Acme United Corporation (ACU) Q1 2012 Earnings Report, Transcript and Summary

Good day and welcome to the Acme United Corporation’s first quarter 2012 earnings conference call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Mr. Walter Johnsen, Chairman and Chief Executive Officer. Please go ahead sir.

Good morning. Welcome to the first quarter 2012 earnings conference call for Acme United Corporation. I’m Walter C. Johnsen, Chairman and CEO. With me is Paul Driscoll, our Chief Financial Officer, who will first read a Safe Harbor statement. Paul?

Forward-looking statements in this conference call including without limitation statements related to 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.

Thank you, Paul. Acme United reported record sales in the first quarter of 2012 of $16.9 million, an increase of 17% over last year. Operating income increased from $183,000 in the first quarter of 2011 to $458,000 in 2012. Earnings per share were $0.08 compared to $0.04 in the first quarter of 2011. Sales in the first quarter were strong in the U.S. and Europe with increases of 19% and 32% respectively. Canadian sales were softer due to initial load-in of new products last year that are now shipping at normal rates. We’re having strong success with new iPoint pencil sharpeners, Clauss professional cutting tools, and Pac-Kit first aid kits. Our Titanium and non-stick scissors are gaining new market shares in the industrial and craft segments. Pac-kit first aid kits continue to grow. Sales in the first quarter were $1.8 million, an increase of 35% due to new industrial and mass market placements. Gross margins are also increasing due to purchasing leverage of components and operating efficiency improvements. The company’s overall gross margins in the first quarter declined from 36.9% in 2011 to 35.2% this year, primarily due to higher proportion of low margin items. Acme United changed its corporate banking from Wells Fargo to HSBC during the quarter. The loan was due for renewal within a year but we evaluated alternatives that we felt would be best for the company. Our relationship with Wells Fargo was excellent, but it appeared to us that it lacked strength in international banking and expertise. HSBC fit our global footprint and provided a relationship team in New York that we believe will add value. Final agreement was an increase in our line from $20 million to $30 million for the five-year term and an interest rate today of about 2%. We are entering the second quarter of 2012 with a very strong order book with back-to-school items, Clauss tools, Pac-Kit first aid kits and Camillus knives. We continue to provide sales guidance of $80 million to $85 million for the year. I’ll now turn the call to Paul Driscoll.

Acme net sales for their first quarter were $16.9 million compared to $14.4 million in 2011, a 17% increase. Excluding the impact of Pac-Kit, sales increased 9%. Net sales for the first quarter in the U.S. segment increased 19%. Excluding Pac-Kit, net sales in the U.S. increased by 8% mainly due to higher sales of pencil sharpeners and first aid kits. Net sales in Canada decreased by 11% in U.S. dollars and 9% in local currency. The majority of the sales decrease was due to new product placements in the first quarter of 2011. Net sales in Europe increased by 32% in U.S. dollars and 39% on local currency due to higher sales in the mass market channel. We expanded our efforts and resources in this channel about 3 years ago and have experienced steady and strong growth. Gross margins were 35.2% in the first quarter of 2012 versus 36.9% in the first quarter of 2011. The lower margin in 2012 was primarily due to unfavorable product and customer mix, as well as the added Pac-Kit business. We expect margins to improve in the second quarter with a better mix. SG&A expenses for the first quarter of 2011 (sic) were $5.5 million or 32% of net sales compared with $5.1 million or 36% of net sales for the same period of 2011. Most of the SG&A increase was due to higher variable selling costs, as a result of higher sales. Operating profit was $458,000 in the first quarter of 2012 compared with $185,000 in the first quarter of 2011. Net income for the first quarter of 2012 was $260,000 or $0.08 per diluted share compared to net income of $120,000 or $0.04 per diluted share for the same period of 2011. The company’s bank debt less cash on March 31, 2012 was $12.8 million compared to $13.2 million on March 31, 2011. During the 12 month period, we paid $800,000 in dividends and generated $2.2 million in cash from operations. The inventory increased 1% from March of last year.

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

[Operator Instructions] Our first question comes from Bill Jones with Singular Research.

I was wondering, I know you have your annual meeting coming up and usually you give some insight into new products that are coming out. I was wondering if you could give us a little insight into what’s exciting this year that we should be thinking about?

Well, there are number of items, Bill, that are really going to be impacting us favorably the rest of this year. One of them is the Camillus knives. We introduced the line totally refreshed about this time last year and we’ve gotten meaningful placement, meaningful for the company’s earnings this year. And you will be seeing Camillus in many of the outdoor sporting goods chains during this year as well as Wal-Mart. So that will have a favorable impact. We are shipping and trying to ship more of the Les Stroud survival tools which you may know, Les Stroud is Survivorman and for a certain segment of our market is very popular. Les Stroud has been placed in many of the outdoor chains. And again back-to-school, I mean the time for Fathers Day, the summer, the fall, holiday time around Christmas -- - all these are area times when Camillus and survival tools are quite hot. We’ve got a scissor mouse which we just began shipping. You will be able find that at Staples chain-wide in the next few days in some cases. They are in the stores. That will be rolling out into the many of the mass market and office channel during the year. And we expect that to be in excess of $1 million of new growth. West Marine cutting tools, these are very rust resistance stainless steel knives, wires, hook removers, gaffs. They're rolling through the West Marine chain as we speak and it's a sizable increase from last year. The iPoint pencil sharpeners -- - the new generation is currently in the line up for back-to-school at a number of the major mass market accounts as well as Staples, Office Max and Office Depot. So there is growth there, but when I net all this up, this is pretty meaningful. In addition to that, Pac-Kit continues to be gaining share. So we’re running on pretty much all cylinders right now.

Excellent. Thank you for that and you had mentioned I think in the remarks, that gross profit was 36% in the quarter and you expected that to be higher in Q2. Would that be true for the year, or should we ...?

No, it’s a very tricky thing because although we are able to forecast sales with some confidence, the margin is a little more difficult, because you’re trying to assess the mix within the customers, but the new products that are coming through have meaningful sales, we believe and they are all well above the current levels of margin. So that’s why Paul gave guidance in the second quarter that margins probably will be up from where they are now. My guess is that that would be the case for the year.

And have you had success in getting the margin up on that Pac-Kit? I know that was kind of the intention right, to get it more in line with the other first aid kit sales?

Yes, and part of that is operating efficiency because we’re running at a third higher volume than we had been when we purchased the business. We are getting operating efficiencies. Second, we truly have leveraged the purchasing power of our existing physician care, first aid kits as well as Pac-Kit volume. So that’s impacting and we saw it in the first quarter and I think it will continue increasing.

Our next question comes from Richard Dearnley [ph] with Longport Partners.

Could you talk about what’s your recent history in terms of production flow and error rates have been and then where are you now? And then you said that you are trying to ship Les Stroud product. So what’s the impediment there?

Well, first, our history of production in general is outstanding. I mean we are making millions and millions and millions of items and getting them delivered to our customers with metrics close to 99% first time delivery. So that’s excellent. We are stressing some of the factories because we’ve got volumes bigger than we ever had before. And so when I talk for example about trying to ship Les Stroud, well of course we are shipping Les Stroud. We cut a [ph] ship it? And some of that's on the water right now. It impacts the second, third quarter, fourth quarter and hopefully for quite a long time. But I wouldn’t worry about production issues. It’s really just produce, keep your eyes down and keep driving.

Okay. And you talked eloquently about the product lines that are up, which ones are not doing so well?

Honestly Dick, I can’t think of any off-hand right now. There's got to be some product lines that are down, but we are not really seeing it.

Well, that sounds good. And when you said your order book is strong, is that were you referring to both back-to-school, which are you’re booking now and,or the new products you sort of called out there?

Well, the back-to-school is going to be very strong back-to-school. So we are in production, we’re shipping in the second quarter right now and that’s doing very well. The new items again have been well received to-date so but you have to have sell through and you have to have reorders, but we've certainly got the initial load-ins for these and they're exciting.

Our next question comes from Henry Druker [ph] with Druker Capital.

I couldn’t quite hear, you were talking about SG&A and I couldn’t quite hear it. I think you said you're at 32% of SG&A this quarter down from the prior year, but you are talking about SG&A and could you just so I could hear that and then I had a follow-on?

I said that SG&A was 32% compared to 36% in the quarter of last year.

Okay. And then you were and then what did you say beyond that in terms of you are talking then about the dollar amount of SG&A going up, because of...

The dollar amount went from $5.1 million to $5.5 million and I said the majority of the increase was due to variable selling costs due to higher sales.

I see, okay. My question is and that’s great that it’s coming down. I’ve been following this for a while and I’m just kind of curious your thought on it -- just, your general level of SG&A. What do you think your target could be? I ask that question because other companies in your industry operate at a far less percentage of SG&A to sales?

What we’re doing is quite different than the guys in our industry. We’re doing a lot of development. You don’t see that, but we’re doing a lot of it, both in the coatings and in the non-stick, the PVDs, the anti-rust treatments that we’re doing and you simply don’t have that kind of technology in the typical office industry. The second thing is we do a lot of new product development, which while the margins are a little bit down this quarter, in general, the new products that are rolling through the rest of this year are all new products that are developed generally internally. So you got the expenses of tooling and production and prototyping, and things out doing market research -- - all that washes through the P&L. Some tooling gets capitalized, but almost everything is washing through. So it’s a number that is high relative to our competitors, but it’s a different business model.

But when you do that tooling and production and prototyping, then would you be manufacturing those new products thereafter or do you then use some of your partners and outsourcers in Asia to manufacture them once you’ve sort of done all the specing if it out?

We do some of the non-stick and titanium coatings internally, and that’s the real proprietary things. When I talk about tooling as an example, it’s our tooling that’s placed to third-parties for manufacture. So but usually the tooling is capitalized, however, all the work that goes into that and the development is all expense.

I see. And so you wouldn’t expect -- - you wouldn’t have a target to try to say we could bring it down several hundred basis points because your model is different from others?

Oh, I would guess that as we leverage sales, that the SG&A will drop, but we’re putting money at an increasing rate into new product development and that piece I've kept even in the times when sales have fallen off in 2009 and ‘10 and we’re seeing the benefits now. We’re just continuing to do that.

[Operator Instructions] And our next question comes from Tom Sparrow with Sparrow Capital.

The sales in the Europe were quite strong. And I was kind of curious whether you expect that to continue this year and perhaps this is the year when Europe breaks into the black, what do you think Walter?

Europe has got some very good mass market business, that is pretty good margin and that is booked and lined up for the year. The office channel there is about flat. The manicure market that we have in Europe is up. So things are pulling together for the European business, I just want to be a little bit cautious about saying, yes, they're in the black, because it’s been such a long time but they're clearly making progress and they were profitable this quarter.

That’s great, that’s great. How are we doing with our new line of garden tools?

We just had one heck of a big reveal at a large mass market retailer and guys came back excited, but who knows. We have gotten more placements in some of the smaller mass market accounts in the U.S. and 2 largish ones in Canada. And so its growing, but we have not cracked the garden market the way, for example, we’re doing with most [ph] knives right now. So we are trying and they have great products so we’re hopeful.

I’m hopeful too. And lastly, Walter, I know from time-to-time, we’ve had unusually high air freight expenses. As a consequence, we’ve tried to boost inventory to avoid some of that. How does that issue stand as we enter the stronger sales period?

We’ll probably have more air freight this year than we did last year, because we’ve got so many new products, the Camillus items, the Les Stroud items, some of the West Marine items, all hitting -- - Scissor Mouse -- - in the second and third quarters and so the production is running pretty high. But by and large I don’t see it to be a problem for the year, but it will probably be higher than last year just because we have so many new things with volume coming through a pretty narrow funnel right now.

Our next question comes from Jeffery Matthews with Ram Partners.

I apologize if these were covered earlier, I was late for the call. Just curious on 2 things, one is the -- - anything in terms of your capitalization related to debt, where are you with your bank lines, any negotiations going on, or are you secure there for a while?

Well, you might have missed it, but we announced that we had entered a new banking relationship. In other words, we completed that in -- - about 3 weeks ago with HSBC. So it’s a $30 million line instead of $20 million, it's a 5-year facility, we save 1/4 percentage point in the rate. So we're really delighted.

Good. And secondly, just costs around the world, any updates on what’s happening in China and where you’re spreading out your production if anywhere else?

Well costs in China seem to have slowed a little bit, but wages still continue to increase and they tend to be somewhere around the 12% to 14% range. So there is still wage inflation. We won’t see it this year for our pricing, it will be next year and our costs are locked in this year. So that’s solid. But wages are still going up. Inflation is continuing there, it's somewhere around 4%. So we’ve got our hands full for next year and again putting through price increases and trying to get better productivity. Having said that, we are spending a lot more time looking at the productivity with our team in China and if we’re successful we should be able to hold back some of the increases we need to maintain our margins. So I’m optimistic, but we have a lot of work to do. The second thing is, moving to the other parts of the world in sourcing. We are moving a little bit more into some sourcing in Italy. We’re doing a little bit more in Columbia. We continue to source from Pakistan, but these are not really meaningful relative to China. Our packet business and our physicians care, first aid kits are entirely domestically produced and they are growing, and they’re growing nicely. So that’s helping a little bit in balancing the sourcing. But still even today we’re very reliant on China.

Okay. And then just if I could follow-up, looking out a few years, what’s the normalized gross margin and then operating margin you think for the business. I think you peaked operating margin -- gross margin was 45% a few years ago. It doesn’t look like that will come back. But what are your thoughts on a financial model in a few years?

Well, that’s a really good question and it’s one that we haven’t shared and I’m a little bit cautious about just winging it. But I think it’s fair to say we’re not a 45 margin business anymore in part because we’ve grown a lot -- - in part because across the cost of our goods from China have increased very meaningfully in the last four years. The U.S. dollar, although people say that R&D is undervalued, the U.S. dollar has lost about I think almost 30% in the last 4 years. So when you look at our margin compression just from that, it’s pretty clear that we’ve been able to push through a great deal of it, but some of it has hurt us in the margin. The other thing is the Pac-Kit business is just lower and that’s a growing part of our growing business. But it’s below what our average is. But I would hope that we can hold somewhere in the mid-30s in margin and we do have a lot of new products that are coming through at higher margins. So if we can hit with those, manage our Asian costs, we should be somewhere in the mid-30s, maybe a little bit higher.

Okay. And if I may one more, you sounded more optimistic about back-to-school than maybe I recall being at this point last year. What’s the -- - what's your basis for that? What are you seeing out there?

We’re just seeing a lot of business. One of our competitors in the ruler business went bankrupts and we gained a bunch of rulers. Now you think those are commodities and they shouldn’t be growing, but when a competitor goes under, well you’re growing and they’re growing nicely. So that was sort of unexpected. In other areas the iPoints, today if you go into WalMart you’ll see several million dollars of that business that’s rolling through for back-to-school. We expect a pretty solid -- - we will have a pretty solid placement at Office Max and at Staples, and at Rite Aid and Walgreens. So when I’m looking at it, I’m looking at the book of business we have and what we got orders placed to ship. What I don’t know is the reorders, but we have a pretty good feel from previous years what that is. So I’m pretty optimistic about it.

[Operator Instructions] And we have a follow-up question from Richard Dearnley with Longport Partners.

Well I guess I should ask the obvious question since you mentioned that the acquisit [ph] -- - the line, the new credit line sort of maybe opens up the acquisition potential and I know there are always things rolling around on the back of the griddle. Anything on the front of the griddle?

Well, all those things we’re looking at, Dick, and we haven’t announced anything. But the acquisition line, I just want to be clear, yes, it's an extra $10 million, but we laid that out with the assumption that if we hit a doubling of sales in five years, which is what we’re trying to do, then is that cash sufficient to do, to finance that and the answer is, it gets you well along the way. Now if an acquisition comes along and it moves faster, that’s terrific. But really it was -- - let's put a little bit more long-term capital in place and we got it at a very good rate with I think a very good partner.

And we have another question from Bill Jones with Singular Research.

Well, to just to follow up on that, you mentioned the doubling of sales in 5 years. Would that include acquisitions or are you thinking internally?

Well, acquisitions have been part of what we’ve done to get to this point. They have been smaller tuck-in acquisitions and my guess is that will be the strategy we continue to employ, but we’re getting bigger, so they'll be a little bigger deals perhaps. These items that we’re developing, the new products have basically more than doubled us in the past six years or so and they’ve -- - the acquisitions have helped a little bit. But if you take for example Camillus, it was an acquisition that we bought the brand for a $180,000 plus tax. And this is going to be a multi-million dollar line for us now, all with new products, but Camillus gave us the brand and some of the potential customer base that we’re now exploiting. I’m pretty optimistic that our internal generation of products will be moving us a long way towards that growth fill [ph].

And it appears there are no further questions at this time, Mr. Johnson. I’d like to turn the conference back to you for any additional or closing remarks, sir.

Well I’d like to thank you for joining us and have a good day. Good bye.

This concludes today’s conference. Thank you for your participation.