Business Context and Reporting Period
Acme United Corporation filed an unaudited Form 10-Q for the quarter and nine months ended September 30, 2022. The company sells first aid and medical products, cutting, sharpening and measuring products through its United States, Canada and Europe segments. Results are seasonal, with stronger sales generally in the second and third quarters due to back-to-school demand.
Financial Highlights
| Metric | Q3 2022 | Q3 2021 | 9M 2022 | 9M 2021 |
|---|---|---|---|---|
| Net sales | $49.7 million | $47.9 million | $149.8 million | $136.3 million |
| Gross profit | $15.9 million | $17.0 million | $49.5 million | $48.7 million |
| Gross margin | 32.0% | 35.5% | 33.0% | 35.8% |
| Operating income | $1.0 million | $3.0 million | $6.3 million | $9.7 million |
| Net income | $0.1 million | $2.0 million | $3.6 million | $11.3 million |
| Diluted EPS | $0.02 | $0.50 | $0.96 | $2.85 |
- Q3 sales increased 4%; nine-month sales increased 13%, primarily from higher first aid and medical sales and Westcott school and office products.
- SG&A expense increased to $15.0 million in Q3 and $43.2 million for nine months, reflecting higher personnel, commissions, shipping and Safety Made integration costs.
- Net interest expense increased to $0.7 million in Q3 and $1.4 million for nine months because of higher debt balances and interest rates.
- Operating cash flow was a use of $7.6 million for the first nine months of 2022, compared with $3.0 million provided in the prior-year period. The principal working-capital uses were inventory and receivables.
- Capital expenditures were $3.3 million, intellectual-property purchases were $0.3 million, and the Safety Made acquisition used $9.6 million of cash.
- Cash, cash equivalents and restricted cash totaled $5.7 million at September 30, 2022, including $1.5 million held in escrow for contingent acquisition consideration.
- Working capital was $90.1 million and the current ratio was 4.69 at September 30, 2022.
Debt, Liquidity and Capital Structure
- Revolving credit borrowings were $57.1 million at September 30, 2022, compared with $33.0 million at December 31, 2021. Approximately $7.9 million remained available under the facility.
- The HSBC revolving facility was increased from $50 million to $65 million and extended to May 31, 2026. The stated interest rate was SOFR plus 1.75%, subject to later leverage-based adjustments.
- A November 8, 2022 amendment increased permitted funded-debt-to-EBITDA ratios for four quarters beginning in Q3 2022, ranging from 4.75:1 to 5.75:1, and permits interest rates up to SOFR plus 2.35% depending on leverage.
- The company stated that it was in compliance with its debt covenants as of September 30, 2022. Long-term debt to equity was 86.0%, compared with 57.2% at year-end 2021.
- The company believes operating cash flow and available revolver capacity will fund operations for the next twelve months under current conditions.
Material Changes Versus the Prior Comparable Period
- Profitability declined materially despite higher sales. Q3 operating income fell 68% and nine-month operating income fell 35%.
- Q3 net income decreased 97%; nine-month net income decreased 68%. The 2021 nine-month comparison benefited from $3.5 million of PPP loan forgiveness and a $0.9 million tax benefit related to stock compensation.
- Gross margin declined 350 basis points in Q3 and 280 basis points for the first nine months, primarily because of unusually high ocean freight and demurrage costs and weaker Canadian and European currencies.
- Exceptional supply-chain costs totaled approximately $3.0 million through September 30, 2022, including $2.4 million in the United States segment and $0.6 million in Europe. Approximately $1.1 million was recorded in Q3.
- Inventory increased $12.6 million to $66.2 million, and receivables increased $5.9 million to $40.1 million from December 31, 2021. Inventory turnover declined to 2.1 from 2.3.
- On June 1, 2022, the company acquired Safety Made for approximately $11 million, including up to $1.5 million of contingent consideration. The preliminary purchase-price allocation included $5.1 million of intangible assets and $3.4 million of goodwill.
Outlook, Commentary, Risks and Unusual Items
- Management reported that freight and demurrage costs began declining in Q3 and were expected to decline further in Q4, although they were expected to remain above historical levels.
- Cost-reduction and productivity initiatives are expected to generate more than $5.0 million of savings in 2023; the filing does not provide a detailed implementation schedule or quantified quarterly impact.
- Management expects continued challenges in Europe from the war in Ukraine, economic softness and the historically low euro exchange rate.
- Principal risks include supply-chain disruptions, inflation, elevated transportation and labor costs, higher interest rates, currency fluctuations, COVID-19 or future pandemics, tariffs and trade-policy changes, changing consumer demand, competition, and integration of acquired businesses.
- The company had no pending material legal proceedings and reported no material changes to critical accounting estimates or internal control over financial reporting. Management concluded that disclosure controls and procedures were effective.
Facts Investors Should Verify
- Whether freight, demurrage, inflation and currency pressures continue to moderate and whether gross margins recover.
- Progress toward the stated 2023 cost savings exceeding $5.0 million.
- Safety Made revenue contribution, integration costs, final purchase-price accounting and the likelihood and amount of contingent consideration.
- Revolver availability, leverage-ratio compliance, interest-rate step-ups and the company’s ability to refinance or reduce debt.
- Inventory aging, turnover and cash conversion given the substantial inventory build and negative operating cash flow.
- Whether European and Canadian sales growth in local currencies offsets foreign-exchange translation pressure.