ACU Acme United Corp

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Item 2. 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 by the Company pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995.

These forward-looking statements include statements of the Company’s plans, objectives, expectations, estimates and intentions, which are subject to change based on various important factors (some of which are beyond the Company’s control). The following factors, in addition to others not listed, could cause the Company’s actual results to differ materially from those expressed in forward looking statements: the strength of the domestic and local economies in which the Company conducts operations, the impact of uncertainties in global economic conditions, changes in client needs and consumer spending habits, the impact of competition and technological change on the Company, the impact of any loss of a major customer, whether through consolidation or otherwise, the Company’s ability to manage its growth effectively, including its ability to successfully integrate any business or assets which it might acquire, and currency fluctuations. For a more detailed discussion of these and other factors affecting us, see the Risk Factors described in Item 1A included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2015. 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 law.

Critical Accounting Policies

There have been no material changes to the Company’s critical accounting policies and estimates from the information provided in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2015.

Results of Operations

On February 1, 2016, the Company purchased certain assets of Vogel Capital, Inc., d/b/a Diamond Machining Technology (DMT), located in Marlborough, MA. DMT products are leaders in sharpening tools for knives, scissors, chisels and other cutting tools. The DMT products use finely dispersed diamonds on the surfaces of sharpeners. The Company purchased inventory, accounts receivable, equipment, patents, trademarks and other intellectual property for $6.97 million using funds borrowed under its revolving credit facility with HSBC. Additional information concerning the acquisition of DMT assets is set forth in Note 8 – Business Combinations, in the Notes to Condensed Consolidated Financial Statements.

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.

Net sales

Consolidated net sales for the three months ended September 30, 2016 were $31,913,000 compared with $29,903,000 in the same period in 2015, a 7% increase. Consolidated net sales for the nine months ended September 30, 2016 were $98,198,000, compared with $86,694,000 for the same period in 2015, a 13% increase.

Net sales for the three and nine months ended September 30, 2016 in the U.S. segment increased 9% and 15%, respectively, compared with the same periods in 2015. Sales in the U.S. for the three and nine month periods increased compared to the same periods last year, primarily due to higher sales of Westcott school and office products, as well as higher sales of first aid products and incremental sales resulting from the acquisition of DMT.

Net sales in Canada for the three months ended September 30, 2016 decreased 5% in U.S. dollars (4% in local currency). Net sales in Canada for the nine months ended September 30, 2016 decreased 2% in U.S. dollars but increased 3% in local currency compared with the same period in 2015.

European net sales for the three months ended September 30, 2016 declined 12% in both U.S. dollars and local currency compared with the same period in 2015. The decline in sales was primarily due to the timing of a shipment of promotional products to a mass-market customer. In 2015, the promotion occurred in the third quarter; in 2016, the promotion occurred in the second quarter. European net sales for the nine months ended September 30, 2016 increased 4% in both U.S. dollars and local currency. The increase in net sales for the nine months was primarily related to market share gains in the office products channel.

Gross profit

Gross profit for the three months ended September 30, 2016 was $11,863,000 (37.2% of net sales) compared to $10,325,000 (34.5% of net sales) for the same period in 2015. The increase in gross profit was primarily due to a favorable product mix. Also, in the third quarter of last year, the Company incurred approximately $150,000 of one-time moving and severance costs associated with consolidating its first aid operations into its Vancouver, Washington facility. Gross profit for the nine months ended September 30, 2016 was $35,743,000 (36.4% of net sales) compared to $31,296,000 (36.1% of net sales) in the same period in 2015.

Selling, general and administrative expenses

Selling, general and administrative ("SG&A") expenses for the three months ended September 30, 2016 were $9,723,000 (30.5% of net sales) compared with $8,334,000 (27.9% of net sales) for the same period of 2015, an increase of $1,389,000. SG&A expenses for the nine months ended September 30, 2016 were $28,008,000 (28.5% of net sales) compared with $24,603,000 (28.4% of net sales) in the comparable period of 2015, an increase of $3,405,000. The increases in SG&A expenses for the three and nine months ended September 30, 2016, compared to the same period in 2015 were primarily the result of incremental fixed costs resulting from the acquisition of DMT assets, increases in delivery costs and sales commissions which resulted from higher sales and higher personnel related costs, which include compensation and recruiting costs.

Operating income

Operating income for the three months ended September 30, 2016 was $2,140,000 compared with $1,991,000 in the same period of 2015. Operating income for the nine months ended September 30, 2016 was $7,735,000 compared to $6,693,000 in the same period of 2015. Operating income in the U.S. segment increased by $123,000 and $760,000 for the three and nine months ended September 30, 2016, respectively, compared to the same periods in 2015. The increases in operating income were principally due to higher sales.

Operating income in the Canadian segment increased by $118,000 and $356,000 for the three and nine months ended September 30, 2016, respectively, compared to the same periods in 2015.

Operating income in the European segment decreased by $94,000 and $74,000 for the three and nine months ended September 30, 2016, respectively, compared to the same periods in 2015.

Interest expense, net

Interest expense, net for the three months ended September 30, 2016 was $247,000, compared with $149,000 for the same period of 2015, a $98,000 increase. Interest expense, net for the nine months ended September 30, 2016, was $642,000 compared to $420,000 for the same period in 2015, an increase of $222,000. The increases in interest expense resulted from higher average borrowings under the Company’s bank revolving credit facility for the three and nine months ended September 30, 2016. The higher borrowings were primarily the result of the acquisition of assets of DMT, on February 1, 2016.

Other expense, net

Net other expense was $65,000 in the three months ended September 30, 2016 compared to $92,000 in the same period of 2015. Net other expense was $38,000 in the first nine months of 2016 compared to $149,000 in the same period of 2015. The decrease in other expense for the three and nine months ended September 30, 2015 was primarily due to lower losses from foreign currency transactions.

Income taxes

The Company’s effective tax rates for both the three and nine month periods ended September 30, 2016 were 19% and 25%, respectively, compared to 31% and 29% in the same periods of 2015. The decreases in the effective tax rate for the three and nine months ended September 30, 2016 were due to the Company generating a higher proportion of earnings in jurisdictions with lower tax rates.

Financial Condition

Liquidity and Capital Resources

During the first nine months of 2016, working capital increased approximately $11,251,000 compared to December 31, 2015. Inventory increased by approximately $2.6 million, or 7%, at September 30, 2016 compared to December 31, 2015, primarily due to normal seasonal purchases as well as additional inventory resulting from the acquisition of the assets of DMT on February 1, 2016. Inventory turnover, calculated using a twelve month average inventory balance, was 2.1 at September 30, 2016, compared to 2.0 for the twelve months ended December 31, 2015. Receivables increased by approximately $6.3 million at September 30, 2016 compared to December 31, 2015. The average number of days sales outstanding in accounts receivable was 63 days at September 30, 2016 compared to 64 days at December 31, 2015. The increase in accounts receivables was due to strong sales in the third quarter. Sales are typically stronger in the second and third quarters compared to the first and fourth quarters. Accounts payable and other current liabilities increased by approximately $1.4 million.

The Company's working capital, current ratio and long-term debt to equity ratio follow:

During the first nine months of 2016, total debt outstanding under the Company’s revolving credit facility increased by approximately $13.8 million, compared to total debt thereunder at December 31, 2015. As of September 30, 2016, $39,706,009 was outstanding and $10,293,991 was available for borrowing under the Company’s credit facility. The increase in the debt outstanding was primarily due to borrowings to fund the acquisition of assets of DMT on February 1, 2016, as well as to fund the increase in working capital. Increases in accounts receivable, inventory and debt outstanding under the Company’s revolving credit facility typically occur in the second and third quarter of each year due to the seasonal nature of the business.

On May 6, 2016, the Company amended its revolving credit loan agreement with HSBC Bank, N.A. The amended facility provides for borrowings of up to an aggregate of $50 million at an interest rate of LIBOR plus 2.0%. In addition, 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. All principal amounts outstanding under the agreement are required to be repaid in a single amount on May 6, 2019, the date the agreement expires; interest is payable monthly. Funds borrowed under the agreement may be used for working capital, acquisitions, general operating expenses, share repurchases and certain other purposes. Under the revolving loan agreement, the Company is required to maintain specific amounts of tangible net worth, a specified debt service coverage ratio and a fixed charge coverage ratio and must have annual net income greater than $0, measured as of the end of each fiscal year. At September 30, 2016, the Company was in compliance with the covenants then in effect under the loan agreement with HSBC.

As discussed in Note 2 to the Condensed Consolidated Financial Statements set forth in Item 1 above, at September 30, 2016 the Company had a total of approximately $67,000 remaining in its accruals for environmental remediation and monitoring, related to property it had owned in Fremont, NC.

The Company believes that cash expected to be generated from operating activities, together with funds available under its revolving credit facility will, under current conditions, be sufficient to finance the Company’s planned operations over the next twelve months.