Acme United Corp: Form 10-Q for the period ended Sep 30, 2022

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, including those risks and uncertainties resulting from the global COVID-19 pandemic, future waves of COVID-19, including through the Delta and Omicron variants and any new variant strains of the underlying virus; any future pandemics; the continuing effectiveness, global availability, and public acceptance of existing vaccines; the effectiveness, availability, and public acceptance of vaccines against variant strains of potential new viruses; and the heightened impact the pandemic has on many of the risks described herein, including, without limitation, risks relating to disruptions in our domestic and global supply chains, and labor shortages, any of which could materially adversely impact the Company’s ability to manufacture, source or distribute its products, both domestically and internationally.

These risks and uncertainties further 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, whether caused by COVID-19 or otherwise, including the impact on the Company’s suppliers and customers; (iii) additional disruptions in the Company’s supply chains, whether caused by COVID-19, the war in Ukraine, or otherwise, including trucker shortages, port closures and delays, and delays with container ships themselves; (iv) labor shortages and related costs the Company has and may continue to incur, including costs of acquiring and training new employees and rising wages and benefits; (v) the continuing adverse impact of inflation, including product costs, and transportation costs; (vi) currency fluctuations including, for example, the increasing strength of the dollar against the euro: the Company’s ability to effectively manage its inventory in a rapidly changing business environment, including the additional inventory the Company has acquired in anticipation of supply chain disruptions and uncertainties; (vii) changes in client needs and consumer spending habits; (viii) the impact of competition; (ix) the impact of technological changes including, specifically, the growth of online marketing and sales activity; (x) the Company’s ability to manage its growth effectively, including its ability to successfully integrate any business it might acquire; (xi) 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 (xiii) 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, 2021 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, 2021.

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, 2021.

Macroeconomic, Supply Chain and Related Considerations

The global macroeconomic environment has continued to be challenging in 2022, characterized by global inflation at multi-decade highs, rising interest rates, and significant currency fluctuations. These factors have exacerbated an economy that was struggling to recover from the COVID-19 pandemic.

During the nine months ended September 30, 2022, the Company experienced significant supply chain issues. In anticipation of potential supply chain disruptions, the Company had purchased and maintained additional inventory to minimize the impact of any disruption in our supply chain. However, as economies have become less restricted by the COVID pandemic, global supply chains have struggled to keep up with increasing demand, and the resulting supply chain disruptions have significantly increased costs. The supply chain issues caused exceptional ocean and inland freight and demurrage costs. The freight and demurrage costs began to decrease in the third quarter of 2022 and we anticipate that they will continue to decrease in the fourth quarter of 2022, while still remaining above historical levels. We recognize those expenses as products are sold and, as a result, the unusually high freight and demurrage costs continued to adversely impact our results for the quarter ended September 30, 2022 and had an overall adverse effect on our operating margin in the first nine months of 2022.

In addition, the war in Ukraine is causing a slowdown in the European economy. This softness, coupled with a historically low exchange rate for the Euro, has led to challenges in our European markets which we anticipate will continue for at least the near future.

Any continuation of supply chain issues, continued high inflation, currency fluctuations, high interest rates, and any further increase in the duration or severity of the COVID-19 pandemic or a resurgence of the pandemic might continue to adversely affect the Company’s business, operations and financial condition. The impact of these developments is highly uncertain and cannot be predicted.

Results of Operations

Traditionally, the Company’s sales 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, 2022 were $49,744,000 compared with $47,923,000 in the same period in 2021, a 4% increase. Consolidated net sales for nine months ended September 30, 2022 were $149,849,000 compared with $136,295,000 in the same period in 2021, a 13% increase.

Sales in the U.S. for the three and nine months ended September 30, 2022 increased 4% and 12%, respectively, compared to the same periods in 2021. As a precaution against supply chain delays, customers accelerated purchases into the second quarter of 2022 from the third quarter of 2022. This reduced sales in the third quarter of 2022. The increase in sales for the nine months was primarily attributable to increased sales of first aid and medical products and Westcott school and office products.

Net sales in Canada for the three and nine months ended September 30, 2022 increased 1% (3% in local currency) and 2% (5% in local currency), respectively, compared to the same periods last year. The growth in the three and nine months ended September 30, 2022 was mainly due to higher sales of first aid products.

European net sales for the three months ended September 30, 2022 decreased 3% in U.S. dollars but increased 13% in local currency compared to the same period in 2021. Net sales for the nine months ended September 30, 2022 decreased 3% in U.S. dollars but increased 9% in local currency compared to the same period in 2021. The increase in net sales for the three and nine months was mainly due to market share gains in the office channel.

Gross profit

Gross profit for the three months ended September 30, 2022 was $15,925,000 (32.0% of net sales) compared to $17,005,000 (35.5% of net sales) in the same period in 2021. Gross profit for the nine months ended September 30, 2022 was $49,475,000 (33.0% of net sales) compared to $48,745,000 (35.8% of net sales) for the same period in 2021. The decline in the gross margin for the three and nine months ended September 30, 2022 was primarily due to exceptionally high ocean container costs and demurrage charges. The impact on gross margins due to the aforementioned supply chain expense were 2.3% and 1.5% for the three and nine months ended September 30, 2022. Also contributing to the decline in gross profit were weaker currencies in Europe and Canada, where we purchase most of our inventory in U.S. dollars.

Selling, general and administrative expenses

Selling, general and administrative ("SG&A") expenses for the three months ended September 30, 2022 were $14,972,000 (30.1% of net sales) compared with $14,044,000 (29.3% of net sales) in the same period in 2021, an increase of $928,000. SG&A expenses for the nine months ended September 30, 2022 were $43,176,000 (28.8% of net sales) compared with $39,028,000 (28.6% of net sales) for the same periods of 2021, an increase of $4,148,000. The increases in SG&A expenses for three and nine months ended September 30, 2022, compared to the same period in 2021 were primarily due to higher personnel related costs and increased commissions and shipping costs related to higher sales. The increased shipping costs included fuel surcharges due to higher gas prices earlier in the year. Also, the Company incurred incremental expenses related to the acquisition and integration of the Safety Made assets.

Operating income

Operating income for the three months ended September 30, 2022 was $953,000 compared with $2,961,000 in the same period of 2021. Operating income for the nine months ended September 30, 2022 was $6,299,000 compared with $9,717,000 in the same period of 2021.

Operating income in the U.S. segment decreased by $1,658,000 and $2,198,000 for the three and nine months ended September 30, 2022, respectively, compared to the same periods in 2021. The decline in operating income for the three and nine months ended September 30, 2022 was primarily due to increased supply chain costs which include exceptionally high ocean container costs and demurrage charges. $2.4 million of exceptional supply chain costs were recognized through September 30, 2022, of which $.9 million was recorded in the three months ended September 30, 2022.

Operating income in the Canadian segment decreased by $64,000 and $238,000 for the three and nine months ended September 30, 2022, respectively, compared to the same periods in 2021.

Operating income in the European segment decreased by $286,000 and $981,000 for the three and nine months ended September 30, 2022, respectively, compared to the same period in 2021. The decline in operating income for the three and nine months ended September 30, 2022 was primarily due to increased supply chain costs as well as weaker currency in Europe where we purchase most of our inventory in U.S. dollars. $0.6 million of exceptional supply chain costs were recognized through September 30, 2022, of which $0.2 million was recorded in the three months ended September 30, 2022.

Interest expense, net

Interest expense, net for the three months ended September 30, 2022 was $714,000 compared with $228,000 in the same period of 2021, a $486,000 increase. Interest expense, net for the nine months ended September 30, 2022 was $1,443,000 compared with $671,000 for the same period of 2021, a $772,000 increase. The increases in interest expense resulted from a higher average interest rate on the outstanding debt as well as higher average debt outstanding under the Company’s revolving loan agreement.

Total other expense (income), net

Total other expense, net was $209,000 in the three months ended September 30, 2022 compared to $68,000 in the same period of 2021. Total other expense, net was $354,000 in the nine months ended September 30, 2022 compared to total other expense, net of $213,000 (excluding income of $3,508,000 from PPP loan forgiveness) in the same period of 2021. The increase in total other expense, net in the three and nine months ended September 30, 2022, was due to losses from foreign currency transactions, primarily due to a declining Euro in our European business.

Income taxes

The effective income tax rate for the nine months ended September 30, 2022 was 19%. Income tax expense for the three and nine months ended September 30, 2021 included a $0.9 million tax credit for stock based compensation. The Company’s effective tax rates for the three and nine months ended September 30, 2021, excluding the tax credit and the income from the PPP loan forgiveness, were 19% and 21%.

Financial Condition

Liquidity and Capital Resources

During the first nine months of 2022, working capital increased approximately $15.2 million compared to December 31, 2021. Inventory increased approximately $12.6 million at September 30, 2022 compared to December 31, 2021. We increased inventory during that period to anticipate our continued growth and to be positioned to offset the impact of potential supply chain disruptions related to COVID-19. The increase also reflects higher product costs. Inventory turnover, calculated using a twelve-month average inventory balance, was 2.1 at September 30, 2022 compared to 2.3 at December 31, 2021. Receivables increased by approximately $5.9 million at September 30, 2022 compared to December 31, 2021. The average number of days sales outstanding in accounts receivable was 62 days at September 30, 2022 compared to 60 days at December 31, 2021. Accounts payable and other current liabilities increased by approximately $4.2 million at September 30, 2022 compared to December 31, 2021. The increase in accounts payable is primarily related to the increase in inventory.

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

19

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 related on the Company’s manufacturing and distribution facilities in Rocky Mount, NC and Vancouver, WA. On May 31, 2022, the Company amended its revolving loan agreement with HSBC Bank, N.A. The amended agreement increases the amount available for borrowing to $65 million from $50 million, at an interest rate of SOFR plus 1.75%; interest is payable monthly. In addition, the expiration date of the revolving loan agreement was extended to May 31, 2026. The Company must pay a facility fee, payable quarterly, in an amount equal to one eight 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 amendment is in effect for four quarters commencing in third quarter of 2022 and includes an increase in the funded debt to EBITDA ratio for the four quarters ranging from a low of 4.75 to 1 to a high of 5.75 to 1. The amendment also increases the interest rate from SOFR +1.75% up to a high of SOFR + 2.35% on a basis that varies on a quarterly basis with the leverage ratio. The increase in the ratio brought the Company into compliance with the covenant as of September 30, 2022, and going forward, provides the Company with the flexibility it needs to conduct its business in light of current and anticipated economic conditions. As of September 30, 2022, the Company was in compliance with the covenants under the revolving loan agreement, as amended.

During the first nine months of 2022, total debt outstanding under the Company’s revolving credit facility increased by approximately $24.1 million, compared to total debt thereunder at December 31, 2021. As of September 30, 2022, $57,131,000 was outstanding and $7,869,000 was available for borrowing under the Company’s credit facility. The increase in debt outstanding was primarily related to the acquisition of Safety Made and the increase in inventory.

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, 2022, there was approximately $11.2 million outstanding on the mortgage.

On June 1, 2022, the Company purchased the assets of Live Safely Products, LLC (d/b/a “Safety Made”) for approximately $11 million, including $1.5 million which is contingent upon meeting certain financial targets over a two-year period. Based in Keene, NH, Safety Made is a leading manufacturer of first aid kits for the promotional products industry.

In response to the challenges encountered by the Company commencing with the COVID-19 pandemic, the Company has implemented a series of cost reduction initiatives that are expected to generate over $5.0 million in savings in 2023. These initiatives have included a reduction of SG&A expenses and other costs and the implementation of a wide range of productivity improvements in our manufacturing and distribution facilities.

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, 2022. 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, 2022, 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, 2021.