Acme United Corporation
Q2 2008 Earnings Call Transcript

Published: 19 Jul 2008

[Operator:]

Good day everyone and welcome to Acme United’s second quarter 2008 earnings conference call. As a reminder this call is being recorded. At this time I would like to turn the call over to Mr. Walter Johnsen, Chairman and CEO.

[Walter C. Johnsen:]

Welcome to the second quarter 2008 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 a Safe Harbor statement.

[Paul G. Driscoll:]

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 including without limitation the following

[Walter C. Johnsen:]

Acme United had a strong second quarter of 2008. We reported record quarterly sales of $22.7 million an increase of 20% over last year. Our net income was $1.7 million or $0.41 per share 15% higher than the second quarter of 2008. We are exceeding the guidance we provided earlier in the year. Our back-to-school sales have been excellent. The Westcott family which is student scissors, rulers, and math kits has had strong orders from the major office superstores, mass market retailers, and drugstore chains in North America. Our antimicrobial school and office scissors are selling well. The iPoint pencil sharpeners are exceeding expectations. Acme sales of office products have been slower in summer counts this year compared to last but overall business has increased. We attribute this to new products and market share gain. Our Clauss professional line has also continued to grow. We have added new industrial distributors, hardware chains, and do-it-yourself accounts which are adding incremental sales. The industrious channel which is the Clauss core today is doing well. We have found the housing related chains to be slower to execute new product introductions perhaps because their existing inventory has been slow to sell. Our customer base has broadened substantially during the past several years. Not long ago the office products industry was our most significant segment with some mass marketing and international sales. Today we benefit from a much stronger presence in the mass market, drugstore chains, food chains and industrial accounts. Our Canadian and European businesses have grown. Shipments from Asia to international accounts have also increased. We believe this diversification of our customer base has provided the platform to continue to execute our growth plans. The speed pack utility knife and replaceable cartridges have now been placed in a number of major office superstores, industrial distributors, and hardware channels. There was minor growth from this product line during the first half but we expect it to contribute more significantly during the remainder of the year. Gross margins declined in the second quarter to 39% from 42% partly due to cost pressures but more significantly was the growth in direct import back-to-school sales which were incremental to our business. The margins were lower than our average but they increased our profitability and built our presence and market shares with our customers. At the beginning of 2008 we provided guidance of $70 million to $72 million in revenues and $4.5 million in net income. It appears that we will exceed the revenue guidance and that we are at least on track to meet the earnings target. I will now call the turn over to Paul Driscoll.

[Paul G. Driscoll:]

Acme’s net sales for the second quarter were $22.7 million compared to $19 million in 2007 an increase of 20% or 17% on local currency. Sales for the six months ended June 30, 2008 were $37 million compared to $31.2 million in the same period in 2007 an increase of 18% or 15% on local currency. Net sales in the US segment increased by 23% in the quarter and 21% for the six months ended June 30. A significant part of the increase was due to higher sales of the iPoint pencil sharpeners and new school scissors, rulers and math kits. Net sales for Canada increased by 4% in the quarter and year-to-date but decreased by 6% in local currency due to soft demands in the office products channel. Net sales for Europe increased by 19% in the quarter and year-to-date or 3% in local currency. Sales were negatively impacted by an inventory reduction program at a major retailer. We expect sales growth to improve in both Canada and Europe in the second half of the year. Gross margins were 39.3% in the second quarter of 2008 versus 42% in the comparable period last year. For the first six months of 2008 gross margins were 40.3% compared to 42.6% in 2007. The gross margin decline is mainly due to greater sales of the back-to-sale lower margin products and also higher product costs as the result of increased raw material and transportation costs and the appreciation of the Chinese currency. SG&A expenses for the second quarter of 2008 were $6.1 million compared with $5.4 million for the same period of 2007. SG&A expenses for the first six months of 2008 were $11 million or 30% of sales compared with $9.6 million or 31% of sales for the same period of 2007. The majority of the increase was due to the higher sales commissions and freight costs associated with higher sales and costs associated with the addition of marketing logistics and customer service personnel. Operating profit was $2.8 million in the second quarter of 2008 compared with $2.5 million in the second quarter of 2007. Operating profit for the six months ended June 30, 2008 was $3.9 million compared to $3.7 million in the same period of 2007. Operating profit for the US segment for the six months ended June 30 increased by approximately $50,000. Operating profit in Canada increased by $100,000 or 25% due to improved gross margins as a result of a better product mix. The European operating loss was $340,000 in the first six months of 2008 compared to an operating loss of $330,000 in the first six months of 2007. Results in local currency were slightly better. We expect improvement in the second half of the year in Europe as sales pick up. Net income for the second quarter of 2008 was $1,730,000 or $0.47 per diluted share compared to a net income of $1,522,000 or $0.41 per diluted share for the same period of 2007. Net income for the first six months ended June 30, 2008 was $2,482,000 or $0.68 per diluted share compared to $2,172,000 or $0.59 per diluted share in the comparable period last year. Interest expense for the six months has been reduced by approximately 40% mainly due to lower interest rates. Other income for the six months increased by $150,000 due to higher exchange rate gains. The company’s bank debt less cash on June 30, 2008 was $11.3 million compared to $9.6 million on June 30, 2007. We expect the net debt level to decline to approximately $6.5 million by the end of the year. During the 12-month period the company repurchased 68,000 shares of Acme stock for approximately $900,000. Last month the company revised its revolving loan agreement with Wachovia. The new 2-year facility increases availability from $15 million to $20 million and lowers the interest rate from LIBOR + 1% to LIBOR + 7/8%.

[Walter C. Johnsen:]

We will now open the call to questions.

[Operator:]

(Operator Instructions.) Our first question comes from Gary Holdsworth - Singular Research.

[Gary Holdsworth:]

You mentioned the speed packs having some distribution added in the quarter but I believe you said you think growth will accelerate in the back half as you add distribution. Is that correct?

[Walter C. Johnsen:]

Yes. Currently you can buy speed packs at Staples, I think it’s at Fred Meyer, it’s got a couple of locations where you can just go in and buy them but the volume in the hardware and do-it-yourself area and in the industrial accounts will begin to kick in we believe in the second half. The major industrial distributors send out their catalogs for 2009 in September and October. So they’ll be building inventory in preparation for sales in the fall and throughout the year and we have one large hardware chain that will be carrying and introducing the product we believe some time in the third quarter. So it will pick up.

[Gary Holdsworth:]

On your Microban products, have you been able to achieve a larger price point because of that feature and is that offsetting the royalty that you have to pay on that product?

[Walter C. Johnsen:]

The royalty is something that’s proprietary of course but it’s a product that has opened up a big chunk of the school business, and while the margins have been a little bit more competitive than in other areas, you will find the Microban in places you haven’t seen any of the Acme products in the past. When you go to back-to-school this year, I suggest some of our listeners go to Wal-Mart and Target and Rite Aid and Staples and Office Depot and look at some of the products that we’ve got. In the school area, it’s cracked open big segments for us.

[Gary Holdsworth:]

Any thought about new products that we haven’t discussed on the call or at least what your plans are for the next 12 months?

[Walter C. Johnsen:]

We have a very full calendar. We’ll be introducing quite a number of new school and office products in the cutting area; there’ll be some new iPoint razor pencil sharpeners, different designs, different price points; in the Clauss line there’ll be a much broader range of cutting implements; you can expect to see some knives coming out to the mass market, a higher priced one; in the safety area we’ll see we believe some very interesting items for the mass market that will be targeted for companies such as Target and Wal-Mart. So stay tuned. There’s a lot coming. And we’ll be making more announcements as we introduce these products formally in September and October.

[Gary Holdsworth:]

One question for Paul. This has to do with the inventory. I saw a large build in inventories and wondered if this is just seasonal or could you talk a little bit about inventory build?

[Paul G. Driscoll:]

The inventory increased by 26% over last June and a big part of that is just the normal sales growth and new products that we’re expecting in the third quarter.

[Gary Holdsworth:]

Nothing out of the ordinary as far as obsolescence?

[Paul G. Driscoll:]

No, nothing out of the ordinary. The extra amount there is new products.

[Gary Holdsworth:]

My final question is on guidance. You mentioned since the start of the year we all are aware we’ve had a deepening economic melee so to speak, but you’re reaffirming the revenue side in particular. I’m impressed with that since you’ve got $37 million through the first half and to get to the high end of your range you’re talking $35 million over the next two quarters. That’s pretty good compared to your history where your third and fourth quarters are good but they’re your second and third best quarters historically. Could you just comment a little bit on that, why you’re confident on your guidance on the revenue side?

[Walter C. Johnsen:]

First, on the revenue side, the back to school isn’t done and so while we’ve shipped the first way to fill the stores, the waves that follow to keep the store shelves filled haven’t been shipped yet, or they’re shipping in July and some in August. So, we’re expecting the second quarter momentum to continue in to the third and in fact, we’re seeing that. The second is the feedback introductions really haven’t shown yet in the first half but when Paul was talking about new products sitting in inventory some of it are received backs ready to go and they will be, we believe, shipping in some volume in the third and fourth quarters. Finally, we’ve introduced some items that are targeted for the Christmas season that we didn’t have last year and given our mass market distributions today that we didn’t have several years ago we’re expecting some stronger growth in the fourth quarter than have been historical. If we took our $37 million and doubled it, I think that might be aggressive but achievable. We made $2.5 million in the first half. If we doubled that it would be $5 million. We’re not expecting that because we’ve have some of these products would be lower margin but, the guidance we have is $4.5 million and we’re expecting to at least do that much. So, you can work backward for the second half.

[Operator:]

Our next question comes from Jeffrey L. Matthews – Ram Partners, LP.

[Jeffrey L. Matthews:]

Two questions from the introduction by Walter and Paul. One is Walter mentioned that gross margin was down partially due to the rising cost of goods but, you seem to stress another factor which I didn’t quite grasp.

[Walter C. Johnsen:]

I’ll address that first. The school market has shown a lot of growth in the second quarter. The 20% growth over the last year was primarily school products and they’re more competitive. They are also shipped in part directly from Asia so we don’t handle the product and we don’t warehouse them domestically. So, when they have somewhat lower margins they are still quite profitable and that frankly, was a bigger chunk of the margin decline than cost but costs is obviously something we’re living with all the time.

[Jeffrey L. Matthews:]

While we’re on that I’ll jump to my third question which relates to the manufacturing cost issue and there was a very good article today in the journal about the movement of manufacturing back to the US in certain cases and obviously what the dollar has done, things have changed a little bit. I wonder if now your biggest competitor has completely gotten out of manufacturing in the US and has gone to China is there any place to bring anything back here or is there anything else you’re doing on the manufacturing side to keep costs lower?

[Walter C. Johnsen:]

First, regarding bringing manufacturing of at least our product lines back to the US, I don’t see that happening for a while, if ever. It’s true that the dollar has depreciated compared to the Chinese currency by about 20% since the start of the float and that’s 20% of costs that we’ve had to absorb in some fashion. But, as we look at the global landscape on our product, there’s essentially no manufacturing of our products in Europe of the kinds of products that we’re selling, none left in Mexico, there’s none left in the US and there’s very, very small amount in Brazil. China has proven to be a very god place today and the last few years to manufacture. The cost advantages we have today compared to when we closed our plant nine years ago continue to be compelling, just plain compelling compared to even most historical costs. But there are some things that we have to deal with and when we look at our product design and our packaging and the productivity of our plants and the scrap rate and the automation, there’s a long way to go compared to Western standards. We’re working very hard to get our own productivity improved so that our costs are very competitive and they’ve historically been. The reason we’ve been able to manage big cost increases, the 20% currency for example with minor price increases is because of productivity. We’re putting a big emphasis there. We also believe that our competitors may or may not be thinking the same way but they should be because there are price points out in the marketplace for consumers and we want to make sure we’re staying in the sweet spot for our end user.

[Jeffrey L. Matthews:]

There was a comment about sales hurt by an inventory reduction program at a major retailer, was that Europe specifically?

[Walter C. Johnsen:]

Yes, that was kind of a silly thing. It was Schleker which is the largest drug chain in European and they made an acquisition which would eventually lead to more sales but in order to pay for it, they cut their working capital and then they wound up having quite a number of empty shelves. Now they’re scurrying back to get product back on the shelves. It was just a mix up.

[Jeffrey L. Matthews:]

Finally, if I could ask halfway through this year which has been a tumultuous year in a lot of regards, given what you’ve done with your guidance, how are you feeling about Acme’s competitive position and product and possibly risk of exposure to slowing sales at Office Depot and those kind of places?

[Walter C. Johnsen:]

We’re gaining market share, every day we’re out there in one of our new channels trying to get some account or introduce some new product and it literally seems to be that way. We feel that we’ve got a very, very attractive product line today and exciting new product introductions. The slowness in particular say in Office Depot is not alone in the office channel but they do have some specific issues. From my view, their geographic footprint in California and Florida, it’s not just with the housing industry, but also with the Dollar Stores and the Wal-Marts which are much more concentrated in areas where people have time and are able to shop and do price comparisons. Depot has had some I think impact there on their store traffic but overall we’re excited about where we’re heading. Relative to other companies that may be faltering, this is the time where we’d be very happy to be looking at some small tuck acquisitions.

[Operator:]

We’ll take our next question from Michael Wasserman – Moors & Cabot.

[Michael Wasserman:]

My questions were related a little bit to one of the last questions you took, but I was wondering if you could comment a little bit on the Chinese currency appreciation and your expectations going forward for that and what the implications for Acme are. Also if you could comment please on the results from Europe aside from this Schlecker short term issue relative to your expectations and previous year experience?

[Walter C. Johnsen:]

First, on the Chinese currency, currently it’s 6.85 RMB to the dollar. We started the year at just about 7, so there’s been about a 3% decline in currency in the first six months, a decline in the US buying power. There, in my view, seems to be a little bit of a delay in continuing that decline and this is really my view, but there’s a lot of factories closing in China right now and there’s a shifting of demand for some items and that’s impacting the Chinese employment, in part because they’ve already appreciated their currency 20%. That’s a big number over the past couple of years. From the US perspective, that will be translated in part into increased pricing and we’re seeing it in inflation and that’s factual. I think there’s going to be less pressure from the US side to continue push for devaluing the US currency further. I think that we may see some stabilization there. But that would be good news for us if it happened. We’re not running our business that way, that’s my personal view. The way we’re running it is we’re locking in our production against our future business bringing it in as soon as we can to keep our factories running stable. We have more inventory than one might like, but then again our interest rate is 3.4% today and it’s a very attractive rate and it insulates us somewhat from price increases. It also gives us time to react to give price increases. Relating to the results from Europe, Europe had a tougher quarter in the second one than we expected. Part of it was inventory reduction and that’s going back. I see the results continuing to improve. See the strange thing, unfortunately, is that the dollar has fallen quite a bit in the European currency so when you translate it into US dollars, even though you’ve made progress it tends to look a little worse than it actually is in local currency. The second half has started pretty strongly for Europe and we are working very, very hard to get that to be an asset, a real asset for the company. Analyst Mike And you’re happy with the changes you’ve made there in terms of personnel over the past couple of years?

[Walter C. Johnsen:]

I am Mike. I think our guys are working the sales side, the cost side, customer service side very, very well and up until this last quarter it’s been the fastest growing part of our business. This quarter was slowing but we’re seeing it come back in the third quarter.

[Operator:]

We will take our next question from Tom Spiro – Spiro Capital Management.

[Tom Spiro:]

Do you guys have any pricing initiatives under way or were there any recent price changes we should think about?

[Walter C. Johnsen:]

We’ve announced a price increase effective January 1st on almost all of our product lines. They’re consistent across our customers but they vary between products and they represent not the full cost of our increases but rather the full cost of what we think we’ll be able to do by the time they get shipped and I’m fairly comfortable that they’ll be more than adequate when they’re implemented in January.

[Tom Spiro:]

January 1st of 09?

[Walter C. Johnsen:]

Of 09.

[Tom Spiro:]

Secondly, Walter, you mentioned some of the success we’ve been having in the industrial channel, are there any names you can share with us, any particular distributors?

[Walter C. Johnsen:]

We’ve got products going into Grainger and that’s the largest industrial distributor in North America and Speed Pack can be carried there and a number of our scissors. The MSB and McMaster Car are other distributors carrying both Speed Pack and some of our new Clauss products. Northern Tools, these are all really top shelf and major industrial accounts so we’re excited about those. As I mentioned we’re introducing Speed Pack with a large do-it-yourself chain sometime we believe in the third quarter. We intend, if that happens, to support it with national advertising.

[Tom Spiro:]

You had a comment in your opening remarks though Walter, perhaps I misinterpreted it, that led me to think that that particular opportunity had been delayed somewhat.

[Walter C. Johnsen:]

There’s a lot of things that go on in accounts and part of it may have to do with just slow economics and moving products off shelves, part of it may be shorthanded people. We’re happy whenever these things finally happen.

[Tom Spiro:]

Lastly, the expanded credit line, anything in particular you’re thinking about using that for?

[Walter C. Johnsen:]

No, we could have had a bigger one but you pay unused credit fee of, for us, it was 0.25% annually. The attention was just some dry powder, we’ve got the ability to write a check and keep our eyes open.

[Operator:]

We will pause for just a moment. We will take a question from Chris Doucet – Doucet Asset Management.

[Chris Doucet:]

Just a couple of quick questions, Walter and I know you probably don’t want to answer this question but do you think that Europe is going to be break even, do you think it’s going to be slightly profitable or do you think the burn is just going to be reduced in 2008?

[Walter C. Johnsen:]

It’ll be reduced for sure.

[Chris Doucet:]

Also what kind of contribution do you think that Speed Pack will add to the top line in 2008?

[Walter C. Johnsen:]

That’s a tough one because a lot of things depend on the success of the customers when they receive them and right now we’ve had very limited sales in the first half. If I gave you a number I might be wrong, but I’m going to guess it was somewhere around a couple hundred thousand dollars in the first half. It wasn’t that big. When we look at other products it tends to be the first year is maybe $1 million in sales if it’s a good product. In the second year it might be $3 million to $5 million and then it gets legs and the family broadens and it’s bigger. I see probably somewhere between $500,000 and $1 million coming from it in the second half. Again, it’s just a quick estimate.

[Operator:]

Gentlemen, there are no further questions at this time.

[Walter C. Johnsen:]

Let’s call this complete. I’d like to thank you for joining us. Good-bye.

[Operator:]

This will conclude today’s conference call. We do thank you for your participation and you may disconnect at this time.