ACME United Corporation — 2017 Q3 Form 10-Q Summary
Business Context and Reporting Period
Unaudited quarterly report for the three and nine months ended September 30, 2017. ACME United sells cutting devices, measuring instruments and safety products through its United States, Canada and Europe segments. The business is seasonal, with stronger sales generally in the second and third quarters because of back-to-school demand. The company acquired the assets of Spill Magic, Inc. on February 1, 2017 for $7.2 million.
Financial Performance and Position
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Net sales | $33.785 million | $31.913 million | $100.380 million | $98.198 million |
| Gross profit | $12.226 million | $11.863 million | $37.273 million | $35.743 million |
| Gross margin | 36.2% | 37.2% | 37.1% | 36.4% |
| Operating income | $1.949 million | $2.140 million | $7.030 million | $7.735 million |
| Operating margin | 5.8% | 6.7% | 7.0% | 7.9% |
| Net income | $1.202 million | $1.473 million | $4.707 million | $5.305 million |
| Diluted EPS | $0.32 | $0.40 | $1.25 | $1.49 |
Interest expense increased to $365,000 in Q3 and $949,000 for the first nine months, versus $247,000 and $642,000, respectively, primarily because of higher borrowings and interest rates. The effective tax rate was 23% for both Q3 and the nine-month period. The nine-month rate benefited by approximately $350,000 from excess tax benefits related to stock compensation; excluding that benefit, management stated the effective rate would have been approximately 29%.
Nine-month operating cash flow was negative $1.196 million, compared with $1.585 million of cash provided in the prior-year period. The principal use was a $10.866 million increase in accounts receivable, reflecting seasonal sales. Investing cash outflows were $9.634 million, including $7.233 million for the Spill Magic acquisition and $2.401 million for property, plant and equipment. Financing activities provided $11.885 million, primarily through $13.033 million of net debt borrowings.
At September 30, 2017, cash was $7.021 million, current assets were $77.847 million and current liabilities were $13.983 million. Working capital was $63.864 million and the current ratio was 5.57. Revolving-credit borrowings were $45.969 million, compared with $32.936 million at December 31, 2016. The company reported $4.031 million of borrowing availability after the facility limit reverted from $55 million to $50 million on October 1, 2017. The facility bears interest at LIBOR plus 2.0%, matures May 6, 2019, and the company was in compliance with its covenants at September 30.
Material Changes Versus the Prior Comparable Period
- Q3 sales increased 6%; nine-month sales increased 2%.
- Sales growth included $1.9 million of Spill Magic revenue in Q3 and $4.9 million for the first nine months.
- Gross margin declined in Q3 because of increased online promotional, advertising, warehouse and distribution costs, although the nine-month gross margin improved.
- SG&A increased $554,000 in Q3 and $2.235 million for nine months, driven by Spill Magic-related costs, personnel expenses, recruiting and variable selling costs.
- Operating income declined 9% in Q3 and 9% for nine months; net income declined 18% in Q3 and 11% for nine months.
- European sales increased 13% in Q3 and 17% for nine months, while Canadian sales increased 5% in Q3 but decreased 1% for nine months, measured in U.S. dollars.
- Direct-import sales fell to approximately 10% of Q3 sales and 12% of nine-month sales, from 15% and 19%, respectively, in the prior-year periods.
Guidance, Outlook, Risks and Unusual Items
No quantitative earnings or revenue guidance was provided. Management expects cash generated from operations, together with available revolving-credit capacity, to fund planned operations for the twelve months following the filing under current conditions.
Management highlighted rapid online-sales growth and related investments in advertising, warehouse operations, employee training, software and facility redesign. Distribution costs have increased faster than sales. Key disclosed risks include economic conditions, consumer spending, competition and technological change, loss of major customers, integration of acquisitions, currency fluctuations and rising interest rates.
On October 26, 2017, after quarter-end, the company exercised an option to purchase its First Aid Only manufacturing and distribution center in Vancouver, Washington for $4 million. The purchase was financed with a variable-rate mortgage based on 30-day LIBOR plus 2.5%.
The company reported no pending material legal proceedings. Environmental remediation at the former Fremont, North Carolina facility was substantially completed, with $48,000 remaining accrued for monitoring expected to continue through 2020. The company was not required to contribute to its qualified pension plan in 2017 and did not anticipate contributions during the remainder of the year.
Investor Verification Checklist
- Verify whether Spill Magic revenue and profitability meet expectations and whether the preliminary $5.8 million intangible-asset valuation changes when purchase accounting is finalized.
- Monitor accounts receivable, seasonal working-capital requirements and the conversion of earnings into operating cash flow.
- Assess debt repayment capacity, borrowing availability after the facility reduction to $50 million, covenant headroom and exposure to LIBOR-based rates.
- Determine whether online-sales investments and higher distribution costs improve or continue to pressure gross and operating margins.
- Separate recurring tax performance from the approximately $350,000 one-time or adoption-related excess tax benefit recognized in the nine-month period.
- Evaluate the financial impact of the $4 million Vancouver property purchase and its variable-rate mortgage.
- Review the company’s 2016 Form 10-K risk factors and subsequent filings for changes in customer concentration, acquisition integration, currency and litigation exposure.