Executives: Walter Johnsen - CEO Paul Driscoll - VP, CFO, Secretary & Treasurer

Analysts: Andrew Burns - D.A. Davidson & Co. Michael Wasserman - Moors & Cabot Timothy Call - The Capital Management Corporation Michael Mork - Mork Capital Management

Operator: Good day, and welcome to the Acme United Corporation's First Quarter 2018 Earnings Call. At this time, I would like to turn the conference over to Mr. Walter Johnsen, Chairman and Chief Executive Officer. Please go ahead, sir.

Walter Johnsen: Good morning. Welcome to the First Quarter 2018 Earnings Conference Call for Acme United Corporation. I'm Walter Johnsen, Chairman and CEO. With me is Paul Driscoll, our Chief Financial Officer, who will first read a 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 had a strong first quarter of 2018. Our sales increased 14% over the first quarter last year to a record $31.7 million. Net income was $764,000, an increase of 16%. Earnings per share were $0.21 versus $0.18, an increase of 17%. All of our major product families had strong growth. Our first aid and safety business led the way with new business at a large industrial distributor in the U.S., a new customer's thrust into food service and strong e-commerce sales. The Westcott family of school, home and office cutting tools gained market share in scissors primarily due to online sales. The Clauss, Camillus and Cuda product lines had record first quarter revenues. Our organic growth for the quarter was 12% after accounting for the impact of the acquisition of Spill Magic on February 2, 2017. Spill Magic sales increased during the first quarter of 2017 due to new customers, including a large supermarket and food chain, new industrial and office distribution and expanded office retailer presence. We expect to begin e-commerce sales of Spill Magic in the coming quarter. Our international businesses contributed to the first quarter growth. In Canada, net sales increased 12% due to expanded mass market and office product offerings. Our European subsidiary grew 27% with strong contributions from our office products customers, growth in Cuda fishing tools and Camillus hunting knives, and new demand from our DMT diamond-based sharpening tools. Our e-commerce business in Europe grew very strongly. Gross margins were 38.2% during the first quarter of 2018 compared to 38.1% in the comparable period last year. This is particularly significant because it reflects greater e-commerce sales and successful management of our overall margin as we shift away from a portion of our retail sales base. We continued to make improvements in our warehouse and distribution costs during the first quarter. This reflected improved accuracy of product dimensions and weights, greater precision of bin locations at closer distances of fast-moving items to the shipping locations. We implemented software to optimize low-cost shippers, particularly the U.S. postal service, which has very attractive last-minute delivery prices. Our warehouse and distribution team is far better trained and has better tools than a year ago, and we believe this will continue to drive our cost down. During the quarter, we brought $5.8 million into the U.S. from international locations. We have initially used the cash to pay down debt and anticipate that we will be able to repatriate additional funds by year-end. We did not provide guidance at the end of last year to better gauge the impact of new business and strong e-commerce sales. Based on performance during the first quarter, we are providing guidance for 2018 of $140 million in net sales, $5.7 million in net income and a $1.53 earnings per share. I will now turn the call to Paul.

Paul Driscoll: Acme net sales for the first quarter were $31.7 million compared to $27.7 million in 2017, a 14% increase. Net sales for the first quarter in the U.S. segment increased 13%. Net sales in Canada increased 8% in local currency due to the market share gains in the school and office channel and hunting knives. Net sales in Europe increased 10% in local currency due to market share gains and the office product channel and increased distribution of DMT products. The gross margin was 38% in the first quarter of 2018 versus 38% in the first quarter of 2017. SG&A expenses for the first quarter of 2018 were $10.8 million or 34% of net sales compared with $9.4 million or 34% of net sales for the same period of 2017. The SG&A increase was due to higher variable selling costs, as a result of higher sales and the addition of sales and marketing personnel. Net income for the first quarter of 2018 was $765,000 or $0.21 per diluted share compared to net income of $660,000 or $0.18 per diluted share for the same period in 2017, a 16% increase in net income and 17% in earnings per share. The company's bank debt less cash on March 31, 2018 was $43.7 million compared to $38.2 million on March 31, 2017. During a 12-month period, we purchased our first aid manufacturing and distribution facility in Vancouver, Washington for $4 million and paid $1.4 million in dividends. Inventory increased $4.6 million in anticipation of new business. We expect to end 2018 with approximately $36 million of net debt and to generate $4 million to $5 million in free cash flow.

Walter Johnsen: Thank you, Paul. I'll now open the call to questions.

Operator: [Operator Instructions]. And we'll hear from Andrew Burns with D.A. Davidson.

Andrew Burns: Two questions for you. Walter, 12% organic growth in the quarter, that's a great number and certainly well ahead of the gross guidance implied in your annual guidance. And I'm just curious when you look at sort of the deceleration in organic growth and guidance, is that a function of some sell-in to new customers that boosted that first quarter organic growth? Or is that really reflective of just the visibility to online channels and the complexity there?

Walter Johnsen: Well, there's two parts. We began selling to a large food service distributor in the first quarter, and there was some sell-in to that. However, they're getting orders and that seems to be carrying through into the second quarter, and we are optimistic because of the very large distributor that it continues. However, there was some sell-in of that. The online business was very strong in the first quarter and continued at 100% annual growth. And I've been very, very careful about forecasting that into the future because that seems to us to be a very, very high growth number. As you may know, we've had 100% online growth for the last three years, including last year. So we're continuing a pace that we've got a history with. The other part that I'm really pleased with is as we've been able to manage the cost of promoted items and placement online that we've been now getting our arms around how to do that in a more effective way, so that, in fact, we are replacing perhaps some sales that were cannibalized at a retail and margins comparable or higher online, and we're growing that share.

Andrew Burns: Great. That's a good segue into my second question, which was very encouraging to see the stabilization on the gross margin line, and I know a lot of efforts gone into improving efficiencies fulfilling online sales. So I'm just curious as those continue to grow, is gaining scale and further efficiencies, is that going to be just about preserving margins? Or is there any opportunity to enhance the gross margin profile as sales continue to shift online?

Walter Johnsen: Well, part of this is margin, is product mix. And as an example, when we sell first aid items and those refills, the refills tend to have higher margins than our historic business. So obviously, we are pushing more refills and that's a good thing for the customer because you get outstanding product at outstanding prices. Similarly, we are getting a lot of back-to-school items now, and we will be getting more of that in later in the year and they tend to have more competitive margins, lower margins. And so managing that mix is something that we're good at and then we're getting better at. But I think it would be reasonable to assume that the margin levels we have now are the levels that would be consistent. And if we're successful with that and we have the growth that we're expecting, we will get operating leverage through the distribution centers.

Operator: And next we'll move on to Michael Wasserman with Moors & Cabot.

Michael Wasserman: I may have missed this, I've been trying to do too many different things this morning, but I apologize, if you mentioned it. But how is the increase in cost of borrowings affecting how you run the business these days? And how you're looking forward in that regard?

Walter Johnsen: Well, the answer to that is that we -- obviously, when rates go up by 25 basis points or 50 basis points, you can do the math, it increases the cost of borrowing. However, the returns we're getting on our assets are in excess of 8% and the return on equity is over 12% consistently. So as we're managing the business it may drive into some of that. In the first quarter, we certainly had higher cost of interest than we did a year ago, despite that we had 17% EPS growth. So the answer is it's one of the costs that we have to continue to deal with until we are doing it.

Michael Wasserman: Yes. And if am I correct that there is no upside cap on how costly your borrowings could become?

Walter Johnsen: Well, there is no upside cost. That's correct.

Michael Wasserman: Okay. So I presume that when you're considering additional acquisitions you're taking that into account in case the -- some unexpected magnitude of increases in the rates occurs?

Walter Johnsen: Well, Michael, that's historically been less significant to us because these acquisitions have been very highly accretive and interest is a very small piece of that. And obviously, looking forward, modeling increase cost is important thing and interest cost would be part of that.

Michael Wasserman: Yes. Okay, and I'm not sure if you mentioned this or not, but the office channel, I think, continues to be somewhat challenged compared to what it historically has been. Do you continue to expect a movement away of revenue from that area to other areas? Or online areas? Do you think that's a trend that will continue?

Walter Johnsen: Well, I do. And I think that it's a major opportunity for us to gain market share. The diversity of cutting tools that we're selling online is greater than we had historically had at retail. And we're seeing a lot more businesses. Shopping as you can imagine online, they still need the tools. And so part of our growth in the Westcott business, and as we announced, we had strong growth in Westcott in the first quarter and last year. It's because the online business is compensating for some weakness at the office superstores and some at the wholesalers, but it's -- we're gaining share.

Operator: And next we'll move to Tim Call with Capital Management Corporation.

Timothy Call: With the online business, the rapid growth last year resulted in some last minute expenses being incurred and so that hurt margins a little bit during some quarters last year. Do you think you have a lot of that better situated now so that it seems like you're handling the online growth today in a much more profitable manner. Do you see that as you go through the seasonality of the company?

Walter Johnsen: Yes, I do. I think that we are much better positioned than we were a year ago. Part of the gross margin issue in the fourth quarter may repeat itself and that's because when we do Black Friday promotions, let's say, in Amazon, is the lowest cost product that you -- pricing that you'll have all year and if that runs for most of the quarter and now we're getting a bigger piece of our business as it continues to grow from Amazon. However, all of that's profitable growth. So I'm comfortable with that. As far as the operational efficiency, I know, we're better. And we see it in our internal metrics, and we see it in the smoothness that we're dealing with deliveries. A lot less stress, a lot less -- almost no overtime, and we're far better than we were a year ago.

Timothy Call: With you're being comp that as the year goes on and showing such strong growth -- mid-teens growth for so many figures this quarter, it looks like the annual guidance for earnings per share growth of around 7% or 8% might be too conservative, where am I wrong on that?

Walter Johnsen: Well, we're trying to over deliver. And I think that giving guidance that we're very comfortable with -- gives us that opportunity. Clearly, if we were able to drive the online business as we have done for the last three years then we would get more organic growth than we're giving guidance for. And at this stage, we've just finished the first quarter with over 100% a year growth in that category. And if you continue at that pace, well, then the overall organic growth in the whole company grows even faster. But it's hard for us to make that forecast now and then fail to live up to maybe something that's so -- too aggressive.

Operator: And next we'll move to Mike Mork with Mork Capital Management.

Michael Mork: Walter, got two questions. One, on the acquisition front. Would you expect anything in the next 12 to 18 months?

Walter Johnsen: Well, Mike, we are always looking. And we've got a team of guys that have worked whether that's in IT or finance or in operations, who are good at integrating them. So I'm looking at our pipeline. Having said that, we're very careful buyers and it's got to fit well and culturally it's got to fit as well the valuation that's strong for us. But next 12 to 18 months, I would guess that we'll find something.

Michael Mork: Okay. Then the next question is, back in the '80s when Reagan cut the corporate tax from 46% to 35%, Walmart took out ads in the paper and said they were going to pass on the tax cut dollar-for-dollar to the customer. And they put pressure on their suppliers to do the same thing. And actually, the economy as a whole also it had a blip up during the tax cuts going from 46% to 35%, and then the profit margins came right back down as competition came in. Do you see that again any retailers putting pressure on you to basically pass on the tax cuts or not?

Walter Johnsen: No, we haven't seen that, Mike. We have had plenty of pressure, competitive pressure from our suppliers not specifically for give us some of your tax savings, but there are always reviews of our categories and they are very, very sharp. But I don't think that this is anything extraordinary.

Operator: [Operator Instructions]. Next move to Andrew Burns with D.A. Davidson.

Andrew Burns: Just one more for you, I appreciate the time. Just curious if you could elaborate a little bit about the strength in the first aid business, SmartCompliance compliant side, you have a -- you're installing boxes when we're getting the resales. Just curious in terms of the installed boxes, it's the growth there, how penetrated do you think you are if you could quantify that sort of initial catalyst for that annuity-like refill sales? And how you're feeling about continued sell-in of the SmartCompliance boxes?

Walter Johnsen: Well, at our sell-in price we're estimating that the market for our first aid and refills is about $800 million, and we're doing about $70 million. So we feel we've got a long runway here. We're demonstrating that the SmartCompliance approach where the customer does the refill of the box of the cabinet by filling the holes in the boxes that are consumed saves them, somewhere between 30% and 50% annually in the refills. But it depends on the mix of what they are buying, but it's very, very substantial and that's the driving force, it's different than other means of delivery, for example, van-based systems. The first quarter had some very exciting installations of our safety hub, which is the software, the fulfillment app software that allows a customer to record the consumption of the first aid item at the site of treatment, aggregates it, does an automatic refill when minimum order quantities arrive and sends packages back to the site that used it to refill. That was installed in a number of very big accounts, and we've got momentum with it. And so to us, that's a very, very exciting step because it means we are selling more than just the first aid cabinet or fulfillment for refills. We're actually eventually going to be able to have data available from the consumption within our customer base to help them better manage safety, and the safety managers are responding to that and pushing to get the installations. So this is a big step for us. And the first quarter was the first time that we really saw the recognition with volume.

Operator: At this time, there are no further questions. I would like to turn the call back over to today's speakers for any additional or closing remarks.

Walter Johnsen: If there are no further questions then this call is complete. We want to invite you to our Annual Meeting at the Cornell Club, which is in New York City at 6 East 44th Street, on April 23, at 11:00 a.m. We look forward to sharing our further plans then. Have a good day and goodbye.

Operator: And that will conclude today's call. We thank you for your participation.