Earnings Call Transcript - ACU Q3 2021

Operator, Operator

Good day, and welcome to the Acme United Corporation's hosted Third Quarter 2021 Earnings Conference Call. At this time, I'd like to turn the conference over to Walter Johnsen. Please go ahead, sir.

Walter Johnsen, Chairman and CEO

Good afternoon. Welcome to the third quarter 2021 earnings conference call for Acme United Corporation. I am Walter 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 very good third quarter of 2021. Our net sales were $47.9 million, an increase of 11% over last year at this time. Our net income for the quarter was $2 million, an increase of 30%. Earnings per share were $0.50 compared to $0.46 last year. Net sales were strong at all of our subsidiaries. In the U.S., our revenues increased 12%. We benefited from excellent back-to-school sales, strong demand for Westcott cutting tools as people return to their offices and excellent sell-through of our craft products. The First Aid and Safety business had increased demand throughout its distribution base. E-commerce sales were strong. Our Canadian business benefited from growth at First Aid Central, which has successfully added new multinational customers since its acquisition last year. Its organic e-commerce sales were excellent. In Europe, revenues for the quarter were even with last year due to timing of some large shipments. Acme United has had many cost pressures, and we have been increasing our selling prices regularly. We have had supply chain shortages, increased labor costs, extraordinarily high shipping costs, increased energy costs and inflation nearly across the board. In addition, we have had many positions unfilled at most of our locations despite increasing wages. It was and is a very challenging time. We do not believe the increased costs are temporary. In fact, we are already seeing new levels of cost increases for 2022, and we are instituting new price increases. As you may recall, we installed a new warehouse management system in April 2021 in our Rocky Mount, North Carolina distribution facility. We've made substantial progress with the new software and are now shipping normally. Although there are many areas still to improve, the system is now positioned to increase our efficiencies to ship small parcels, track shipments more thoroughly and strengthen our operational control. Acme United began building its global inventory about 30% starting in June of 2020. We did this because we feared supply chain disruptions from COVID-19 when workers in China left for their homes during Chinese New Year. However, we did not anticipate the tsunami of orders to the Chinese factories caused by pent-up COVID spending and the U.S. stimulus packages, but they overwhelmed the Chinese capacity to produce and ship right in the middle of the back-to-school and summer product surge. The extra inventory provided a substantial cushion to meet customer requirements despite the external shipping chaos. We have extended the projected lead times from order to delivery and are managing our supply chain with the expectation of continued delays. We anticipate these issues in 2022 and are prepared. We're converging on another successful year and anticipate record sales and earnings in 2021. Our sales of Westcott cutting tools continue to grow, and demand for our First Aid products is strong. We are optimistic about 2022. I will now turn the call to Paul.

Paul Driscoll, CFO

Acme's net sales for the third quarter were $47.9 million compared to $43.3 million in 2020, an increase of 11%. Sales for the 9 months ended September 30, 2021, were $136 million compared to $123 million in the same period in 2020, an increase of 11%. Net sales in the U.S. segment increased 12% in the third quarter and 8% for the 9 months ended September 30. The sales increase for both periods was mainly due to market share gains in First Aid and Safety products. Net sales for Europe were constant in local currency for the quarter due to some large shipments last year. Sales in the third quarter of 2020 increased 32% compared to the previous year. Sales for the 9 months ended September 30, 2021, grew 15%, mainly due to growth in e-commerce and market share gains in Westcott, school and office products. Net sales in local currency for Canada were constant in the quarter. Higher sales of First Aid products offset a decline in sales of school and office products. Due to COVID-19 lockdowns in 2020, back-to-school shipments temporarily shifted from the second to the third quarter. Sales were up 49% in Q2 of this year compared to Q2 of last year. Net sales in local currency for the 9 months ended September 30, 2021, grew 23%, mainly due to higher sales of First Aid products. The gross margin was 35.5% in the third quarter of 2021 compared to 34.5% in 2020. Selling price increases offset higher material, labor and transportation costs. The year-to-date gross margin was 36% for both 2021 and 2020. SG&A expenses for the third quarter of 2021 were $14 million or 29.3% of sales compared with $12.8 million or 29.6% of sales for the same period of 2020. SG&A expenses for the first 9 months of 2021 were $39 million or 28.6% of sales compared with $36 million or 29.3% of sales in 2020. Net income for the third quarter of 2021 was $2 million or $0.50 per diluted share compared to a net income of $1.6 million or $0.46 per diluted share for the same period of 2020, an increase of 30% in net income and 9% in earnings per share. Net income, excluding the impact of the PPP loan forgiveness for the first 9 months ended September 30, 2021, was $7.8 million or $1.97 per diluted share compared to $6.1 million or $1.75 per diluted share in the comparable period last year, increases of 29% and 13%. The company's debt less cash on September 30, 2021, was $38.1 million compared to $34.4 million on September 30, 2020. During the 12-month period, we paid $9.3 million for the Med-Nap acquisition, spent $1.7 million on dividends, received full forgiveness on the $3.5 million PPP loan and generated approximately $2 million in free cash flow.

Walter Johnsen, Chairman and CEO

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

Jim Marrone, Analyst

Congratulations on a decent quarter. My first question is about the logistics and supply chain. I'm trying to understand the backlog of container shipments and port delays and how they are impacting your business, as well as what you anticipate for the near future regarding this issue. I have a follow-up question after that.

Walter Johnsen, Chairman and CEO

Well, in general, it's a mess. The supply chain could have been managed much differently than it has been, but it's being run cluelessly. I can tell you that the shortages of containers are exacerbated because they're stuck in places like our ports and then we don't have truck drivers. That's not going to change quickly. We've got production that's going on in China for delivery now next summer. And we figure sometime between now and next summer, we'll get deliveries. That's ridiculous. It's completely ridiculous. The fact that we added 30% extra inventory allows us to plan for this kind of chaos, and we are. But it's crazy for us to be looking at deliveries almost 9 months or a year away, and we are doing that. I don't see a near-term solution, nor do I believe that people understand this is a lot more than toys for Christmas, and the popular commentary talks about a weak holiday. They're missing the fact that the U.S. economy, if it doesn't get critical parts, grinds to a halt. And this is serious. So while we feel we're prepared, we don't see enough activity going on, on a macro level and within our own government.

Jim Marrone, Analyst

You mentioned that you've managed to reduce higher costs through effective inventory management. However, in your prepared comments, you noted that these higher costs were also offset by increased selling prices. Can you confirm this? Additionally, how well are you able to pass these higher prices onto consumers? What is the level of consumer acceptance for increased selling prices? If this indeed involves higher selling prices and effective inventory management, are these the key factors driving the 30% increase in profit, while your top line is only growing at 10%?

Walter Johnsen, Chairman and CEO

Well, first on the ability to price. We try very hard to deliver value to our customers. I mean that's obvious. But when your costs go up, you pass your costs on. And there are a lot of costs. And when you can't identify all the costs, but they keep coming in everywhere, well, you increase your prices to cover that. And we've continually done that throughout the year and anticipate continuing to do it because we don't see a letdown whatsoever. Relative to the gross margin increase in the quarter, I think that is representative of product mix, but it does represent that we have pricing power.

Jim Marrone, Analyst

Right. And regarding the impact of higher selling prices on consumers, do you have an idea of when your volumes might be affected as a result of passing on those increased prices?

Walter Johnsen, Chairman and CEO

Well, I don't think, really, our products are the ones which will have much resistance because the average selling prices are well under $25 for most of our Westcott items and Camillus knives. With the First Aid kits in the industrial market, they're higher. But there, it's a whole different market dynamic. I think a bigger thing is the collective drag on the U.S. economy from inflation that's coming in from every front, and that may slow demand across the board. I can see already the major capital equipment slowing in part because they can't get parts. But the factories don't operate when they don't get parts. And so I think there's a cycle here that is very concerning.

Operator, Operator

We'll go next to Alan Kaplan, a Private Investor.

Unidentified Analyst, Analyst

Yes. I was wondering, do a significant number of your options get awarded to employees who are not classified as insiders?

Walter Johnsen, Chairman and CEO

No. The options only go to employees. And they've been a very important part of maintaining this talent pool that we have, probably more so than any single thing. But they all go to employees.

Unidentified Analyst, Analyst

No. What I was asking was, are a number of them granted to employees not classified as insiders, and therefore, not filing Form 4s?

Walter Johnsen, Chairman and CEO

Oh, sure. There's a lot of those that don't file Form 4s that are employees.

Unidentified Analyst, Analyst

Okay. Since your last earnings release, there was a significant increase in the basic number of shares. The only explanation I can think of is that some employees were exercising their options. Is that correct?

Walter Johnsen, Chairman and CEO

Yes. I think that would be the accurate, Alan.

Operator, Operator

And we'll move to our next question from Michael Mork of Mork Capital Management.

Michael Mork, Analyst

Two questions. A couple of years ago, Amazon was growing exponentially with your company, and then it kind of flattened out. Can you give us any update on what's going on there?

Walter Johnsen, Chairman and CEO

Yes, Mike. Amazon has been growing rapidly both in the U.S. and in Europe for us. And amazingly, it should be by now our biggest customer, but Walmart has also been growing very rapidly, and they've sort of been neck and neck. But Amazon is doing terrifically well for us.

Michael Mork, Analyst

Your Amazon business has begun to increase again after a period of stagnation, and you're still trying to understand the reasons behind that plateau.

Walter Johnsen, Chairman and CEO

Yes.

Michael Mork, Analyst

Okay. My second question is about inflation. Could you provide a specific percentage? Are we seeing price increases of 3%, 5%, 10%? Can you give us a rough estimate of the inflation we are experiencing?

Walter Johnsen, Chairman and CEO

Well, we are seeing inflation at the factories. In China, these aren't ours. This is across the board in China of around 9.5% to 10%. And I don't know that, that's being publicly reported, but that's what China is facing right now. So the broad production that's being exported. So when we get those kinds of increases, we match them. So it's higher numbers than you might think.

Michael Mork, Analyst

So do you think your products are 9%, 10% higher at the retail than they were, say, a year or two ago?

Walter Johnsen, Chairman and CEO

I really can't answer that because I haven't actually done that analysis. But I can tell you, Mike, that if we get a 9% price increase, we're going to pass on a pretty hefty price increase as well. And those are the kinds of numbers we're looking at. We're not looking at 3% or 4%.

Operator, Operator

And we'll move to our next question from Richard Dearnley of Longport Partners.

Richard Dearnley, Analyst

Could you give an approximate headcount for the North Carolina distribution center?

Walter Johnsen, Chairman and CEO

Paul, do you have an approximate headcount?

Paul Driscoll, CFO

I think it's about 150 now.

Walter Johnsen, Chairman and CEO

And then you have the temporary workers as well.

Paul Driscoll, CFO

Yes. There's probably another 50 temporary workers.

Richard Dearnley, Analyst

And I take it finding people is a mess.

Paul Driscoll, CFO

Finding and retaining people.

Walter Johnsen, Chairman and CEO

Yes. Finding and retaining people.

Richard Dearnley, Analyst

And retain, yes.

Walter Johnsen, Chairman and CEO

Well, there's something going on, and it depends on, of course, where you live. But the unemployment in certain areas matches the living standard. At which point, there appears to be not so much incentive to show up. And the game we see again and again and again is come in, work a day or 2, leave. And then you've got another 6 months of unemployment. And people are smart, and they figured the game out.

Richard Dearnley, Analyst

You get unemployment if you just work a day or a week?

Walter Johnsen, Chairman and CEO

You have to be looking for employment. You get employment enough to stay long. You can be off.

Richard Dearnley, Analyst

I got it. Okay. Last quarter, you said you had a $5 million or so of orders that you couldn't ship because of the warehouse. Did that clear in this quarter? And is there any carryover from warehouse difficulties this quarter?

Walter Johnsen, Chairman and CEO

Most of the back orders from the end of June that were in our warehouse have been cleared. However, there is a significant amount of products waiting to be shipped in China at freight consolidators. These are not booked as sales; they are recorded against the purchase order. Unfortunately, our major customers are unable to get containers to pick them up, and they are now 3 to 4 months behind schedule. These are valid purchase orders, and they will likely be picked up in this quarter, but they have carried over from June, July, and August due to the inability to secure containers for the goods.

Richard Dearnley, Analyst

Yes. There was an article on Twitter about some investor who rented a boat and toured the LA harbor and then all through the docks and went and talked to people and he said, 'If you can find a container, you can't find a place to put it.' It was just gridlock. It was a total mess.

Walter Johnsen, Chairman and CEO

No. It's chaos. It's chaos. And it is so much more than what's being reported about, 'God, there won't be toys for Christmas.' It's just not getting how serious this is.

Operator, Operator

And we'll go to our next question from Jeffrey Matthews of RAM Partners.

Jeffrey Matthews, Analyst

I have a few questions. First, regarding China, why is the inflation so high there? Is it due to raw materials, or is it a labor shortage, which you have mentioned for many years in relation to the declining birth rate?

Walter Johnsen, Chairman and CEO

Regarding raw materials, the prices of oil are influenced by the global market, and we've seen oil prices increase significantly, likely around 50% to 60% over the past year. This rise presents challenges for plastics and fuel. There's also a shortage of coal, particularly coking coal, which is essential for steel production. Additionally, the electric supply is constrained, with factories operating only 3 to 4 days a week due to power shortages. Compounding these issues are shipping container shortages in China and labor shortages, which contribute to the overall supply challenges.

Jeffrey Matthews, Analyst

Does what is happening in China influence your views on your supply chain for the future, or is this a challenge you will face for an extended period?

Walter Johnsen, Chairman and CEO

Over the last six years, we have made acquisitions that have predominantly been in the U.S. and one in Canada. This includes companies like Spill Magic, DMT, First Aid Only, Pac-Kit, and First Aid Central, all of which are U.S. manufacturers. We have diversified our sourcing so that now about half of our products come from outside the United States, which is a significant change from five years ago. For example, with Med-Nap, which we acquired in December, we are now producing essential alcohol prep pads and wipes for our First Aid kits in Florida. We continue to explore sourcing options beyond China, looking at regions like Northern Africa, Eastern Europe, Southeast Asia, and the Philippines. Domestic manufacturing remains a priority for us, and we are approaching it thoughtfully. I wouldn't be surprised if our next acquisition is also in the U.S. as we aim to strengthen our domestic sourcing base.

Jeffrey Matthews, Analyst

Okay. That leads into another question I wanted to ask, which is in this challenging operating environment, are you identifying more potential opportunities for acquisitions, or is the flow still the same?

Walter Johnsen, Chairman and CEO

Well, we have plenty of activity looking at acquisitions. And as you can imagine, we've got quite a database that we've developed over the years and we're constantly calling and checking in. And a lot of times, when you follow up, you might be surprised, but now is the time, and then you follow up with an actual transaction. I know the private equity market is very, very strong, and that impacts some of the pricing that we'd see for sure. But really, we're not in that market. We're looking at companies a half step away from what we're doing with these relationships, and they tend not to be marketed, although we do pay fair prices for them.

Jeffrey Matthews, Analyst

Sure. For the final question, your remarks on the critical shortages and supply disruptions in the economy highlight some significant issues. Can you share one or two specific examples that stand out to you? You're discussing not just Acme-related problems, but also capital equipment and supply chain challenges. What are one or two examples that are causing you additional concern?

Walter Johnsen, Chairman and CEO

Well, I have conference calls every week on Tuesday mornings with Asia, and I see what's going on. And it is a very serious supply chain calls with our team. And what I say is we can anticipate these things, but many, many companies did not add 30% to their inventory 18 months ago. And they're stuck. And it's terrifying. I read that one of the F-150 Ford truck plants has thousands of trucks right now finished, except for components. I read that a drone manufacturer in Connecticut laid off half its staff because it couldn't get parts for military drones. I worry about getting critical medicines when you can't get them on containers. I read that a major running shoe company, which shifted its production from China to Vietnam, can't get the boats to pick up those shoes, and they were airfreighting them. These are just some examples. I see it everywhere.

Operator, Operator

And with no further questions in the queue, I'd now like to turn the conference back to our presenters for any additional or closing remarks.

Walter Johnsen, Chairman and CEO

Well, if there are no further questions, then this call is complete. We look forward to providing year-end results in early 2022, and thank you for joining us. Goodbye.

Operator, Operator

And so this concludes today's call. We thank you for your participation. You may now disconnect.