ACME UNITED CORP 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Information The Company may from time to time make written or oral “forward-looking statements” including statements contained in this report and in other communications by the Company, which are made in good faith pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. Such statements are based on our beliefs as well as assumptions made by and information currently available to us. When used in this document, words like “may,” “might,” “will,” “except,” “anticipate,” “believe,” “potential,” and similar expressions are intended to identify forward-looking statements. Actual results could differ materially from our current expectations. Forward-looking statements in this report, 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 that may impact the Company’s business, operations and financial results, including those risks and uncertainties resulting from the global COVID-19 pandemic, future waves of COVID-19, including through the Delta and Omicrom variants and any new variant strains of the underlying virus; any future pandemics; the continuing effectiveness, global availability, and public acceptance of existing vaccines; the effectiveness, availability, and public acceptance of vaccines against variant strains of potential new viruses; and the heightened impact the pandemic has on many of the risks described herein, including, without limitation, risks relating to disruptions in our supply chain, and labor shortages, any of which could materially adversely impact the Company’s ability to manufacture, source or distribute its products, both domestically and internationally. These risks and uncertainties further include, without limitation, the following: (i) changes in the Company’s plans, strategies, objectives, expectations and intentions, which may be made at any time at the discretion of the Company; (ii) the impact of uncertainties in global economic conditions, whether caused by COVID-19 or otherwise, including the impact on the Company’s suppliers and customers; (iii) additional disruptions in the Company’s supply chains, whether caused by COVID-19 or otherwise; (iv) labor shortages and related costs the Company may incur, including costs of acquiring and training new employees; (v) the impact of rising inflation rates; (vi) the Company’s ability to effectively manage its inventory in a rapidly changing business environment, including the additional inventory it acquired in 2020 and 2021 in anticipation of supply chain disruptions; uncertainties; (vii) changes in client needs and consumer spending habits; (viii) the impact of competition; (ix) the impact of technological changes including, specifically, the growth of online marketing and sales activity; (x) the Company’s ability to manage its growth effectively, including its ability to successfully integrate any business it might acquire; (xi) rising wages and benefits; (xii) currency fluctuations; (xiii) international trade policies and their impact on demand for our products and our competitive position, including the imposition of new tariffs or changes in existing tariff rates; and (xiv) other risks and uncertainties indicated from time to time in the Company’s filings with the Securities and Exchange Commission. For a more detailed discussion of these and other factors affecting the Company, see the Risk Factors described in Item 1A included in this Report Annual Report on Form 10-K and below under “Financial Condition”. All forward-looking statements in this report are based upon information available to the Company on the date of this report. The Company undertakes no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events, or otherwise, except as required by applicable law or regulation. Critical Accounting Policies & Estimates The following discussion and analysis of financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in conformity with generally accepted accounting principles in the United States of America. The Company’s significant accounting policies are more fully described in Note 2 of the notes to consolidated financial statements. Certain accounting estimates are particularly important to the understanding of the Company’s financial position and results of operations and require the application of significant judgment by the Company’s management and can be materially affected by changes from period to period in economic factors or conditions that are outside the control of management. The Company’s management uses its judgment to determine the appropriate assumptions to be used in the determination of certain estimates. Those estimates are based on historical operations, future business plans and projected financial results, the terms of existing contracts, the observance of trends in the industry, information provided by customers and information available from other outside sources, as appropriate. The following discusses the Company’s critical accounting policies and estimates: Estimates – Operating results may be affected by certain accounting estimates. The most sensitive and significant accounting estimates in the financial statements relate to customer rebates, valuation allowances for deferred income tax assets, obsolete and slow-moving inventories, potentially uncollectible accounts receivable, intangibles, accruals for income taxes, and stock-based compensation. Although the Company’s management has used available information to make judgments on the appropriate estimates to account for the above matters, there can be no assurance that future events will not significantly affect the estimated amounts related to these areas where estimates are required. However, historically, actual results have not been materially different than original estimates. Revenue Recognition – The Company's revenues result from the sale of goods or services and reflect the consideration to which the Company expects to be entitled. The Company records revenue based on a five-step model in accordance with Accounting Standards Codification ("ASC") 606, Revenue from Contracts with Customers ("ASC 606"). For its contracts with customers, the Company identifies the performance obligations (goods or services), determines the transaction price, allocates the contract transaction price to the performance obligations, and recognizes the revenue when (or as) the performance obligation is transferred to the customer. A good or service is transferred when (or as) the 17 customer obtains control of that good or service. Depending on the contractual terms of each customer, revenue is recognized either at the time of shipment “FOB Shipping Point” or upon delivery “FOB Destination" . When revenue is recorded, estimates of returns are made and recorded as a reduction of revenue. Customer rebates and incentives earned based on promotional programs in place volume of purchases or other factors are also estimated at the time of revenue recognition and recorded as a reduction of that revenue. Refer to Note 9 – Revenue from Contracts with Customers , in the notes to consolidated financial statements in this report for a more detailed discussion . Allowance for Doubtful Accounts – The Company provides an allowance for doubtful accounts based upon a review of outstanding accounts receivable, historical collection information and existing economic conditions. The allowance for doubtful accounts represents estimated uncollectible accounts receivables associated with potential customer defaults on contractual obligations, usually due to potential insolvencies. The allowance includes amounts for certain customers where a risk of default has been specifically identified. In addition, the allowance includes a provision for customer defaults based on historical experience. The Company actively monitors its accounts receivable balances, and its historical experience of annual accounts receivable write-offs has been negligible. Customer Rebates – Customer rebates and incentives are a common practice in the office products industry. We incur customer rebate costs to obtain favorable product placement, to promote sell-through of products and to maintain competitive pricing. Customer rebate costs and incentives, including volume rebates, promotional funds, catalog allowances and slotting fees, are accounted for as a reduction to gross sales. These costs are recorded at the time of sale and are based on individual customer contracts. Management periodically reviews accruals for these rebates and allowances and adjusts accruals when appropriate. Obsolete and Slow Moving Inventory – Inventories are stated at the lower of cost or net realizable value. Cost of inventories is determined by the first-in, first-out method. An allowance is established to adjust the cost of inventory to its net realizable value. Inventory allowances are recorded for obsolete or slow moving inventory based on assumptions about future demand and marketability of products, the impact of new product introductions and specific identification of items, such as discontinued products. These estimates could vary significantly from actual requirements if future economic conditions, customer inventory levels or competitive conditions differ from expectations. Income Taxes – Deferred income tax liabilities or assets are established for temporary differences between financial and tax reporting bases and are subsequently adjusted to reflect changes in tax rates expected to be in effect when the temporary differences reverse. A valuation allowance is recorded to reduce deferred income tax assets to an amount that is more likely than not to be realized. Intangible Assets and Goodwill – Intangible assets with finite useful lives are recorded at cost upon acquisition and amortized over the term of the related contract, if any, or useful life, as applicable. Intangible assets held by the Company with finite useful lives include patents and trademarks. The weighted average amortization period for intangible assets at December 31, 2021 was 9 years. The Company periodically reviews the values recorded for intangible assets and goodwill to assess recoverability from future operations whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. At December 31, 2021 and 2020, the Company assessed the recoverability of its long-lived assets and goodwill and believed that there were no events or circumstances present that would require a test of recoverability on those assets. As a result, there was no impairment of the carrying amounts of such assets and no reduction in their estimated useful lives. Accounting for Stock-Based Compensation – Stock based compensation cost is measured at the grant date fair value of the award and is recognized as expense over the requisite service period. The Company uses the Black-Scholes option - pricing model to determine fair value of the awards, which involves certain subjective assumptions. These assumptions include estimating the length of time employees will retain their vested stock options before exercising them (“expected term”), the estimated volatility of the Company’s common stock price over the expected term (“volatility”) and the number of options for which vesting requirements will not be completed (“forfeitures”). Changes in the subjective assumptions can materially affect estimates of fair value stock-based compensation, and the related amount recognized on the consolidated statements of operations. Refer to Note 11 – Stock Option Plans, in the notes to consolidated financial statements in this report for a more detailed discussion. Results of Operations 2021 Compared with 2020 Traditionally, the Company’s sales are stronger in the second and third quarters and weaker in the first and fourth quarters of the fiscal year, due to the seasonal nature of the back-to-school market. COVID-19 Pandemic Related Considerations As noted above under “Forward-Looking Statements” and the Risk Factors described in Item 1A included in this Report Annual Report on Form 10-K, in response to the COVID-19 pandemic U.S. federal, state, local, and foreign governments adopted mitigation measures, creating significant uncertainties in the U.S. and global economies, including the shutdown of large portions of, or imposition of restrictions on, the U.S. and global economies. Notwithstanding a general improvement in conditions and reduction of adverse effects from the pandemic, as of December 31, 2021 there continues to be significant uncertainty around the scope, severity, and duration of the pandemic, as well as the breadth and duration of business disruptions related to it and the overall impact on the U.S., global economies, and our operating results in future periods. Commencing late in the first quarter of 2020 and continuing through the filing of this report, the COVID-19 pandemic and certain related challenges have affected the Company’s financial results and business operations. These challenges include: difficulties in hiring employees for 18 its manufacturing and distribution centers due to current domestic labor shortages, increased labor costs, higher employee turnover compared to pre-pandemic levels. In addition, a portion of the Company’s workforce in its headquarters and elsewhere continue to work remotely. As a result, the Company has experienced and continues to experience operating inefficiencies. In addition, as economies have re-opened, global supply chains have struggled to keep up with increasing demand, and the resulting supply chain disruptions have, in certain cases, affected our ability to ship products in a timely manner. These supply chain disruptions and the increase in demand have also led to increased freight, labor and product costs that affected our operating margin in 2021, and those disruptions and increased costs are likely to persist in the near term and potentially for the foreseeable future. As a result, the Company, beginning in April 2020 and continuing through the end of 2021 and through the present has acquired and maintained additional inventory to minimize the impact of any potential disruption to its supply chain. The Company believes that it has sufficient inventory of its products to meet anticipated demand in the near future. However, any further increase in the duration or severity of the COVID-19 pandemic or a resurgence of the pandemic and the continuation of related supply chain and labor issues, might adversely affect the Company’s ability to manufacture, source or distribute its products both domestically and internationally. The occurrence of any of these factors could have a material adverse effect on the Company’s business, operations and financial condition. Further, the resurgence in the spread of COVID-19 toward the end of 2021 and into 2022 has created greater uncertainty regarding the economic outlook for the near term, even as vaccines have become widely available. The extent to which the COVID-19 pandemic will continue to affect the Company’s business, financial condition, liquidity and the Company’s operating results will depend on future developments, which are highly uncertain and cannot be predicted. Net Sales In 2021, sales increased by $18,084,519, or 11%, to $182,087,559 compared to $164,003,040 in 2020. The U.S. segment sales increased by 9%, in 2021 compared to 2020. Approximately 65% was attributable to strong sales of first aid and medical products, primarily due to continued market share gains in the industrial channel as well as increases in mass market and e-commerce channels. Approximately 35% of the growth came from strong sales of Westcott craft products. Net sales in Canada for the year ended December 31, 2021, increased 31% in U.S. dollars and 22% in local currency compared to the same period in 2020, primarily due to higher sales of first aid products. European net sales for the year ended December 31, 2021, increased 19% in U.S. dollars and 15% in local currency, compared with the same period in 2020. Approximately 75% of the increase was due to increased sales in the e-commerce channel across all brands. The remaining growth was mainly due to market share gains in Westcott cutting products Gross Profit Gross profit was 35.6% of net sales in 2021 compared to 36.3% in 2020. The decline was primarily due to cost inflation pressures and higher transportation costs, which equally contributed to the decline. Price increases have partially offset the cost increases. Selling, General and Administrative Selling, general and administrative (“SG&A”) expenses were $52,030,370 in 2021 compared with $48,182,050 in 2020, an increase of $3,848,320, or 8.0%. SG&A expenses were 28.6% of net sales in 2021 compared to 29.4% in 2020. Approximately 80% of the increase in SG&A expenses was due to higher commissions and shipping costs related to higher sales. The remaining increases was mainly due to added expenses related to the acquisition of Med Nap. Operating Income Operating income was $12,769,987 in 2021, compared with $11,412,664 in 2020, and increase of $1,357,323. Operating income in the U.S. segment increased in 2021 by approximately $649,000 over 2020, primarily due to higher sales. Operating income in Canada increased in 2021 by approximately $561,000 over 2020, primarily due to the acquisition of First Aid Central. Operating income in the European segment increased in 2021 by approximately $147,000 over 2020, primarily due to higher sales. Interest Expense, Net Net interest expense for 2021 was $908,223, compared with $919,709 for 2020, a decrease of $11,486. Other Expense Other expense was $194,877 in 2021 compared to $666,227 in 2020. The decrease in other expense is primarily related to a one-time non-cash charge of approximately $750,000 related to the termination of the Company’s Defined Benefit Pension Plan in 2020. 19 Income Tax Expense Income tax expense was $1,519,255 in 2021, resulting in an effective tax rate of 10% compared to 1,727,962, an effective tax rate of 18% in 2020. Income tax expense in 2021 included a $1.4 million tax credit for stock-based compensation. The Company’s effective tax rate for the year ended December 31, 2021, excluding the tax credit and the income from the PPP Loan forgiveness was 24%, compared to 21% in 2020. The higher effective tax rate in 2021 is due to a higher proportion of earnings in jurisdictions with a higher tax rate. Off-Balance Sheet Transactions The Company did not engage in any off-balance sheet transactions during 2021. Liquidity and Capital Resources During 2021, working capital increased by approximately $11.5 million compared to December 31, 2020. Inventory increased by approximately $3 million, or 6%. The increase was primarily due to anticipated growth in our business as well as the acquisition of product to offset the impact of potential supply chain interruptions. The Company expects that changes in inventory levels will continue to be consistent with changes in sales, including the seasonal impact on the Company’s revenue stream. Inventory turnover calculated using a twelve-month average inventory balance, was 2.3 at December 31, 2021 as compared to 2.3 at December 31, 2020. The reserve for slow moving and obsolete inventory was $1,554,217 at December 31, 2021 compared to $1,471,925 at December 31, 2020. We do not anticipate material increases in the allowance for slow moving and obsolete inventory in the ordinary course of business during 2022. Receivables increased by approximately $7.0 million at December 31, 2021 compared to December 31, 2020. The increase is primarily due to higher sales in the second half of the fourth quarter. The average number of days sales outstanding in accounts receivable was 60 days in 2021 compared to 60 days in 2020. Long-term debt consists of (i) borrowings under the Company’s revolving loan agreement with HSBC Bank, N.A. and (ii) amounts outstanding under the fixed rate mortgage related on the Company’s manufacturing and distribution facilities in Rocky Mount, NC and Vancouver, WA. The revolving loan agreement provides for borrowings of up to $50 million at Prime Rate less 1.25%. The credit facility has an expiration date of May 24, 2023. The Company must pay a facility fee, payable quarterly, in an amount equal to two tenths of one percent (.20%) per annum of the average daily unused portion of the revolving credit line. The facility is intended to provide liquidity for working capital, growth, share repurchases, dividends, acquisition and other business activities. Under the revolving loan agreement, the Company is required to maintain specific amounts of tangible net worth, a specified debt to net worth ratio and a fixed charge coverage ratio and must have annual net income greater than zero, measured as of the end of each fiscal year. At December 31, 2021, the Company was in compliance with the covenants then in effect under the loan agreement. At December 31, 2021, total debt outstanding under the Company’s revolving credit facility decreased by approximately $5.7 million compared to total debt at December 31, 2020. As of December 31, 2021, $33,037,172 was outstanding and $16,962,828 was available for borrowing under the Company’s revolving credit facility. On May 7, 2020, the Company received a two-year loan (the “PPP Loan”) from HSBC Bank USA, N.A., the lender, in the amount of $3,508,047 under the Paycheck Protection Program established by the Coronavirus Aid, Relief and Economic Security Act (CARES Act). Under the CARES Act, all or a portion of the PPP Loan was eligible to be forgiven by the U.S. Small Business Administration (“SBA”) and the lender, upon application by the Company, provided that the Company shall have used the loan proceeds for certain eligible purposes. The PPP Loan was fully forgiven by the SBA and on June 9, 2021, payment in the amount of $3,508,047 was made by the SBA to the lender. The Company recorded the amount forgiven as income during the year ended December 31, 2021. The Company’s manufacturing and distribution facilities in Rocky Mount, NC and Vancouver, WA were financed by a fixed rate mortgage with HSBC Bank, N.A. at a fixed interest rate of 3.8%. The Company entered into the agreement on December 1, 2021. Payments of principal and interest are due monthly, with all amounts outstanding due on maturity on December 1, 2031. The outstanding principal on December 31, 2021, was $11,620,000. Capital expenditures during 2021 and 2020 were $6,372,615 and $2,569,174, respectively, which were, in part, financed with borrowings under the Company’s revolving credit facility. The increase is primarily related to improvements at our distribution center in Rocky Mount, NC including new HVAC (approximately $2 million) and warehouse management systems (approximately $1 million). The Company believes that cash on hand, and cash generated from operating activities, together with funds available under its revolving credit facility, are expected, under current conditions, to be sufficient to finance the Company’s planned operations for at least the next twelve months from the issuance of this Form 10-K. Recently Issued and Adopted Accounting Standards In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. The update eliminates, clarifies and modifies certain guidance related to the accounting for income taxes. ASU 2019-12 is effective for annual reporting periods beginning after December 15, 2020. The adoption of ASU 2019-12 did not have a material effect on the Company’s consolidated financial statements. In January 2017 , the FASB issued ASU No. 2017 - 04 , Intangibles – Goodwill and Other (Topic 350 ): Simplifying the Test for Goodwill Impairment . The amendments in this update eliminate Step 2 from the goodwill impairment test. The annual, or interim, goodwill impairment 20 test is performed by comparing the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. In addition, income tax effects from any tax-deductible goodwill on the carrying amount of the reporting unit should be considered when measuring the goodwill impairment loss, if applicable. The Company adopted this standard on January 1, 2020 . The adoption of this standard did not have an impact to the financial statements of the Company. Item 7A. Quantitative and Qualitative Disclosures about Market Risk As a smaller reporting company, the Company is not required to provide this information.