Acme United Corporation — Form 10-Q Summary
Business context and reporting period
This unaudited Form 10-Q covers the three and nine months ended September 30, 2018, filed November 9, 2018. Acme United sells cutting and sharpening products and first aid and safety products through its United States, Canada, and Europe segments. Sales are seasonally stronger in the second and third quarters because of the back-to-school market.
The company adopted ASC 606, Revenue from Contracts with Customers, on January 1, 2018 using the modified retrospective method. Management reported no material impact on the financial statements.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | Change |
|---|---|---|---|
| Net sales | $34.731 million | $33.785 million | +3% |
| Gross profit | $12.450 million | $12.226 million | +2% |
| Gross margin | 35.8% | 36.2% | Down 40 basis points |
| Operating income | $1.373 million | $1.970 million | Down 30% |
| Net income | $0.807 million | $1.202 million | Down 33% |
| Diluted EPS | $0.23 | $0.32 | Down $0.09 |
| Metric | Nine months 2018 | Nine months 2017 | Change |
|---|---|---|---|
| Net sales | $106.191 million | $100.380 million | +6% |
| Gross profit | $39.286 million | $37.273 million | +5% |
| Gross margin | 37.0% | 37.1% | Down 10 basis points |
| Operating income | $6.363 million | $7.095 million | Down 10% |
| Net income | $4.007 million | $4.707 million | Down 15% |
| Diluted EPS | $1.12 | $1.25 | Down $0.13 |
Q3 sales increased in the United States, Canada, and Europe. U.S. first aid and safety sales rose 7%, while Westcott school and office sales declined 6% because of excess office-scissor inventory at a large online retailer and store closings. Nine-month growth was primarily attributed to market-share gains in first aid and safety products.
SG&A expense increased to $11.077 million in Q3 from $10.256 million and to $32.923 million for the nine months from $30.178 million. The increases primarily reflected added sales and marketing personnel, recruiting and compensation costs, and higher freight and commissions.
Interest expense increased to $496,000 in Q3 and $1.346 million for the nine months, compared with $365,000 and $949,000, respectively, in the prior-year periods. The increase reflected higher average borrowing rates and interest on the Vancouver, Washington mortgage. Effective tax rates were 5% for Q3 and 19% for the nine months, compared with 23% for both comparable 2017 periods, primarily because of the Tax Cuts and Jobs Act and excess tax benefits from stock-option exercises.
At September 30, 2018, cash and cash equivalents were $4.021 million, compared with $9.338 million at December 31, 2017. Accounts receivable were $30.869 million, inventories were $41.274 million, and total current assets were $78.434 million. Working capital was $67.096 million and the current ratio was 6.92.
Operating cash flow was negative $4.496 million for the first nine months, compared with negative $1.196 million in 2017. Cash usage reflected increases in accounts receivable, inventory, and reductions in accounts payable and accrued liabilities. Capital expenditures were $2.252 million.
Revolving-credit borrowings were $47.028 million, leaving $2.972 million available under the $50 million facility. Long-term debt to equity was 96.3%. The company also had $3.511 million of mortgage debt, net of the current portion. The revolving facility was amended in May 2018 to reduce pricing to LIBOR plus 1.75% and extend maturity to May 24, 2023. The company was in compliance with its debt covenants at September 30, 2018.
Material changes versus the prior comparable period
- Sales grew, but operating income and net income declined because SG&A costs increased faster than revenue.
- Gross margin decreased modestly, while SG&A increased from 30.4% to 31.9% of Q3 sales and from 30.1% to 31.0% of nine-month sales.
- Interest expense increased materially because of higher variable borrowing rates and the Vancouver property mortgage.
- Operating cash flow deteriorated, and cash declined by $5.317 million during the first nine months.
- Borrowings increased by approximately $3.6 million from year-end 2017, primarily to fund seasonal working-capital needs.
- Direct-import sales represented approximately 12% of Q3 sales and 11% of nine-month sales, compared with 10% and 12%, respectively, in 2017.
Guidance, outlook, risks, contingencies, and unusual items
Management began expense-reduction actions in Q3 that are expected to produce approximately $1.5 million of annual savings: approximately $700,000 from personnel, $400,000 from print advertising, and $400,000 from productivity initiatives. The filing does not provide formal revenue or earnings guidance.
The company expects operating cash generation and available revolving-credit capacity to fund planned operations for the twelve months following the filing under current conditions. However, only $2.972 million remained available under the revolving facility at September 30, 2018.
A September 2018 U.S. tariff round imposed a 10% tariff, scheduled to increase to 25% in 2019, on products affecting approximately 10% of the company’s purchases. Management implemented price increases, but additional tariffs could increase costs, reduce demand, require alternative sourcing, and adversely affect results.
Other identified risks include global economic conditions, customer and consumer spending, competition, execution of growth and acquisitions, foreign-currency fluctuations, rising interest rates, tax-law uncertainty, and international trade policies. The filing reports no pending material legal proceedings and no material changes to internal control over financial reporting.
Important facts for investors to verify
- Whether the planned $1.5 million of annual cost savings are realized and sufficiently offset the prior SG&A increase.
- The effect of tariffs, subsequent tariff increases, pricing actions, and possible sourcing changes on gross margin and demand.
- Borrowing levels, interest rates, remaining credit availability, covenant compliance, and liquidity as seasonal working-capital needs continue.
- Whether the decline in Westcott school and office sales reflects temporary retailer inventory issues or a broader demand problem.
- The sustainability of operating cash flow, particularly the conversion of earnings after receivables and inventory requirements.
- The impact of foreign exchange, variable-rate debt, and the Vancouver mortgage on future interest and other expense.