Acme United Corporation
Q2 2018 Earnings Call Transcript

Published: 20 Jul 2018

[Operator:]

Good day, ladies and gentlemen. And welcome to the Acme United Corporation Second Quarter 2018 Earnings Call. At this time, I would like to turn the conference over to Walter Johnsen. Please go ahead, sir.

[Walter Johnsen:]

Good morning. Welcome to the second quarter 2018 earnings conference call for Acme United Corporation. I am Walter C. Johnsen, Chairman and CEO. With me is Paul Driscoll, our Chief Financial Officer, who will first read Safe Harbor statement. Paul?

[Paul Driscoll:]

Forward-looking statements in this conference call, including without limitations, 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, including without limitation the following; One, the Company's plans, strategies, objectives, expectations and intentions, are subject to change at any time at the discretion of the Company; Two, the Company's plans and results of operation will be affected by the Company's ability to manage its growth; And three, other risks and uncertainties indicated from time-to-time in the Company's filings with the Securities and Exchange Commission.

[Walter Johnsen:]

Thank you, Paul. Acme United reported second quarter 2018 net sales of $39.8 million compared to $38.8 million in 2017, an increase of 2%. Our net income for the quarter was $2.4 million compared to $2.8 million during the same period last year. Net sales in the second quarter for the first aid and safety business increased 7% to a new record. Our Westcott back-to-school products declined 5%, which we believe reflect a shift in our online sales close to the times students go back to class and what we have made up in our third quarter. Our Cuda fishing tools, Camillus knives and DMT sharpeners, had record sales for the second quarter. Canadian sales decreased 1%, while European sales grew 14%. Our gross margins in the second quarter were 37%, which is the same as for the comparable period in 2017. The first and second rounds of U.S. tariffs have not had an impact on our product costs. However, we may have savings in the future from the strengthening of the U.S. dollar compared to the Chinese RMB. During the second quarter, we continued to improve our operating performance at our Rocky Mountain, North Carolina distribution facility. This is gratifying since our team worked very hard during the past 12 months to become more efficient and we are seeing the results. As you may recall from prior calls, steps included adding experienced executives and managers to improve the accuracy, speed and cost of deliveries; install new software modules to improve the efficiency of the pick lines and building mezzanine level for storage of online products close to the point of shipment. We’ve started the third quarter strongly, including large back-to-school and online orders. Although, it is early in the quarter, Westcott sales through yesterday was strong including sales through Amazon. We plan to begin to roll out new first aid and safety products to a large industrial distributor during the third quarter, and expect strong Cuda fishing and Camillus hunting sales during the next six months. As we look into the remainder of the year, we are reaffirming the guidance we provided in April of $140 million in net sales, $5.7 million net income and $1.53 earnings per share. I will now turn the call to Paul.

[Paul Driscoll:]

Acme’s net sales for the second quarter were approximately $40 million compared to approximately $39 million in 2017, an increase of 2%. Sales for the six months ended June 30, 2018 were $72 million compared to $67 million in the same period in 2017, an increase of 7%. Net sales in the U.S. segment increased 2% in the quarter and 7% for the six months ended June 30th. Net sales in local currency for Canada decreased 5% in the quarter and were constant year-to-date. Net sales for Europe increased 5% in local currency for the quarter and 7% for the six months ended June 30th. The sales increase for both periods was primarily due to new customers in the office channel, as well as higher sales in DMT sharpening products. Gross margin was 37% in both the second quarter of 2018 and ’17. Year-to-date, gross margin was 38% compared to 38% in last year’s period. SG&A expenses for the second quarter of 2018 were $11.1 million or 27.9% of sales compared with $10.6 million or 27.3% of sales for the same period of 2017. SG&A expenses for the first six months of 2018 were $21.9 million or 31% of sales compared with $20 million or 30% of sales in 2017. The SG&A increase for the three and six months was due to higher variable selling costs and the addition of sales and marketing personnel. Net income for the second quarter 2018 was $2.4 million or $0.67 per diluted share compared to net income of $2.8 million or $0.75 per diluted share for the same period of 2017. Net income for the first six months ended June 30th was $3.2 million or $0.88 per diluted share compared to $2.5 million or $0.94 per diluted share in the comparable period last year. The Company's bank debt less cash on June 30, 2018 was $46 million compared to $41.3 million on June 30, 2017. During the 12 month period, we purchased our first aid manufacturing and distribution facility in Vancouver, Washington for $4 million and paid $1.5 million in dividends. Inventory increased $6.9 million, mostly in anticipation of new business. We expect to end 2018 with approximately $37 million of net debt and to generate approximately $4 million of free cash flow. On May 24th, we renewed our $50 million loan facility with HSBC. The maturity was extended from three to five years and the interest rate was reduced from LIBOR plus 2% to LIBOR plus 1.75%.

[Walter Johnsen:]

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

[Operator:]

Thank you [Operator Instructions]. And we will take our first question from Michael Kawamoto with D.A. Davidson.

[Michael Kawamoto:]

Just on the first-aid business, it’s great to see another quarter of solid performance. Can you just elaborate on the strength you’re seeing there? And then maybe talk about the safety hub and any traction you’re seeing there as well?

[Walter Johnsen:]

One of the first thing is the first aid business is a strong business for us. And we have gained some major distribution, which is gradually rolling out through this year and will continue into next at higher levels. We won the largest industrial distributor in the United States at year-end and that begins to be shipping in volume the new business does during the third quarter and continues. We also initiated a major distribution arrangement with a food service company that is now taking this product throughout its entire customer base. And that’s very exciting to us and we’re hopeful that that piece of business becomes one of our largest customers in the company. The safety hub, as you may recall, allows a customer to record the use of components in first aid incidents. At the time the products are being used, those are then relates to the safety manager who can refill our cabinets. And more importantly, when minimum order quantities are reached, it automatically places fulfillment orders to the distributor that’s servicing the account. And our distributors love this product, because it has tightened the link between the original product sell and the ongoing annuity of refills. We give this product away for free and we train their sale force. I believe it’s one of the reasons that we’ve been successful out in the market place, lending these major distribution partners. The other thing that we’ve done is migrated from a variable rate commission basis in many sections of the country to direct sales basis where our first aid salespeople, our full time employees and are dedicated to driving, both our SmartCompliance first-aid kits, as well as our general safety items. And this is having strong benefit to us. So as we’re looking into the year, we’ve had a very good first half and the second half. We believe it’s going to be stronger.

[Michael Kawamoto:]

And then I think ICAST was a couple of weeks ago. Can you just talk about any takeaways you have there and the reception of your Cuda product?

[Walter Johnsen:]

So the ICAST is the largest fishing show in United States, and it’s held each year at least for the last several years in Orlando, Florida. We had an excellent show with a lot of fishing pros in attendance. We’ve had major buyers from chains coming to us to expand the line for next year. And so the goal is not only visibility, but also to close future business. And we achieved both of them this past -- several weeks ago.

[Michael Kawamoto:]

And last or couple more for me. Do you expect this trend of buying closer to use to continue with the growth of your online sales? Or do you see a more normal seasonal growth pattern going forward? And then, I think there was an impact from hurricanes and maybe a difficult retail environment that weighed on 3Q growth last year. So as we model the back half, would you expect more growth in 3Q this year, given the easier comp?

[Walter Johnsen:]

First, the online business. It’s not just our Amazon and walmart.com growth, but all of our retail customers have online businesses. So even though, we don't -- we're unable to break out some of the customers’ online business, we can see it in the order patterns. And we know that, for example Staples with Staples.com, with Target doing in Target.com, Home Depot does their thing, Office Depot does online business, Walmart does of course And so it’s this aggregate of being closer to the customer, it’s not just Amazon. However, Amazon is now our number two or number one customer depending on the quarter and it’s growing very, very quickly. So its impact would arguably continue to be shifting products next year and in the future from the second quarter for back-to-school into the third. And we’re clearly seeing it right now in the July orders.

[Michael Kawamoto:]

And then just last one. I think last time you said free cash flow is $4 million to $5 million, and you said $4 million this quarter. What’s the difference there?

[Paul Driscoll:]

The main difference is the inventory forecast that we had done earlier was slightly lower than what we’re forecasting today. I think, we’re going to make a lot of progress with our inventory. And we’re going to reduce it between now and the end of the year, but not necessarily as aggressively as I thought three months ago.

[Operator:]

And we’ll take our next question from [Alan Kaplan].

[Unidentified Analyst:]

I am a long time shareholder, and I noticed that in 2017 or before 2017, you awarded an atypical and extraordinary number of options. And I am wondering if you could comment on that?

[Walter Johnsen:]

I am not really prepared to, Alan, because I don’t know exactly what you’re talking about.

[Unidentified Analyst:]

Unless I’ve made a mistake, I thought that the number of options in your 10-K show that the number of stock options awarded for 8% of your total number of shares. Am I incorrect in that?

[Walter Johnsen:]

We’d be happy to get back to you on that. So maybe after the call, you can call and we’ll get the facts.

[Operator:]

And we will move onto Brad Shiveley with Capital Management Corporation.

[Brad Shiveley:]

Walter, I’m stepping in for Tim today on the call here. I just want to ask you around the -- it looks like you got quite the staff since last quarter and is this setting you up to better be prepared to fulfill Internet orders. And so should Q3 margins rebound, do you think, from last year's lower levels?

[Walter Johnsen:]

Paul, why don’t you go over that one?

[Paul Driscoll:]

I think your question was did we add staff, is that -- I didn’t catch that word.

[Brad Shiveley:]

Yes, did you add staff since last quarter?

[Paul Driscoll:]

Well, we added the staff more in the second half of last year, they weren’t recent staff additions. What was the second part of your question?

[Brad Shiveley:]

Well, do you think this should help you see margins rebound from the last year lower levels?

[Paul Driscoll:]

The addition of staff for sales and marketing so it drives sales in the future, it’s not necessarily to effect margins.

[Brad Shiveley:]

And then moving on, you seem to be showing pretty strong reoccurring Internet sales growth and a rebound in margins from Q3 2017 levels. Could that impact your full year guidance, and essentially prove that to be a little too conservative you think?

[Paul Driscoll:]

I think we want to wait until we finish the third quarter to determine if we’re going to change our guidance at this point…

[Walter Johnsen:]

One thing that you should note perhaps is that when we're doing online sales, particularly with the back-to-school items, it should be increasingly gross margin because it’s more efficient delivery and we’ll see if that occurs. But this seems to be happening.

[Brad Shiveley:]

And then also around the Internet sales, I might have missed it, I think someone might have asked this. But they seem like they continue to have continued strong growth there about 100%. Do you believe this might impact Q3 sales growth to approach 50% overall, total Q3 sales?

[Walter Johnsen:]

No, I don’t expect Internet sales to approach 50% of our total sales, but they’re continuing to be strong. And at some point, it has to top out and it will be more aligned with what online sales are growing. But we’re gaining market share right and that’s in both in first aid, as well as in the Westcott family. So it’s a good time.

[Operator:]

And we’ll take a question from Justyn Putnam with Talanta Investment Group.

[Justyn Putnam:]

So I was just wondering if you might comment a little bit on what you’re seeing in the overall retail environment, especially maybe compared to last year or two.

[Walter Johnsen:]

Well, as you know, the retail stores are certainly changing the complexion of how things get sold. And in the case of the office products business, which is a much smaller part of our business than it used to be, it’s still about a quarter of the revenues. And within that, more is business direct sales so that would be with truck delivery to various locations and business-to-business delivery. The retail emphasis at Staples and Office Depot continues to decline. The contract business continues to increase. The online businesses also are increasing, and that’s where most of the retail business is winding up, I believe. The stores such as, Walmart, have been very, very aggressive in implementing online business, and we’ve been working hand-in-hand with them. That’s I think consistent with what's happening with online deliveries in total. And I think the mass market stores, particularly Walmart, are absolutely in tune with what the overall market is doing. Relative to the back-to-school, the latest report by Deloitte that I reviewed, suggested that we should have a pretty strong back-to-school, so not for us specifically but in the aggregate. So we’re looking forward to that.

[Justyn Putnam:]

We’ve seen some recent macro retail data that’s, I think, little bit encouraging, little bit improvement. And I am just trying to get a sense of if that’s a tailwind that you’re seeing as well or not?

[Walter Johnsen:]

Within our online businesses, we’re gaining share. So sometimes you’re not quite sure whether it’s the macro environment overall retail or whether -- we’re just doing a more effective job. But the reports I am seeing suggest that, at least in the back-to-school, it should be very strong back-to-school and better than last year.

[Operator:]

And we have a question from Richard Dearnley with Longport Partners.

[Richard Dearnley:]

I think to continue on the higher margins on back-to-school, that’s being online. So does that mean that the Staples business -- you’re seeing more of the volume go through Staples online or -- as opposed to the store? In other words, the women -- the shopper isn’t going to the store, she's just doing it online through Staples to you?

[Walter Johnsen:]

Staples doesn’t break out to us how the sales are being -- how the products are being sold, whether it’s online, or contract, or through the retail stores. But with the store checks, we see less apparent activity in the stores than we remember and it used to be. The margins occur because we make better margins in our Westcott product family on some of the online retailers than we do with some of the superstores.

[Richard Dearnley:]

I guess, the question was getting to the office supply, people's traffic, just instead of traffic in the stores, it's going to online, which I guess has been going on for a while.

[Walter Johnsen:]

Yes.

[Richard Dearnley:]

And the tariffs, the proposed tariffs didn't affect you at all?

[Walter Johnsen:]

The first round of tariffs were for basically unfinished Chinese steel and aluminum, and that was 25% tariff. It included some other items, but -- like ball bearings. But by enlarge that’s what it was and that certainly didn’t impact us. The second round, which was the 10% tariff related to other items that we’re bringing in steel that was basically unfinished steel, it was also some chemicals. But the products like ours, which are made in China, Chinese steel and they don’t have U.S. competitors really, it just -- it was a non-event. The second round of tariff also affected some of the steel and the refrigerators and washing machines that came in from China, for example, through Haier. And that compensated in part, because of the raw material cost but would increase for domestic manufacturer. Again, that didn’t impact us. What has impacted us is that the dollar has strengthened against the Chinese currency to the order of about 7.7% since my trip in May. And since we buy in dollars a portion of their products, we might anticipate some improvement in our product cost due to the currency during the future quarters.

[Richard Dearnley:]

Do you hear any chatter that the currency depreciation is China’s way of striking back at our tariff?

[Walter Johnsen:]

Well the exchange rate is -- not in tariffs that’s [Multiple Speakers] and the Chinese do have a complex equation. I wouldn't be surprised if they have some impact in that.

[Richard Dearnley:]

You mentioned that Cuda cutting was strong. Is that specifically excluding Cuda’s non-cutting, or was it…

[Walter Johnsen:]

The entire Cuda family, which is primarily knives for fishermen, but that whole family is doing very well this year.

[Operator:]

And we have a follow up question from Michael Kawamoto with D.A Davidson.

[Michael Kawamoto:]

Just one more quick one. You guys have done a pretty great job of innovating this across the portfolio, and you highlighted some new things you’re doing in first aid. But I was wondering if you could talk about some of the new product innovation you guys working on, maybe over the next 12 months that are coming to market?

[Walter Johnsen:]

One of the things that we have announced, perhaps the most important, is the backend analytics that will be available with our safety hub, our online reordering app. And it will allow the safety managers and large corporate entities to be able to evaluate where the accidents are occurring, what types of accidents they are within the sites and how they’re being treated with our first-aid products. Those analytics may eventually include being able to do comparative analysis with an industry as we rollout that software throughout our customer base. That's pretty powerful and our customers love it, so that’s significant. We’ve shown to a number of customers the line of new scissors that we’ll be getting in retail chains next year. And I don’t want to go into too much detail with that, but they’re all in the Westcott family. We’ve extended the Glue Gun business with additional segmentation for different types of glues. Also, a broader line including some that are lighter weight and some that are heavier weight glue guns, and we’re getting good reception from those. The Cuda fishing area has a whole line of professional tools that are now being shown into the commercial fishing market, and for the food preparation market. We don't know yet whether that’s going to be meaningful or whether it will be, but there seems to be a lot of interest with the food processing industry with these products. The Camillus knives have recently won the Boys Scout Knives for Eagle Scout and that’s about $1 million new piece of business, and that comes out in the second half. And we’re shipping some of that in Q3. So this is quite a portfolio of items that we’re rolling through, and that would be pretty much consistent with what we’ve done every year.

[Operator:]

And we’ll take our next question from Jeffrey Matthews with Ram Partners.

[Jeffrey Matthews:]

The inventory build, 19% build versus the 2% sales increase. And it sounds like based on your cash flow, your free cash flow forecast at this point, it was somewhat of a surprised inventory build. And you would expect that if sales come in a little lower than anticipated. But what I'm trying to square is you're saying that the inventory build was related to new products, new customers. And I wonder why would it grown so much…

[Walter Johnsen:]

Well, let me give you a little color on that. We’ve landed a major piece of new business in the food service area, and those products are rolling out as we speak. And it’s throughout the entire customer base of this large distributor. We’ve also won, as I’ve mentioned, the largest industrial distributors in the U.S. first aid business and that’s preparing to be shipped. There is another aspect, which is some of the direct sourcing of our components that are coming from China. And that’s taking a longer delivery cycle, longer supply chain than a domestic manufacturer, but there is sizable savings by doing that. And so some items we added a quite a bit of first aid components that are now imported directly from China, and that will be rolling into our gross margins in first aid as we begin to utilize those products.

[Jeffrey Matthews:]

And then your space at Rocky Mount, you seem to be doing all things there. Do you have -- this sounds like a goofy question given how the big the space was, and I remember visiting it a few years ago when you weren’t utilizing much of it at all. Do you have enough room down there? Is that -- you ever going to run out of space there and need more?

[Walter Johnsen:]

Well, we’ve modeled to be able to pretty easily accommodate about $160 million in sales out of there. And I think that’s a probably pretty accurate today as well. We are adding more capacity in first-aid into that facility and restoring more raw materials than we had originally when we more of these items were sourced indirectly in the U.S., which would have had faster delivery times just in time delivery, but substantially more expensive. So we’ve been utilizing that space and we anticipate to be driving down the cost to some of our first aid kits. The 33 acres that are there, there is plenty of room for an expansion if we wanted to build another facility, but I don't see doing that in the near-term. Rather I see utilizing some of our other locations that we are in tight situation, so it’s adequate.

[Jeffrey Matthews:]

And then my final question is you’re adding people, you talked about like a lot of other companies are. Is it getting tougher? Is your turnover higher? And are your expenses going up higher than you might have thought when you were doing the budget last year?

[Walter Johnsen:]

The ability to attract and maintain an organization is critical thing to do. And we’ve got to take competitive prices for that, wages and benefits and there is some upward movement in that for sure. The recruiting for some key positions has been more expensive than we expected but the quality of the people are excellent, and so I wouldn't say there is any surprises here. But there is clearly -- it’s a competitive market to keep your people, and we’re competitive.

[Operator:]

And we have a question from Richard Dearnley with Longport Partners.

[Richard Dearnley:]

Did you all write the backend analytics app in-house?

[Walter Johnsen:]

Yes.

[Operator:]

And we have question from Steve Chick with Yucaipa.

[Steve Chick:]

Walter, I was wondering if you could quantify the dollar sales impact of the Westcott back-to-school shift that it had on the quarter. And then given your comments on the strength you’re seeing of the online order and back-to-school trends to-date in this quarter, can we expect to get that equivalent dollar sales, I guess, back in Q3?

[Walter Johnsen:]

I haven’t done that analysis, Steve and I am not I’d be able to share it with you, but we’re clearly seeing changes from last year. And the aggregate isn’t done for the back-to-school, so I am not sure what’s coming in the rest of July and August compared to what didn’t ship in June. But what I can tell you is that we’re running substantially ahead of last year in the July Westcott shipments substantially ahead.

[Steve Chick:]

And then second thing on the first aid business, which obviously looks good, the 7% growth rate. Do you have -- I know you added I think some new business in the first quarter. Do you have what that growth rate was in the first quarter this year? And then given that what you’re adding, you expect to add in the second half with some customer business. Can we assume that the growth rate in the second half will be higher than that 7%?

[Walter Johnsen:]

I’ll let Paul address this one.

[Paul Driscoll:]

The growth rate was 24% in the first quarter, 17% in the second quarter. For the remainder of the year, it will be in excess of 7% but probably more than 10%.

[Steve Chick:]

So what you say is 24% in Q1, 7% in Q2 as you reported today, and then it’ll be in excess of the 7% in the second half. That’s where you’re assuming?

[Paul Driscoll:]

Right.

[Operator:]

[Operator Instructions] And it appears we have no further questions in the queue. I would like to turn the conference back over to our speakers for any closing remarks.

[Walter Johnsen:]

Thank you. If there are no further questions then this call is complete. We look forward to updating you in October regarding our continued progress. I’d like to thank you for joining us. Good bye.

[Operator:]

Once again, ladies and gentlemen, that concludes today’s conference. We appreciate your participation today.