOFR +1.60% up to a high of SOFR + 2.35% on a basis that varies quarterly with the funded debt to EBITDA ratio. As of September 30, 2023, the Company was in compliance with the covenants under the revolving loan agreement as then in effect.

During the first nine months of 2023, total debt outstanding under the Company’s revolving credit facility decreased by approximately $17 million, compared to total debt thereunder at December 31, 2022. As of September 30, 2023, $33,000,000 was outstanding and $32,000,000 was available for borrowing under the Company’s credit facility.

The Company’s manufacturing and distribution facilities in Rocky Mount, NC and Vancouver, WA were financed by a fixed rate mortgage with HSBC Bank, N.A. at a fixed interest rate of 3.8%. The Company entered into the agreement on December 1, 2021. Payments of principal and interest are due monthly, with all amounts outstanding due on maturity on December 1, 2031. At September 30, 2023, there was approximately $10.8 million outstanding on the mortgage.

In response to the supply chain challenges encountered by the Company, the Company has implemented a series of cost reduction initiatives that are expected to generate over $6.0 million in savings in 2023. These initiatives have included a wide range of productivity improvements in our manufacturing and distribution facilities as well as a reduction of SG&A expenses.

The Company believes that cash generated from operating activities, together with funds available under its revolving loan agreement, will, under current conditions, be sufficient to finance the Company’s operations over the next twelve months from the filing of this report.

(a) Evaluation of Internal Controls and Procedures

Under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of September 30, 2023. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures are effective.

(b) Changes in Internal Control over Financial Reporting

During the quarter ended September 30, 2023, there were no changes in our internal control over financial reporting that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

See Risk Factors set forth in Part I, Item 1A of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2022.