Acco Brands Corporation

Good day, ladies and gentlemen, and welcome to the second quarter 2019 Echo Brand Corporation earnings conference call. At this time, all participants are in a listen-only mode. Later, we'll conduct a question and answer session, and instructions will follow at that time. If anyone should require operator assistance, please press star then zero on your touchtone telephone. As a reminder, this call is being recorded. I would now like to introduce your host for today's conference, Christine Hanneman. Senior Director of Investor Relations. You may begin.

Good morning. This is Christine Hanneman, Senior Director of Investor Relations. Welcome to ACCO Brands' second quarter 2019 conference call. Speaking on the call today are Boris Ellisman, Chairman, President, and Chief Executive Officer of ACCO Brands Corporation, and Neil Fenwick, Executive Vice President and Chief Financial Officer. Slides that accompany this call have been posted to the investor relations section of accobrands.com. When speaking about quarterly results, we may refer to adjusted results. Adjusted results exclude transaction, integration, and restructuring costs and reflect an adjusted tax rate. Schedules of adjusted results and other non-GAAP financial measures and a reconciliation of these measures to the most directly comparable GAAP measures are in today's earnings release and the slides that accompany this call. Due to the inherent difficulty in forecasting and quantifying certain amounts, we do not reconcile our forward-looking adjusted earnings per share, free cash flow, net leverage ratio, or adjusted tax rate guidance. Forward-looking statements made during the call are based on certain risks and uncertainties, and our actual results could differ materially. Please refer to our press release and SEC filings for an explanation of certain of these risk factors and assumptions. Our forward-looking statements are made as of today, and we assume no obligation to update them going forward. Following our prepared remarks, we will hold a Q&A session. Now I will turn the call over to Boris.

Good morning. We reported record second quarter sales in adjusted EPS, continuing our strong performance of the first quarter. Sales rose almost 7%, excluding currency translation, led by the strong back-to-school sell-in in North America. Profit growth was driven by sales and excellent control of expenses. I'm very pleased by our execution year-to-date, and while we will always have areas to improve, our results show that our strategies are bearing fruit and delivering good revenue and profit growth. Let me remind you of our strategic imperatives to drive profitable growth, the path we've been on for the last few years. We're diversifying our geographies and channels, organically and with acquisitions, to have a larger presence in faster growing countries and channels, and to have less dependency on any one customer. We're focusing more on the end consumer, investing more in consumer-centric brands and categories, organically and through acquisitions, and are choosing routes to market that are more closely aligned with where consumers want to shop. We're developing more products within users-driven innovation, as demonstrated by our recent launches of TruSense air purifiers, Photon 30 automatic laminators, Kensington SD7000 Surface Pro docking stations, and Rixell Momentum and LightsIQ shredders. We're laser-focused on reducing unnecessary costs in the business and improving the productivity of our resources. our Lean Six Sigma-based productivity programs generate substantial savings every year that are either reinvested in the business or returned to shareholders. We're diligent about execution, always the most difficult part of any business, but something that we at Echo Brands do well every quarter and especially this year. And lastly, we're prudent stewards of shareholder capital, ensuring that we invest in areas with good shareholder return and this includes acquisitions, or returning capital to shareholders. We have been working on these strategic vectors over the last few years and have delivered good revenue, EPS, and cash flow growth. Our record results this quarter are another confirmation that our strategies are working and that we're capable of generating profitable growth in a challenging environment. Now let me turn the call over to Neil for a review of segments guidance, and other financial commentary. And then I'll join him in answering your questions. Neil?

Thank you, Boris. Good morning, everyone. We posted record sales in the quarter, up 4%, based on price increases across all segments and volume growth in North America, driven by strong back-to-school sell-in. We also reported record second quarter adjusted net income of $36.3 million, or $0.36 per share. based on higher operating income offsetting a $0.02 negative impact from foreign exchange and the higher tax rate. As shown on slide 7, gross margin was 32%, down slightly due to unfavorable product mix in North America and international, and one-off expenses in EMEA. SG&A expenses as a percent of sales were down in the quarter to 18.4% from 20% last year, primarily because of good expense management and leverage from higher sales. Operating income increased to $61 million from $52 million, and operating margin expanded to 11.8% from 10.4% last year. On an adjusted basis, operating income increased largely due to cost savings and higher net sales. Our adjusted tax rate was 29.7% in the quarter. We still expect our full-year adjusted tax rate to be 30% to 31%. Now let's turn to some details of our segment results. Net sales in North America rose 9%, driven by pricing of 7.5% that was needed to offset input inflation and tariffs. Volume contributed 1.5%. We saw growth in almost all channels, and back-to-school orders have been strong, and sales growth continued with the Kensington brand from new products. As we mentioned last quarter, in our second and third quarters, the faster-growing channels such as e-tail and mass merchants carry a higher proportion of sales due to back-to-school shipment. Our initial view on our North American back-to-school season was that sales growth would be consistent with last year, when we grew back-to-school sales 2%. We now expect to do better than that and anticipate higher growth than last year's 2%. North America operating margin increased to 19.6% from 18.8%, driven by cost savings and price increases, which offset inflation and tariffs. For the full year, we now expect North America sales to be close to flat, rather than down low single digits. In our EMEA segment, sales decreased 9%. Currency reduced sales by approximately 9 million, or 6%. Comparable sales decreased due to the timing of Easter, which had benefited the first quarter, and higher sales last year ahead of our warehouse moves and from the European privacy law implementation, which led to strong sales of shredders. Year-to-date, comparable sales in EMEA are up slightly. EMEA adjusted operating income declined 3 million due to lower volume and one-off expenses. We expect European sales to be roughly flat for the year on a comparable basis. International segment sales increased 9% due to the GOBA acquisition in Mexico, which added approximately $12 million in sales. Operating income rose significantly on both the reported and adjusted basis from the acquisition and cost savings. Results within the international segment were mixed. Mexico rebounded versus last year with strong back-to-school performance in both our legacy business and with the Barilito branded products we recently acquired with Gova. We continue to see good results out of Brazil, but it is their seasonally smallest quarter. Australia results were lower as the market continues to be difficult with a slowing economy, customer consolidation, and lost placements, as customers focused on lower price points. Going forward, we anticipate continuing strong performance in Mexico, as well as in Brazil as it enters its back-to-school season in the fourth quarter. We also anticipate continuing challenges in Australia. Overall, including GOBA, we anticipate low double-digit growth in the international segment for the full year. The GOBA acquisition impact was all in the first half, and therefore the rate of growth in the second half will be lower. Let's move now to our balance sheet and cash flow. We were very pleased that our high inventory levels protected our back-to-school margins, but as we discussed last quarter, it shifted the seasonality of our cash flow. This will self-correct as we collect receivables in the third and fourth quarters without building up the inventory as we did last year. We have not changed our view on the full-year cash flow as we anticipate a significantly stronger second half cash flow than our historical pattern. We used 62 million of free cash flow in the quarter. The large cash outflow was as expected. In the quarter, we repurchased 3.4 million shares for a total of 27.4 million and paid 6 million in dividends. Year to date, we repurchased 4.7 million shares for a total of 38 million and paid 12 million in dividends. Given our performance year to date and our forecast for the second half, We are increasing our outlook for 2019. We now estimate that sales will be at the top end of our original range, which is flat, and this includes a 2% adverse foreign exchange effect. We are raising the bottom of our EPS range and now expect EPS to be 115 to 120 per share, including 3 cents negative impact of foreign exchange. We anticipate that back to school will continue to be strong in the third quarter. However, the North American channels we are growing in are not as significant in the fourth quarter. In addition, in last year's fourth quarter, we released incentive reserves of almost $7 million. And given our performance this year, we will be accruing for incentive compensation. Therefore, our fourth quarter will be a very difficult comparison. The outlook for free cash flow remains unchanged at $165 to $175 million. We anticipate year-end net leverage will be down from last year. As always, we have included certain assumptions in our slide deck on page 13. Now let's move on to Q&A, where Boris and I will be happy to take your questions. Operator?

Thank you. Ladies and gentlemen, if you have a question at this time, please press star then 1 on your touch-tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Again, that is star then one if you would like to ask a question. Our first question comes from the line of Bill Chappell with SunTrust. Your line is now open.

Thanks. Good morning. Good morning, Bill. Boris, just want to dig a little bit further into the North American performance and kind of what you're seeing. And maybe if you can break down what you're seeing out of the category, do you expect back to school to be kind of as a category to be up year-over-year this year? Is it more share gains? And mainly, I understand the pricing benefit, but just trying to understand the volume and then what you expect over the next, you know, as we move through back-to-school season.

Sure, Bill. The growth that we saw in North America has been very broad across many categories and many channels. We saw growth in MAS and OSS. and in e-tail as well. We got bigger placement for Five Star, Hilroy, Kensington, BBC, and Quartet brands. And we also gained a lot of private label business for back to school. And remember, from a compare standpoint, that's one of the things that we lost a year ago in back to school. So we're set up for a very good back to school, and as Neil mentioned in his prepared remarks, we expect the growth to be stronger than 2% that we experienced last year. Given our 9% growth in the second quarter, I certainly do believe that we took share. I don't think that the market is growing at that particular rate. But we're set up for back to school. Obviously, we'll have to see what happens during the season. The season is just starting. So it's a little bit too early to comment on that.

And is the thought or the hope that OSS is finally not enough of a drag to offset kind of the gains you're seeing in the other channels and maybe we're through the multi-year consolidation impact?

You know, that certainly is the hope. And we have seen that, especially in the second and third quarter, When mass plays a much bigger role in our seasonality, we're seeing the pressures from OSS consolidation to be a lot smaller in those two quarters. And then in the first and fourth quarter, they typically are larger. But certainly as other channels become a bigger part of our mix, the negative effects from OSS consolidation will be felt less. It is important to reinforce that we did see growth in OSS in this particular back-to-school sell-in, in this particular Q2. It wasn't across all customers and channels, but overall, if I combine all the sales, we did see growth in Q2.

Got it. And then last one, just back on Europe, maybe a little more color in what's going on. And I can't remember the exact... Impact expected from Brexit, but as we look over the next few months, I know you have a meaningful UK business and how you're expecting that to affect the P&L.

Sure. Europe had a difficult compare versus a year ago. We grew a lot a year ago. We had a couple of one-time things happening a year ago that boosted revenue. We moved the warehouse, so we shipped ahead of that. There was the European privacy law, GDPR, that was launched in May of last year and then drove a lot of shredder sales in May, in June. And also we had kind of a holiday shift that benefited Q1 and took away from Q2. So that affected European sales. We are seeing a slowdown in the UK, to your point. So we do expect that Brexit will affect sales to some effect. The good thing about our business in EMEA is that UK is now a much smaller percentage of our sales. It used to be around a third of our sales in Europe. Now it's down to 10%, 12%. So we believe we can be flat for the year despite some of the challenges that we expect to be in the UK associated with Brexit.

Got it. Thanks so much. Thanks, Bill.

Thank you. Our next question comes from the line of Brad Thomas with KeyBank Capital Markets. Your line is now open.

Hi. Good morning, Boris, Neal, and Christine, and congrats on the nice quarter here.

Good morning, Brad. Thank you.

I wanted to ask a couple of follow-up questions on North America, if I could. I guess just to ask it directly, do you feel like there were any timing nuances in terms of the timing of shipments that occurred? Because I know sometimes there can be some shifting between 2Q and 3Q in orders, and how is that playing out this year?

Yeah, that's a good question, Brad. We don't think that the shifting was significant. There's always shifting, as you mentioned, between Q2 and Q3, and some customers want it a little bit early, some customers want it a little bit later. But whatever it was this year was not really significant to change our view that the back-to-school, we think, would be better than it was last year. The back-to-school growth will be better than it was last year.

And then just putting into context, I mean, this is a very strong 2Q in terms of North America growth. Do you still believe you can grow sales in North America in the third quarter, or do you think this may make a tough bar for posting growth in the third quarter specifically against what is a pretty easy comparison in the third quarter last year?

No, we think back-to-school season will be good. So we always aspire to grow. We achieved our results in the first half in North America with especially strong Q2. We believe we can grow in Q3. Q4 becomes more challenging, one, because we have a little bit less visibility in Q4, and two, as I mentioned, that's where the more challenged customers become a bigger percentage of sales. So growing significantly becomes more difficult.

Great. And then some of the new products clearly seem like they're having a strong launch and getting some traction out of the gate. I mean, when you think about new product introductions, I mean, are they big enough to kind of call out as a specific percentage of sales? And and worth calling out is how much they contributed here to this quarter, or are they still more in their infancy at this point?

You know, it really depends. Of the products that I mentioned, if we look at shredders that were launched very early in the year, we achieved sales in the millions of dollars, so certainly it has an impact on the first half revenue. Some of the other products that we talked about, such as TrueSense, a Photon 30, those launched in the middle to end of Q1. So about $518 million in revenue. It doesn't really have a huge effect on... That's helpful. Congratulations. The growth has been significant, Brad. The growth has been significant, and the trend is off to the right, and certainly we hope that at some point in time we'll be... calling out the exact amount delivered by those products. Thank you. That's great. Thanks again. Thanks, Brad.

Thank you. Our next question comes from the line of Chris McGinnis with Sedodian Company. Your line is now open.

Good morning. Thanks for taking my questions in the next quarter.

Thank you, Chris.

I was wondering if you could just maybe comment on the wholesale market that you serve into and how that's performing. Is that picking up, or are you still seeing some kind of headwinds with the consolidation?

Yeah, thanks, Chris, for that question. Yeah, if you remember last year, we had a lot of inventory being taken out of the wholesalers, U.S. wholesalers. We've seen that normalized, and we're seeing a normal operating performance out of our wholesale channels. actually on a global basis, so there's nothing unusual about the sales pattern that we're seeing with wholesalers.

Okay, thanks. And then secondly, just with the change with the credit facility, any thoughts about changing to maybe a more consistent strategy on the share of purchase?

Could you elaborate on that, Chris?

Just with the change in the credit facility, I mean, obviously you've been pretty proactive with share of purchase, but you're a tax. before, now that opens you up or frees you from that. Is it maybe more consistent in the sense of you're going to dedicate a certain amount of free cash flow to share or purchase a year? Thanks.

Right. So just as a reminder, we refinanced our facility, as Chris mentioned. And from a practical standpoint, as long as our leverage stays below 3.25. We don't have any limitations on share repurchases. We expect in Q2 and Q3 to be above 3.25, which means we'll limit it to $75 million, but limitation to go away in Q4. And we don't believe we'll be buying $75 million in the first three quarters anyway. So we won't have a Again, from a practical standpoint, the limitation on our repurchases. And then from a strategy standpoint, we remain opportunistic when it comes to share repurchases. If the price is right, we will be buying more shares, and if the price gets high, we think that from a shareholder return perspective, we will probably deploy our money better somewhere else.

Well, thank you very much for your time today. I appreciate it, and I'll be looking forward to it.

Thank you, Chris.

Thank you. Our next question comes from the line of Kevin Steinke with Barrington Research. Your line is now open.

Good morning, everyone. I think when you initially gave your outlook for 2019, there was an assumption that there would be some degradation in sales volume just due to the significant price increases you were implementing. I mean, it doesn't sound like that's been the case, but have you seen that at all in reaction to the price increases?

Yes, you're correct, Kevin. We assumed pretty much a one-to-one offset between pricing and volume, and we have not seen that. So the effect of the price increases has been – the negative effect has been less than we anticipated.

Okay, that's good to hear. And then Neil mentioned somewhat of a headwind in the fourth quarter from accrual of incentive compensation. How should we think about that in terms of margin impact for the remainder of the year?

It was a $7 million or close to $7 million release we had last year, which we won't have this year. So it's literally it's a $7 million impact on Q4 operating margin.

Okay, got it. Perfect. Thanks. That's all I had. Thank you, Kevin.

Thank you. Our next question comes from the line of Hamid Korsan with BWS Financial. Your line is now open.

Hey, good morning. Just a few questions here. Could you just talk about on the back of school that you're seeing the volume increase for Is that coming in with a higher ASP than what you've usually been accustomed to as far as what your customers are buying, or is this low ASP kind of business? It's just volume-driven kind of revenue.

Thanks, Ahmed. It's a combination of the two. We have raised prices on those products that were affected by inflation and tariffs. So on those products, we are seeing higher ASP, but we also want incremental private label business, which is typically, you know, more commodity, low ASP business. We haven't, I don't think we've done analysis, Neil, of the overall portfolio ASP, but, you know, I believe it would be a combination of the two.

Okay. And is that commoditized business as, that you're opting for winning, is that purely just to run your manufacturing at an efficient rate, or why are you going after that business?

It's a profitable business. It gives us marginal profit dollars, good for our shareholders. I've talked about it before. We look at that business opportunistically. If it's accretive to our bottom line, we would do it. If not, we won't do it. It's not strategic for us in nature, but given the incremental revenue and profit dollars, when we can get it, we want it.

Then on the accounts receivable, is there any credit quality issues here, or has there been net terms extensions? If you could just provide some color as far as the increase.

The increase is fundamentally driven by the higher sales, and so you've also got the acquisition of, GOBA, which year-over-year makes an impact on the AR balance. But the biggest issue is just high sales in the second quarter and the timing of those sales, which, as you would understand, with back-to-school being a big constituent part, they happen late in the quarter, and so they all just end up on AR at the end of the quarter.

And DSO days are comparable to last year, so we don't see any kind of incremental risk.

Okay, my last question is just on that product warranty comment that you made. Is this new products that you had issues with, and could you provide some aspect of what the impact was and if there was any manufacturing delays because of this product warranty issue?

Yeah, we had some quality issues in Europe on some of our products, so we had some reserves associated with that. The products are fairly new. They were not launched this year, but they were fairly new. subset of Alliance. So we're working through that. We think from an impact to the end-user standpoint as well as the financial reserve standpoint, that's all already incorporated in our numbers and beyond us. But it did affect our results, especially for EMEA second quarter.

Okay.

Thank you. Thanks, Ahmed.

Thank you. Our next question comes from the line of William Ruder with Bank of America. Your line is now open.

Hi, guys. This is Mike on for Bill. Can you talk about the potential impact of a 25% tariff on the list four items?

Which one are you talking about? There's so many of them. Are you talking about the $300 billion one that people are speculating about? Yeah. Are you talking about the one... So obviously, if tariffs are raised on the remaining Chinese imports, we would have to pass through those tariffs on to the consumer. Neither us nor we believe other manufacturers there can absorb a 25% cost increase is what this would be. and we will have to pass it on. We don't think that it's likely that these $300 billion will be implemented, but if they are, we will pass them on.

And is there any estimation about the dollar value of that?

If you look at the tariff impact that is already in place, which is roughly the same amount, It's on the order of $28 million. So, you know, basically you would earn another $28 million in additional cost if the other $300 billion would come into play, and we would have to recoup that $28 million in additional pricing.

The likelihood of it impacting this year, though, is getting low just given the way the calendar's working and how long it takes us to be able to implement price increases. So... the effect is always at least a quarter out from whenever anything occurs.

Gotcha. Thanks. Lastly, can you talk about what you're seeing in the M&A pipeline and how you guys are looking at valuations right now? Thanks.

As I commented before, acquisitions are a core part of our strategy as we try to change the profile of our business towards faster-growing categories, channels, and geographies. We're very disciplined in our approach. There's lots of potential acquisitions out there. We're disciplined in our approach, and we only act if it makes sense from a return on invested capital perspective for our shareholders. Beyond that, I can't comment on any specifics.

Great. Thanks so much.

Thanks, Mike.

Thank you. Our next question is coming from the line of Hale Holden with Barclays. Your line is now open.

Good morning. Thanks for taking the call. I had two questions. In the slide deck, you called out enabling independent dealers to increase direct purchases to become more price competitive. I was wondering if you could give us some more color on what you're doing with the independent dealers in the U.S. and what the opportunity set was there.

Yeah, we launched a program a few months ago to enable independent dealers to buy directly from us in economic order quantities if they want to. and therefore they can avoid the wholesaler margin and be more competitive with e-tail. And that program's been very successful. We had a lot of adoption. Dealers still have a choice whether they want to buy through a wholesaler or directly from us, and a lot of them make those decisions based on not just pricing but credit availability and some of the other factors, warehouse space, etc., But we have seen a positive uptake on that program. We have more dealers buying direct from us, which allows them to compete more effectively with their competitors. And just as an aside, we have a very successful independent dealer initiatives in EMEA, where the majority of our sales actually do go directly to independent dealers and not to wholesalers. As a result, our dealer business and our all business in EMEA is very healthy and robust. What's happening in North America, in a way, is mimicking what we've done in EMEA over many, many years.

You had also called out good sales flow through to the wholesalers or expectations of that and the back to school. I assume that there's been no blowback to you from that channel?

No. Obviously, wholesalers want to have dealers buy directly from them, but our sales with wholesalers have been growing, albeit it's because they were taking inventories down last year, so the compares are a little bit easier. But no, we haven't seen a lot of blowback from wholesalers on that.

Got it. And then my second question was, in Europe... I think the office superstore is a pretty small component of what you're selling into, but we had seen headlines earlier in the week that one of them had a factor that was not providing support to them. I was wondering if that was an issue for you guys at all or not.

Yeah, the environment in Europe is very different. As you said, superstores are a very small percent of the business in Europe. and because they're such a small percent of the business in Europe, we effectively can offset some of the headwinds that we've seen from them over the last several years with growth through other channels. So, yeah, we're aware of all the happenings in Europe. We don't think it's going to have a material effect on our business there.

Great. Thank you so much. I appreciate it.

Thank you, Hale.

Thank you. Our next question comes from the line of Karu Martinson. Jeffrey, your line is now open.

Just following up on the wholesalers, has there been any change really with the ascendant being integrated or being assumed by Staples parents?

We haven't seen the effects of that combination yet in our business. We anticipate, obviously, that something will happen, but we have not seen it yet.

Okay. Okay. And just with Staples launching Private Label, a number of brands, how does that change the aspects? Is Private Label still kind of the category entry point that you always thought it was, or has that changed?

No, nothing has really changed. I mean, Staples has had Private Label for many, many years. They just now branded it something different than Staples, but the strategy is not that much different. So we don't think it's going to have any different impact than it has had over the last many years in our business.

Okay. Just lastly, in terms of freight and shipping, what's the outlook there?

Did you say, Karu, freight and shipping?

Exactly. Okay.

We have seen rates rise, and that's a continuation of what we saw last year in the second half, similar issues in terms of shortage of truckers and digital metering, et cetera. So they're still at the elevated levels. They're not increasing at the same rate that we saw last year. last year, but they certainly are not going down.

Okay. Thank you very much, guys. Appreciate it. Thank you, Koro.

Thank you. Our next question comes from the line of Joe Gomez with Noble Capital. Your line is now open.

Thanks. Good morning, guys. Good morning, Joe. Most of my questions have already been asked, but one of the things you mentioned was that you're looking at doing some more insourcing to your existing plants. I wonder if you could give us a little more color on that. How much can you do? What type of products are you pulling back? Anything in there would be appreciated.

Sure. So if you look at tariffs affect different categories unevenly. They're causing us to actually outsource in some categories because it's cheaper to buy a finished product than to import raw materials which are affected by tariffs and then build it in our factories. On the other hand, in a category like binders, it's now more effective to manufacture them in our facilities than to import finished goods from Asia, from China. So binders specifically, we'll look into in-source more, but on some of the categories like glass boards, we're actually manufacturing less and bringing more from Asia.

Okay, great. And I don't know if you could give us an impact. I know last year we talked a little bit about lost calendar placements. I was wondering if you know, going into this period, whether you regain those placements or not?

Yeah, we've seen the lost placements anniversary in Q1 of this year. It didn't really have an effect on our Q2 sales, and we're hoping for incremental placement and incremental share in the Q3 and Q4 timeframe. So, The negative effects are behind us, and we're hoping for positive effects in the second half of the year.

Okay, great. Thank you.

Thank you, Joe.

Thank you. This concludes today's question and answer session. I would now like to turn the call back over to Boris Ellisman, Chairman, President, and CEO, for closing remarks.

Thank you, Sarah. In closing, we're very pleased that the business has performed well in the first half, driven by North America's strong back-to-school business and global acquisition. We remain confident about our future and continue to position the company for growth and strong returns for our shareholders. I look forward to speaking with you again after we report our third quarter earnings in a couple of months. Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program.