Earnings Call Transcript - ACU Q2 2023

Operator, Operator

Good day, and welcome to the Acme United Corporation Second Quarter 2023 Earnings. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. At this time, I would like to turn the call over to Walter Johnsen, Chairman and CEO. Please go ahead, sir.

Walter Johnsen, Chairman and CEO

Good morning. Welcome to the second quarter 2023 earnings conference call for Acme United Corporation. I'm Walter C. Johnsen, Chairman and CEO. With me is Paul Driscoll, our Chief Financial Officer, who will first read the safe harbor statement. Paul?

Paul Driscoll, CFO

Forward-looking statements in this conference call, including, without limitation, statements related to the company's plans, strategies, objectives, expectations, intentions and adequacy of capital and other 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, including, among others, those arising as a result of a challenging global macroeconomic environment characterized by continued high inflation and high interest rates. In addition, we have experienced supply chain disruptions, including those resulting from the COVID-19 pandemic, and we may experience supply chain disruptions in the future. We're also subject to additional risks and uncertainties as described in our periodic filings with the Securities and Exchange Commission in our current earnings release.

Walter Johnsen, Chairman and CEO

Thank you, Paul. Acme United had an excellent second quarter of 2023, with net income increasing 26% and earnings per share increasing 35%. Our net sales were $53.3 million, a decrease of 6%, which was anticipated due to inventory reductions of several of our large customers. Net income was $3.4 million compared to $2.7 million in the second quarter of 2022. Earnings per share were $0.96 compared to $0.71 in the second quarter last year. In 2022, the cost of shipping a container from Shanghai to Long Beach, California increased to as high as $19,000 versus our budget of $12,500. This resulted in additional expenses in 2022 of approximately $4 million. The company did not raise prices to adjust for these costs but they obviously reduced profitability in 2022 by approximately $4 million. In 2023, container costs have declined to about $5,000 each. We implemented a $5 million cost savings plan in September of 2022, and we are on track to accomplishing our goal. We hired an experienced Director of Distribution to improve training, increased wages and began new automation projects in our North Carolina facility. We have also substantially lowered staff turnover. As you may know, we improved the working conditions in our 345,000 square foot facility in North Carolina by installing massive air conditioning units during 2021 and 2022. About nine months ago, it appeared that the worst of the supply chain problems were easing. The company began to reduce its inventory being careful not to impact unexpected customer requirements should we be unprepared for another interruption. The result has been a $9.1 million reduction in inventory since June 30, 2022. We’ve used the cash flow to pay down debt and are positioned to fund another acquisition to take advantage of a new growth opportunity. We have not provided guidance for 2023, but we anticipate performance during the year far exceeding that of 2022. We expect sales to be impacted by global supply chain reductions, but we have new programs in all our segments that will also drive us forward. I'll now turn the call to Paul Driscoll.

Paul Driscoll, CFO

Acme's net sales for the second quarter were $53.3 million compared to $56.8 million in 2022, a decrease of 6%. Sales for the six months ended June 30, 2023 were $99.2 million compared to $100.1 million in the same period in 2022, a decrease of 1%. Net sales in the U.S. segment decreased 8% in the second quarter due to customer inventory reductions of school and office products that were heavily purchased in the second quarter of 2022. Sales decreased 1% for the six months ended June 30. Net sales for Europe decreased 7% in local currency for the quarter and 5% for the six months ended June 30. The sales decrease for both periods was mainly due to the economic recession in Europe. Net sales in local currency for Canada increased 21% in the quarter and 8% for the year-to-date due to growth in First Aid products. The gross margin was 37.5% in the second quarter of 2023 compared to 32.7% in 2022. The higher gross margin was mainly due to the productivity improvement initiatives that began in Q4 of 2022, as well as lower transportation costs. SG&A expenses for the second quarter of 2023 were $14.8 million or 28% of sales compared with $14.6 million or 26% of sales for the same period of 2022. SG&A expenses for the first six months of 2023 were $29 million or 29% of sales compared with $28 million or 28% of sales in 2022. Operating profit in the second quarter increased 32% due to an improved gross margin and tight control of SG&A spending. Interest expense for the second quarter of 2023 was $830,000 compared to $420,000 in the second quarter of '22. The increase was entirely due to higher interest rates; in fact, average debt declined by $8 million in the second quarter of 2023 compared to Q2 of last year. Our overall average interest rate in the second quarter of 2023 was 6.4% compared to 2.9% for the second quarter of 2022. Net income for the second quarter of 2023 was $3.4 million or $0.96 per diluted share compared to a net income of $2.7 million or $0.71 per diluted share for the same period of 2022, an increase of 26% in net income, and 35% in earnings per share. Net income for the first six months ended June 30, 2023 was $4.4 million, or $1.25 per diluted share compared to $3.6 million or $0.93 per diluted share in the comparable period last year, increases of 24% and 34%. The company's bank debt less cash on June 30, 2023 was $47 million compared to $60 million on June 30, 2022. During the 12-month period, the company paid $2 million in dividends and generated approximately $14 million in free cash flow, including an inventory reduction of $9 million. Net debt declined $8 million from December 31, 2022.

Walter Johnsen, Chairman and CEO

Thank you, Paul. I will now open the call to questions.

Operator, Operator

Thank you. Ladies and gentlemen, we will now be conducting a question-and-answer session. Our first question comes from the line of Jim Marrone with Singular Research. Please proceed with your question.

Jim Marrone, Analyst

Yes. Thank you. Good quarter, gentlemen. I guess my question deals with what you anticipate going forward. It seems like you got past the headwinds of supply side and the higher costs associated with it. But going forward, a lot of economists are talking about recession. And I'm just curious on what your thoughts on how Acme will be insulated, if they are at all insulated to any upcoming recession. Can you anticipate lower volumes or what do you plan on doing to mitigate any of the negative effects of a recession? Thanks.

Walter Johnsen, Chairman and CEO

Good question, Jim. First, Acme is not insulated from recession. We have faced every bit of the challenges that any other company has. And if there are supply chain problems, we face that. We faced inflation just like everybody else. And if we go into a recession, we face a demand issue and that's pretty clear. The first aid side, where we're now the second largest in North America, has a recurring revenue stream from our refill business, as kits are used during the pollen season, through an accident or if they become obsolete. Those kits have to be refilled regularly. So there's a very strong recurring revenue stream that may be somewhat insulated. Relative to new first aid installations, we've got a number of programs going on with major companies in North America. And we've got increasing growth in Canada. We're using First Aid Central and our multinational companies that operate there, throughout every field, including mining, oil and gas, transportation, and general retail. On the first aid side, we also have a number of new products that are going into retail accounts in the United States and Canada. So those are the things that offset some of the headwinds, if we go into a recession. With the Westcott business, the cost of our products, which are primarily scissors and cutting tools, those are not expensive items. Most of them are under $25, and many are under $10. While there may be migration from one product to another within different price points, it's not the same as capital goods. It's not a refrigerator or a house or a car. So in past recessions, we've seen some backing off of Westcott, but certainly not the same as if it was a capital good. Relative to the inventory reductions, it depends on the retailer and it's uneven within departments. But obviously, the heavy purchasing they did a year ago is gradually being worked off. In the case of back-to-school, it was probably more opportune in the second quarter when back-to-school is an area through which you can sell product. But my belief is that by year-end, maybe sooner, most retailers will have been completely out of the inventory that they bought a year ago. And in many cases, that’s occurred already. And we’re seeing, as we speak, increased demand from them. I hope that helps, Jim. That was a good question.

Jim Marrone, Analyst

No, very good. Thank you. That was great insight.

Operator, Operator

Our next question comes from the line of Bill Holobowski with Sidoti. Please proceed with your question.

Bill Holobowski, Analyst

Thank you for taking my question and allowing me to participate. I have two questions. The first is again on the supply chain. I believe earlier in the commentary, you mentioned that customers may have stocked up last year, which perhaps set difficult comparisons for this period. Can you shed any light on your expectations for the second half of the year, if we may see similar? And then my second question, if I may, is since you mentioned recession, do you believe that would occur? And if it does, do you feel that you're positioned well based on the price points that you mentioned that, as you said, are more affordable and not like buying huge appliances and so forth? Thank you for any light you can share from those.

Walter Johnsen, Chairman and CEO

First, regarding supply chain issues, last year's second quarter saw customers purchasing from various sources to obtain products, especially for the back-to-school season among other products in our segment. With seasonal demands like back-to-school, it's crucial to have stock on shelves, especially online, where the key selling window runs primarily from June to September. At that time last year, retailers were buying as much as they could due to significant port congestion on both coasts and in Rotterdam, which created major challenges in getting products out of China. This situation emphasized the need for retailers to stock up a year ago. Fortunately, things have improved since then. Although there was some inventory sell-off in the last quarter, which we anticipated, the situation has mostly stabilized. Retailers have had nearly a year to adjust their inventory levels since last September when the supply chain began to ease. We are now seeing a closer alignment with real customer demand and have noted positive growth, although it's still early in the quarter. Looking ahead to the second half of the year, we expect continued revenue growth supported by our current programs. On the earnings front, conditions will significantly improve as we no longer face elevated shipping costs that had previously impacted product costs in the third and fourth quarters. We believe margins will continue to grow in the latter half of the year, and we foresee a strong performance during this period. In terms of a potential recession, I believe that ongoing interest rate hikes could lead to one, likely affecting sectors like housing, automotive, and capital goods that are sensitive to these rates. While many companies, including us, are seeing increased earnings and employee compensation, it's important to remember that taxes are due on these gains, and consumers are limited by post-tax spending, making it difficult to keep everything aligned. Therefore, I do expect a recession. The Federal Reserve, in its effort to combat inflation, is likely to continue raising rates without fully understanding the potential unintended consequences, which we have already seen ripple through the banking sector. However, I remain optimistic about our healthcare sector, thanks to strong refill rates and our existing programs. There may be some challenges with Westcott cutting tools since they are more consumer-oriented, but I do not expect this to be significant. I hope this information is helpful.

Bill Holobowski, Analyst

It does, and I appreciate the candor. Thank you so much.

Operator, Operator

Our next question comes from the line of Richard Dearnley with Longport Partners. Please proceed with your question.

Richard Dearnley, Analyst

Good morning. I guess one for Paul. You're on average inventory rather than LIFO or FIFO as I remember. Does that mean that the high-cost inventory has largely flowed through the P&L at this point?

Paul Driscoll, CFO

Yes.

Richard Dearnley, Analyst

Last quarter, you estimated that inventories would decrease by $5 million for the year, bringing the total to around $58 million. Now that we're at a different point, is there a revised target for the inventory, or is the current level appropriate?

Paul Driscoll, CFO

I think the current inventory is about where we will end the year, maybe it's $1 million more.

Richard Dearnley, Analyst

Okay. That's great. What was the sales mix in the quarter between first aid and Westcott or first aid and...

Paul Driscoll, CFO

Okay. So the first aid was 59% in the quarter and year-to-date. So for the three months and the six months, it was both 59%.

Richard Dearnley, Analyst

Right. And Walter, how did you get invited to that conference in Qatar? That was quite something.

Walter Johnsen, Chairman and CEO

Well, for those that don't know, I was presenting at the Bloomberg Conference in Qatar. It related to supply chain, which we deal with regularly. This is not the first time I've spoken about supply chain with Bloomberg; it's probably the fourth time. We know what we're discussing when it comes to what's going on in China and the situation with containers. We experience it daily. I have weekly calls with Asia and, of course, I'm in China often. So it was a natural invitation, I felt.

Richard Dearnley, Analyst

Great. It was interesting to hear that. Then the expansion in square footage in Canada to serve both Canada and multinational markets. Why is it more advantageous to open markets in Canada compared to the U.S.?

Walter Johnsen, Chairman and CEO

When we acquired First Aid Central in Canada, we gained the capability to manufacture first aid products locally. Although the borders are open, each province has distinct requirements, similar to the various regulations across different U.S. regions for kit components. Before our acquisition, it was quite challenging for a non-Canadian supplier to effectively meet these needs. However, with First Aid Central in our portfolio, we tapped into the significant purchasing power of our combined businesses, allowing us to offer very competitive product costs. Additionally, we now have a complete sales team for North America and Europe, collaborating with multinationals in Canada to provide products we developed in other regions that were previously unavailable there. We have successfully started producing these products in our facility near Montreal. Our success has been such that despite doubling our space, we still find ourselves in need of more, which is an exciting challenge.

Richard Dearnley, Analyst

Great. Oh, Paul, do you have last year's second quarter mix on first aid cutting?

Paul Driscoll, CFO

Okay. The second quarter last year was 51%.

Walter Johnsen, Chairman and CEO

Thank you very much.

Operator, Operator

Our next question comes from the line of Norman Sarafian with RBC Wealth Management. Please proceed with your question.

Norman Sarafian, Analyst

Thank you for the informative call. I have two questions. First, one person suggested there might be a recession. What if there isn't one, and we continue to grow? It seems like consumers are spending significantly this summer, for instance at Disneyland. Considering this, could we potentially have a soft landing or avoid a recession altogether, as the economy appears to be performing better? People seem surprised by the positive impact of rising interest rates, which seems to be driving more business activity, despite lower activity levels when rates were low. Are we ready to meet the demand for our products in terms of inventory? If we don’t have enough inventory to satisfy consumer demand for items like emergency kits, could that negatively affect our business if we are not equipped for a strong economy? My second question is...

Walter Johnsen, Chairman and CEO

Go ahead. First, regarding what if it is not a recession. Wow, that's fantastic! I think you prepare for the worst and maybe you're lucky. Relative to inventory, we've raised our inventory about 30% in preparation for supply chain issues and did that during COVID, and that's what we've peeled back. So we're in a position for normal growth. In fact, when Paul said we thought we had bottomed out with the inventory and when the question was asked, well, you stated you reduced it $5 million, but you actually did $9 million. That's because we thought we could, but we're very sensitive at this point to being able to supply our customers should there be more demand. I think we're positioned to do that. So again, we just pulled back from the stock that we had during COVID when we really didn't know what supply would be like. And now we're in a position, and I think if we're lucky, we get more growth.

Norman Sarafian, Analyst

Good. Now the other part of the question though, now would be a little bit of a downer. So let's say, because of COVID and people aren't going back to work in the office like they were, is this a potential drag on business demand for the product if people are not going to show up in the office? Working remote seems quite popular. I'm just wondering how that would affect your business.

Walter Johnsen, Chairman and CEO

I think we've already run through that. We shifted to a remote workforce during COVID, and we basically did promotions online and at places where they would shop for food, which proved to be the right area. You may recall that when offices were closed, the people weren't shopping at many retailers, but we shifted within a week to online sales. However, if the office is closed, would we lose business on the safety, the first aid products? Is there less demand if there are fewer people working in an office environment? That’s the question. The bulk of our first aid business is industrial. While sure, we sell to the offices, the majority goes to industrial companies, such as Exxon and Boeing; a lot is sold to companies like Grainger in the industrial market. Our biggest online customer is Amazon, and we find a broad mix of people buying there. I don’t believe, honestly, that a change in work patterns at this stage would have any impact.

Norman Sarafian, Analyst

Wonderful. Thank you so much, Walter. Appreciate it.

Operator, Operator

Our next question comes from Chris Sakai with Singular Research. Please go ahead with your question.

Chris Sakai, Analyst

Yes. Hi, Walter. Just had a question on what's driving the first aid demand in Canada.

Walter Johnsen, Chairman and CEO

We're gaining market share. We're introducing new products, particularly industrial products that had not been available, at least from Acme in the past. We have better pricing than most of the Canadian competitors because we have the scale to purchase them, and we have a really good team. It seems to be working.

Chris Sakai, Analyst

Okay. Sounds good. On to gross margin, seeing there's improvement there. How are we supposed to look at that in future quarters? Will there be more improvements or will it be leveling off here?

Walter Johnsen, Chairman and CEO

Chris, I'll turn that over to Paul Driscoll because he models that pretty carefully. Paul?

Paul Driscoll, CFO

Yeah. The next two quarters will be similar to the latest quarter, the second quarter, maybe a little bit higher, maybe 37.5% to 38%.

Chris Sakai, Analyst

Okay. And do you have any projections in future quarters after that?

Paul Driscoll, CFO

Well, I think it will level off at that.

Chris Sakai, Analyst

Okay. All right.

Paul Driscoll, CFO

There are a lot of factors that affect the gross margin, so I think at this point, being at 37.5% in the second quarter, we'll probably do something similar to that, a little bit higher in the third and fourth quarter. It's hard to predict what will happen next year.

Chris Sakai, Analyst

Okay. Thanks.

Operator, Operator

Our next question comes from the line of Ralph Marash with First Manhattan Company. Please proceed with your question.

Ralph Marash, Analyst

Hi, Walter and Paul. My first question is, do you think that innovation within your product line has suffered at all with all the challenges during COVID?

Walter Johnsen, Chairman and CEO

That's hard to call, Ralph. I would say we've probably done less in the coding area than we had in earlier years. As you know, we have about 150 patents on coatings. I think some of the collaboration that we would have done during COVID probably wasn't done because it was harder to connect. On the other hand, on the first aid side, our customers are pulling us into different segments so quickly. A couple of the acquisitions, like Spill Magic, where it's being used for bloodborne pathogen kits and spill cleanups for bodily fluids, this didn't even exist; we've got a business rising now that we just didn't have. I don't think it's across the board, but the kind of research for new products we were working through ideas together, we're starting them again, but I think that probably suffered a little bit.

Ralph Marash, Analyst

Okay. Thank you. And on the acquisition front, do you see a third leg or will you continue to grow First Aid and your office supply business?

Walter Johnsen, Chairman and CEO

Yeah. I don't see a third leg particularly. I see reinforcing in the First Aid segment where we've got really a lot of momentum. There's a number of ways that we can grow within our market, both horizontally and in terms of competitors, as an example, or companies that are a half step away with products, but also the vertical integration of the components that go into the first aid kits. An example of that is Med NAP, where we're making alcohol wipes, prep pads, Castile wipes, all going into our kits as well as selling them externally, and Med NAP will eventually be making other components, perhaps burn creams and hand sanitizers that also go into those kits. There will likely be other acquisitions in first aid, again, either horizontally expanding market share or vertically integrating into what we produce. They'll probably be in North America.

Ralph Marash, Analyst

Thank you. My last question is, I'm assuming since you didn't mention it, that the good news is that your distribution facility in Rocky Mount was spared any tornado damage.

Walter Johnsen, Chairman and CEO

So for those that don't know, on Friday, a tornado in Rocky Mount, North Carolina, struck and destroyed a significant section of the Pfizer Hospira facility, which is seven miles away from ours. It destroyed about 25% of the injectable pharmaceuticals in the United States. They are a supplier, but it's going to be a massive shortage. We have an emergency shelter within our facility and evacuated 180 workers. Fortunately, we were spared. We were lucky. However, for Pfizer and for the country, we've got serious problems because there's going to be a shortage of injectable pharmaceuticals, whether that's for chemotherapy, penicillin, or many other items; it's a big issue. We're okay.

Ralph Marash, Analyst

Great. Excuse me, I was glad that was really good news. Thanks, Walter.

Walter Johnsen, Chairman and CEO

Thank you.

Operator, Operator

There are no further questions in the queue. I'd like to hand the call back to Mr. Johnsen for closing remarks.

Walter Johnsen, Chairman and CEO

Okay. No further questions. Thank you for joining us. We look forward to talking to you as we complete the third quarter and have the earnings. Bye-bye.

Operator, Operator

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.