Earnings Call Transcript - ACU Q2 2022

Operator, Operator

Good day, and welcome to the Acme United Corporation's hosted Second Quarter 2022 Earnings Conference Call. At this time, I would like to turn the conference over to Walter Johnsen, Chairman and CEO. Please go ahead.

Walter Johnsen, Chairman and CEO

Good morning. Welcome to the second quarter 2022 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 a 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 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 such as, among others, those arising as a result of the effects of the COVID-19 pandemic, including the ongoing economic downturn and the other risks and uncertainties described in our periodic filings with the Securities and Exchange Commission and in our current earnings release.

Walter Johnsen, Chairman and CEO

Thank you, Paul. Acme United had a challenging second quarter of 2022, but also one of accomplishment. The company had record sales. We completed the acquisition of Safety Made, which manufactures personalized first aid kits and safety products. And we increased our debt facility to position the company for additional growth. Our net sales of $56.8 million was an increase of 27% over the second quarter of 2021. This represented the highest revenues in a quarter in the company's history. However, we did not keep up with rapidly escalating costs. Our net income for the quarter was $2.7 million, which was a decrease of 3% from last year after adjusting for a one-time tax credit of $900,000. Earnings per share without the tax credit in 2021 was $0.71, similar to 2021. Many events happened quickly and they created unanticipated expenses. The ports in Shenzhen and Shanghai abruptly closed due to COVID. We rerouted a large number of containers to Ningbo and delivered to our customers on time. However, we paid an average of $18,000 per container when the budget was $12,500. This extra expense was approximately $500,000 in the second quarter. Fortunately, container costs have since declined to about what we have budgeted for $12,500. The U.S. ports in Los Angeles and Long Beach were overwhelmed with containers, due to port workers ordered to work round the clock by the U.S. administration. But there were not enough truck drivers to pick up the containers. The resulting pile up caused the ports to store containers on available land everywhere. They became jumbled in huge piles and the port workers could not quickly or easily access containers to be placed on trucks. A similar situation occurred on the East Coast ports. In addition, the container ship Ever Forward got stuck in the mud off Baltimore and our cargo languished for weeks. U.S. federal law limits truck drivers to 10 hours of driving per day. We had drivers waiting for containers for 10 hours, limiting out and going home without cargo, only to return the next day. The U.S. administration declared fines for unpicked up cargo. As a result, we incurred demurrage expenses of $130,000 in the second quarter. When the war in Ukraine broke out in mid-March, the euro began a rapid decline in value against the U.S. dollar from about $1.14 to $1.02 to-date. Since we pay in dollars for our products that are imported to Europe from China, we recognized an unanticipated expense of $160,000 in the second quarter as we marked our payables to market. In addition, our gross margins in Europe declined over 8 percentage points. Our inland transportation costs grew rapidly due to diesel prices increasing from mid-March of approximately $4 a gallon to $5.60 a gallon at the quarter's end. While we could go on forever about the state of affairs, here’s what we are doing. We've increased prices in the U.S. and Europe on July 1 to be sensitive to the end user demand curve and yet meet the increased costs. We are implementing serious productivity improvements. Last year, we installed new warehouse management software in our largest facility located in Rocky Mount, North Carolina. The new software went live in April 2021 and we anticipate savings of over $300,000 annually starting in June 2022. We will be installing new bottling equipment in our Spill Magic plants in the fourth quarter of this year. This $580,000 investment is projected to generate annual savings of about $450,000 in 2023 and thereafter. Our Med-Nap facility in Florida is building a robotic filling machine, which is expected to become operational in the fourth quarter of 2022. This capital project cost about $800,000. It reduces the cost of placing alcohol wipes and pads in boxes and has projected savings annually of $350,000. Even more importantly, it reduces our production costs in the U.S. for many Med-Nap products to potentially gain new business in the large domestic medical and defense markets. As you may know, two years ago, we intentionally increased our global inventory. This was done as a precaution for potential supply chain issues, particularly related to the impact of COVID in China. Our current plan is to reduce our global inventory by $4 million by the end of 2022. In addition to increasing the prices of our products, bringing on stream new productivity improvements, and beginning to reduce inventory, we made progress with a new acquisition and an expanded banking facility in the second quarter. In June 2022, we purchased Safety Made, which produces customized first aid kits for the promotion market. The company had revenues of approximately $5 million in 2021 and pre-tax income of a little over $1.1 million. It has performed well and was accretive in the second quarter. We also entered a new loan with HSBC in the second quarter of 2022. Our new facility is $65 million, compared to the former one of $50 million on essentially the same terms. The interest rate is SOFR plus 1.75% or about 3.3% today, and the term is four years. As you may recall, we also obtained mortgages in November 2021 on our Rocky Mount, North Carolina and Vancouver, Washington plants totaling $11.6 million at a fixed interest rate of 3.8%. We'd like to thank HSBC for its support as we continue to grow. We are providing guidance of approximately $200 million in revenues in 2022. We plan to continue to adjust prices as appropriate as the year progresses and look forward to delivering solid results. I'll now return the call to Paul.

Paul Driscoll, CFO

Acme’s net sales for the second quarter were $56.8 million, compared to $44.8 million in 2021, an increase of 27%. Sales for the six months ended June 30, 2022 were $100.1 million, compared to $88.4 million in the same period in 2021, an increase of 13%. Net sales in the U.S. segment increased 33% in the quarter, due to higher sales prices, increased volume, and first-quarter back orders filled in the second quarter. The first-quarter back orders resulted from supply chain disruptions. Sales increased 13% for the six months ended June 30, mainly due to higher sales of First Aid and Westcott products. Net sales for Europe increased 12% in local currency for the quarter and 7% for the six months ended June 30. The sales increase for both periods was mainly due to new customers in the office channel. Net sales in local currency for Canada were constant in the quarter and grew 4% for the year-to-date. The gross margin was 32% in the second quarter of 2022, compared to 36% in 2021. The year-to-date gross margin was 34%, compared to 36% in 2021. The lower gross margin was mainly due to product cost inflation pressures, higher transportation costs, and higher labor costs. Price increases partially offset the cost increases. SG&A expenses for the second quarter of 2022 were $14.6 million, or 26% of sales, compared with $12.4 million, or 28% of sales for the same period of 2021. SG&A expenses for the first six months of 2022 were $28 million, or 28% of sales, compared with $25 million, or 28% of sales in 2021. The second quarter of 2021 included $3.5 million of PPP loan forgiveness, reflected in other income. Also, the second quarter of 2021 tax expense included $0.9 million of tax credit for stock-based compensation. Excluding these impacts, adjusted net income in the second quarter of 2021 was $2.8 million. Net income for the second quarter of 2022 was $2.7 million or $0.71 per diluted share, compared to the adjusted net income for the second quarter of $2.8 million or $0.71 per diluted share, a decrease of 3% in net income and constant for earnings per share. Net income for the first six months ended June 30, 2022 was $3.6 million or $0.93 per diluted share, compared to adjusted net income of $4.9 million or $1.23 per diluted share in the comparable period last year, decreases of 27% and 25%. That net income decline in the six months was due to the decline in gross margin as a percentage of sales. The company's debt less cash on June 30, 2022 was $59.8 million, compared to $39.3 million on June 30, 2021. During the 12-month period, we paid $11 million for the Safety Made acquisition, spent $1.8 million on dividends, and repurchased $1.5 million of common stock. Inventory increased approximately $15 million, primarily due to anticipated growth in our business, higher costs, and purchasing additional safety stock to offset the impact of potential supply chain disruptions related to COVID-19.

Walter Johnsen, Chairman and CEO

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

Operator, Operator

Thank you. And we'll first hear from Tim Call of the Capital Management Corp.

Tim Call, Analyst

Congratulations on the very strong sales given all the economic headwinds and disruptions, the rest of us are facing.

Walter Johnsen, Chairman and CEO

Well, Tim, thank you very much. As I said, it was a challenging quarter and our team really rose up to it. It was tough.

Tim Call, Analyst

This year might see the first normal back-to-school season in a few years. And a lot of back-to-school sales have shifted to the third quarter being web-based stores and last minute restocking. How do you see the competitive landscape and shelf space versus peers?

Walter Johnsen, Chairman and CEO

Well, Tim, we've been gaining market share. And in the second quarter, we had a very strong already back-to-school. We saw a number of our customers, we believe, bringing in product in advance, giving more of a buffer, which was terrific. Of course, it put a lot of strain on us as we tried to expedite that and it cost us a lot of money. But it's going to be a very good back-to-school. And you're right, it is far more normal fortunately. So we've got market share gains and it's going to be a good back-to-school.

Tim Call, Analyst

And then with First Aid, you finally broke into the Canadian market in recent years. Do you think it's just as hard to enter the EU market and can you make headway there over time?

Walter Johnsen, Chairman and CEO

So we actually are selling First Aid products in Europe and it's small compared to our North American business. But the fortunate thing is we're leveraging the knowledge we have and we truly are gaining headway in Europe. So that's without an acquisition.

Tim Call, Analyst

Well, congratulations. Thank you.

Walter Johnsen, Chairman and CEO

Thank you.

Operator, Operator

We'll hear from Richard Dearnley of Longport Partners.

Richard Dearnley, Analyst

Good morning. Could you give a rough idea of how much carryover from the first quarter revenue was in the second quarter?

Walter Johnsen, Chairman and CEO

Yes, Dick, it was about $3.5 million to $4 million.

Richard Dearnley, Analyst

Okay. And the strength in Europe in new office customers, was that in both Westcott and First Aid or was it mostly in one of those?

Walter Johnsen, Chairman and CEO

In Europe, our biggest segment is Westcott. And as I mentioned, we're having a very good back-to-school. But in addition to that, Westcott gained market share in the normal office business as well in Europe. So the combination was a very strong second quarter.

Richard Dearnley, Analyst

Yes. Now what we have to do is worry about the foreign exchange?

Walter Johnsen, Chairman and CEO

Well, we are adjusting prices, but I mean the big thing is when you have a stable base, you can adjust prices and you can work off of that. This was a very precipitous decline within weeks, the euro dropped 11% and that was not priced. So we're addressing that, and as I said, we're working on productivity improvements that hopefully will really give value to our customers.

Richard Dearnley, Analyst

Right. Great, well keep up the good work.

Walter Johnsen, Chairman and CEO

Thank you.

Operator, Operator

Next question comes from Jim Marrone of Singular Research.

Jim Marrone, Analyst

Yes. Good afternoon, gentlemen. So I have a few questions. So let's start with the sales increase, so really nice healthy increase in sales. I'm just trying to get a sense of how much of that did it reflect the price increase? Or how much of that reflected an increase in volumes? And then, yes.

Walter Johnsen, Chairman and CEO

Jim, we're not going to break out our price increases for competitive reasons. But we said that $4 million carried over from the previous quarter. And you can imagine if inflation in the U.S. is running at 9.1% and you've got gasoline and transportation higher, then you're going to be somewhere in that range depending on the product and the customer and where it's coming from. But the net was we had a lot of organic growth plus price increase.

Jim Marrone, Analyst

Right. Okay, so there's some reflection of price increase in these numbers then though, right?

Walter Johnsen, Chairman and CEO

Oh, for sure. Yes.

Jim Marrone, Analyst

Right. And so you plan on implementing further price increases from your prepared comments?

Walter Johnsen, Chairman and CEO

Well, the challenge for all of us is that inflation is not a one-and-done; it compounds. And we believe we’ll have to stay current with the current inflation. And if it's a number like 9% that gets to be easy because it's predictable. It's not predictable when you've got a war and port closures and disease and a disrupted supply chain exacerbated by administrative mandates, that will happen in 12 weeks. But yes, the inflation rate, whatever it is, we intend to be passing through on a consistent basis, plus any productivity that we can do, because we're trying to deliver value as well on a regular basis to our customers. And hopefully we're providing value to the end user, because after all they are the reason we're in business.

Jim Marrone, Analyst

Okay, very good. And so then in terms of the cost structure, the issue is not really a demand issue. If everyone's experiencing it’s the supply side, not the demand side. So I'm just trying to get a sense of how like you're going about controlling those costs. So I know you've been doing inventory management for a while. I'm just trying to get a sense whether that is starting to factor in your cost structure going forward?

Walter Johnsen, Chairman and CEO

Well, in the second quarter, there were many direct import programs, particularly for back-to-school with major retailers globally. And those are picked up in China and delivered directly to their locations. That piece is where we were mostly hurt, because we had to deliver on the spot market then and there, and we get. The inventory that we hold in Europe, U.S., and then Canada for our daily everyday business, the Westcott and the First Aid-only business, that is buffered against at least supply chain shortages and we've got that extra capacity that we added. We're going to start to reduce that safety stock, and we are doing that because we believe the supply chain will start to get better in the course of the next 12 months, which we're going to be monitoring carefully. But if that occurs, then the plan is to have generated an extra $4 million of cash from inventory by year-end. And as I see it now, I believe that's attainable.

Jim Marrone, Analyst

Okay. That’s encouraging. And so is there any effort going forward on reducing the reliance on China and other foreign countries and sourcing out suppliers from maybe domestically or other options?

Walter Johnsen, Chairman and CEO

Sure. About ten years ago, we relied on Asian suppliers, mainly from China, for over 80% of our needs. In the last seven acquisitions, we've focused on U.S. manufacturers. Currently, 40% of our global sales come from imports, while the remaining 60% is produced in our own plants. This enables us to implement productivity improvements and make investments, as I mentioned earlier, due to our facilities in the U.S. and Canada. I expect that future acquisitions will likely be in Western Europe, the U.S., or Canada, rather than depending on China. We are currently at a 40% reliance on imports. In the second quarter, we faced challenges due to direct import business with major retailers for back-to-school supplies. However, this is changing as we adjust the mix for the remainder of the year.

Jim Marrone, Analyst

Thank you for that information. I have one more question. I've noticed that interest expenses are roughly doubling year-over-year, which seems to indicate that higher rates are already having an impact. You also mentioned a negative effect from the strengthening U.S. dollar against depreciating foreign currencies. I’m curious if you are taking any steps to hedge against risks, perhaps by using derivatives or swaps for interest rate and foreign exchange exposure?

Walter Johnsen, Chairman and CEO

Well, we are in a very serious, but indirect way. The inventory that we hold has been delivered. So there's not a currency risk on that and there's not an interest rate risk. You basically own it. Now we did fix the interest rates on $11.6 million of our debt last November in mortgages. So that piece is fixed. And the remainder is variable, and the goal is to start to drive it down.

Jim Marrone, Analyst

Right. And are you just going to drive it down by rolling over into new terms? Or are you going to do a derivatives overlay? Like how do you plan on addressing this?

Walter Johnsen, Chairman and CEO

We're not doing any with derivatives. What I said to drive the debt down, I mean cash flow, pay it off. Because we have a very strong cash flow business. So the $4 million of inventory reduction at year-end pays down debt. The cash flow that comes in from our earnings for the first six months will have been collected by the second half, particularly back-to-school that pays down debt. So that's what I meant.

Jim Marrone, Analyst

Well, that's very encouraging as well then. So thank you for the color in regards to my questions.

Walter Johnsen, Chairman and CEO

Thanks, Jim.

Operator, Operator

Michael Mork of Mork Capital Management.

Michael Mork, Analyst

Hi, Walter. Good quarter considering all the problems. My question is assuming you do the $200 million this year and assuming the inflation rate, which is currently 9% or 10% glides down over the next 12 to 18 months to 4% or 5%. What type of revenue should we expect next year like up 10% to $220 million or what do you think?

Walter Johnsen, Chairman and CEO

Well, I have personal goals of seeing us adding $20 million to $25 million for each of the next three years plus doing at least one acquisition in that period, probably more. To be looking at closer to $300 million over that timeframe. Some of that will be from, we hope, organic growth. And so if you were to add 10% growth on $200 million, you are at $220 million, you do that for three years, you're probably at $270 million, $275 million. So that's what we're trying to accomplish, and I think we can do it. So your estimate of hopefully, inflation is at 5%, I hope it is 2%, and I hope the rest of the growth is real growth.

Paul Driscoll, CFO

Yes. Well, we follow the monetary stuff real closely here and the inflation was because the Fed’s money supply probably grew up 27% plus, but now it's only growing about 5% or 6%. So I think the slowdown inflation is kind of baked in the cake right now.

Michael Mork, Analyst

I hope so. That would be terrific.

Paul Driscoll, CFO

Okay. Anyway, thanks a lot.

Walter Johnsen, Chairman and CEO

Thanks, Mike.

Operator, Operator

Next, we'll hear from Sam Namiri of Ridgewood Investments.

Sam Namiri, Analyst

Hey, Walter. Nice job dealing with all the stuff. All the issues in the quarter.

Walter Johnsen, Chairman and CEO

Thank you, Sam.

Sam Namiri, Analyst

My question was kind of related to that is on the M&A front, are you seeing others out there who are just kind of maybe tired of dealing with inflation, supply chain issues, etc.? And are now maybe coming to the table and looking to get down to business?

Walter Johnsen, Chairman and CEO

We have built a substantial database over the last 15 years from our interactions with a variety of companies in our industry and related sectors. We maintain ongoing conversations with them. I believe there may be some opportunities this year, and we offer fair prices whether the market is strong or weak. I hope some companies will reach out to us. In short, we are actively exploring options, and this could be an opportune time to collaborate with us.

Sam Namiri, Analyst

Thank you. And then also on that end as well too, how do you see this as an opportunity to take share as well? Like maybe don't take as much price with inflation. And I don't know, is that something that you look at and opportunistically think advantage of as well too or someone else is raising their prices and the customer maybe doesn't want to say or start shopping around to switch suppliers?

Walter Johnsen, Chairman and CEO

Well, our customers are really sophisticated and if we're not in the competitive range where we're going to lose business. And by and large, we are in that competitive range and we're gaining share. And you're correct if some of our competitors get too far out of step with costs we're going to be at their tail and hopefully we get some of that business.

Sam Namiri, Analyst

Got it. Okay, thank you. Thanks again.

Walter Johnsen, Chairman and CEO

Thank you.

Operator, Operator

And it appears there are no further questions at this time. I’ll turn the call back over to the presenters for any additional or closing comments.

Walter Johnsen, Chairman and CEO

Well, if there are no further questions, then this call is complete. We look forward to speaking with you at the end of the third quarter. Thank you and good-bye.

Operator, Operator

That does conclude today's conference. Thank you all for your participation. You may now disconnect.