Acco Brands Corporation

Ladies and gentlemen, thank you for standing by, and welcome to the 2Q 2021 Echo Brands earnings conference call. At this time, all participants are in a literacy-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star 1 on your telephone. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today, Christine Hanneman. Thank you. Please go ahead.

Good morning. This is Christine Hanneman, Senior Director of Investor Relations. Welcome to ACCO Brands' second quarter 2021 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 our results, we may refer to adjusted results. Adjusted results exclude transaction, integration, amortization, and restructuring costs and other non-recurring items 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 the earnings release and slides that accompany this call. Due to the inherent difficulty in forecasting and quantifying certain amounts, we do not reconcile our forward-looking non-GAAP measures. Beginning with the first quarter of this year, we changed the way we calculate and report adjusted non-GAAP results by excluding non-cash amortization of intangible assets. Please see our press release for further explanation of this change. Forward-looking statements made during the call, including statements concerning the impacts of the COVID-19 pandemic on the company, are based on the beliefs and assumptions of management based on information available to us at the time the statements are made. Our forward-looking statements are subject to risks and uncertainties, and our actual results could differ materially. Please refer to our earnings release and FCC 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 Ellisman.

Good morning, everyone. Thank you for joining us. I will spend a few minutes reviewing the second quarter highlights. Nir will follow me with details on the numbers and provide additional comments on our balance sheet, cash flow, and second half outlook. Then we'll take your questions. We had an excellent quarter with a rebound in demand for many of our commercial products reflecting the economic recovery. Second quarter sales and profits exceeded our internal expectations as we posted a significant increase in total sales as well as robust organic growth for both the second quarter and year to date. Our total second quarter sales were near record levels and comparable to 2019. And each of our segments experienced a steady improving level of demand throughout the quarter. I'm very pleased with our performance and remain confident in our strategy of transforming our business to become more consumer-oriented. In general, the U.S., EMEA, Australia, New Zealand, and Asia continue to see strong recoveries as more people return to offices, hiring rebounded, and many schools return to in-person learning. EMEA had an excellent quarter, driven by outstanding organic sales growth returning the business to pre-pandemic levels. We believe we continue to take share as customers move toward the well-known brands and more reliable service that we provide. Strong sales growth is widespread, led by computer accessories, DIY tools, wellness products, shredders, art supplies, and a general increase in demand from all categories. In North America, we had a robust recovery of office and commercial categories, which improved sequentially throughout the quarter as offices begin reopening. Our second quarter is usually driven by North America back-to-school orders, and we expect most schools will be open for in-person, five-day-a-week education beginning this fall. Our major customers of back-to-school inventory remaining from last year saw our second quarter sales, while very good, were lower than normal expected selling. We plan for this in our second quarter guidance. We have expectations for a strong total season, which should trigger greater replenishment needs in the second half, where our ability to locally produce product may be an added benefit due to global supply chain problems. PowerA had a very good second quarter performance, with sales up 19%. It would have been even better, but gaming console product availability was restricted due to supply chain challenges, including semiconductor chip shortages. There is substantial demand for overall gaming products, and the console producers are backorders. We expect many more gaming consoles to ship in the seasonally stronger second half, and believe PowerAid sales will increase as it is well positioned to take advantage of greater demand. We continue to expect 25% sales growth for the year from PowerAid. Our integration of Farway continues on track, and we expect to end the transition services agreement with the previous owner in August. We are pleased with this acquisition in all aspects. Turning to the international segment, the region overall had a good quarter. Latin America is still operating in a challenging environment, but vaccinations are increasing, and that should bode well for office and school reopenings to accelerate. In the quarter, The segment had organic sales growth and profit improvement, despite sporadic lockdowns in various parts of the region. We're expecting continued recovery in this segment over the next few quarters. Moving on, last year our Kensington computer accessories business received the largest order it has ever had, which means a difficult comparison in the second and third quarters this year. Despite the difficult comps, the Kensington business grew in the quarter, as we continue to introduce new, innovative products. One of those products, which I spoke about during our first quarter earnings call, is the studio dock for Apple iPads. That product has been so popular that it is now out of stock, and we have a lengthy backorder list, which we expect to fulfill in the second half. Despite increased competition, our TrueSense wellness products continue to perform well in the quarter, with double-digit growth from last year. Expanded product offerings in this category later this year and next should fuel continued growth of health and wellness products. Turning to the supply side of the business, the main issues we face worldwide are continued supply chain disruptions due to COVID-19 impacts and high inflation. We're carrying more inventory where possible because of elongated supply chain lead times. Logistics costs have risen significantly compared with last year's rates as have the cost of commodities such as oil, plastics, steel, and paper. While the rates of increase have subsided, we expect cost to stay at these elevated levels at least for the rest of the year. As a result, we have taken price increases in most countries and announced additional price increases that will occur later this summer and fall. Favorable foreign exchange is helping to mitigate some of the higher costs in EMEA, Canada, and parts of our international segment. In summary, we continue to focus on executing our strategy of improving sales growth and profitability by shifting our business towards more consumer-centric products and faster-growing channels. As occurred this quarter, our growth will come from acquisitions such as PowerA, as well as organic sales from demand recovery, innovative new products, and market share gains. We have adapted quickly to take advantage of the changing post-pandemic environment by aggressively pursuing the long-term opportunities we think will grow most rapidly. We're making larger investments in growth areas such as video gaming accessories, wellness products, work, learn, or play from home products, and computer accessories. and are reducing our investments in some commercial office products that we expect will remain relatively weak longer term, although we're seeing some post-pandemic recovery even in these product lines as offices reopen. We now have better visibility for the second half and are expecting a sustained economic recovery in all regions in the third quarter. We believe that environment will lead to continued organic sales growth with inflation offsetting some of the gross profit gains from volume growth. For the full year, we're expecting record sales and a strong profit performance. Now I will turn the call over to Neil for a more detailed review of the segments, our outlook, and other financial commentary. And then I'll join him in answering your questions. Neil?

Thank you, Boris, and good morning, everyone. Our second quarter reported net sales increased 41% due to an increase in sales of commercial products, as well as the contribution of PowerA, which added $51 million. Our comparable sales rose 21%, helped by steadily improving market conditions. Second quarter net income was $49 million, or $0.50 per share. Adjusted net income was 42 million and adjusted EPS was 43 cents, much better than our outlook based on higher sales. Our gross margin rose to almost 32% compared to 30% in 2020. The increase was largely the result of cost savings and lower inventory reserves. SG&A expenses were 98 million compared with 77 million last year. Results in 2020 benefited from many pandemic-related temporary cost reduction efforts that impacted both SG&A and cost of goods sold. This year's expenses are at a more normal level for our company. SG&A as a percent of sales was 19% compared to 21%, primarily because of higher net sales. Reported operating income was $50 million compared with $19 million last year. The operating margin was almost 10% versus 5% in 2020. We recorded $9 million of upper income because of a Brazilian Supreme Court tax ruling that will allow future offset for certain indirect taxes previously paid. We anticipate as the lower courts continue to apply the Supreme Court's ruling, we will record additional income in future periods. Our adjusted tax rate of 28% was in line with our full year estimate of approximately 29%. Barre's sales rose 19%, however, the increase would have been larger if not for a shortage of consoles related to the chip shortage, as Boris described. We continue to expect a strong second half from Power A as console manufacturers fill their back orders and because of the normal seasonally strong demand for the December holidays. The Power A earn-out is payable in two equal instalments over the next two years if certain sales and profit targets are met. Each quarter we recognise any change in fair value of the earn-out as an expense in our income statement. we expect quarterly charges throughout the two-year earn-out period. This quarter, we booked a $5 million expense related to the earn-out, which, along with the $4 million of amortization related to the acquisition, resulted in MES-wide operating contribution from PowerA. PowerA contributed $0.03 to adjusted EPS. Now let's turn to some details of our segment results. Net sales in North America increased 27%, largely due to the contribution from PowerA. Comparable sales rose 8% as a result of strength in commercial office products. As expected, the selling effect of school products was less than last year's second quarter, as customers used inventory they held from last year. we still expect back-to-school season to be significantly higher than last year, with replenishment to come in the third quarter and possibly also in the fourth quarter. North America operating income and operating margin increased as a result of higher sales, $5 million of lower restructuring costs, and $5 million less expense for inventory reserves. Now let's turn to EMEA. Net sales rose significantly to $157 million and comparable sales rose to $136 million, which are both above 2019 levels. The strong increases were the result of a general economic recovery as well as market share gains. We have now seen four quarters of strong business improvement in EMEA. EMEA posted a $10 million operating profit versus a $2 million loss last year, primarily due to the higher sales, which offset higher costs, particularly from normalized expenses and logistics. Moving to the international segment, net sales and comparable sales increased significantly because of higher demand in all countries. Mexico and Brazil continue to be impacted by COVID-19, although we are seeing improvement as vaccination rates have increased. our businesses in Australia, New Zealand, Asia and Chile are much less impacted. As a result of improved sales, this segment posted an adjusted operating profit of $5 million versus a loss of $2 million last year. Results were also helped by $2 million of lower bad debt reserves, $1 million of lower inventory reserves and $1 million of lower restructuring costs. Let's move now to our balance sheet and cash flow. In the second quarter, we used approximately $13 million in net cash from operating activities and had $18 million of free cash outflow. We paid dividends of $6 million and CapEx was approximately $5 million. Year to date, we used approximately $55 million in net cash from operating activities and used $64 million of free cash outflow. We paid dividends of $12 million and CapEx was $9 million. Our use of cash is lower this year than last year by $12 million. If you exclude PowerA, it was $35 million better. As we have noted before, the planned use of free cash flow for this year will be to fund our dividend and to reduce debt. Our capex outlook for 2021 is less than $30 million. At quarter end, we have $331 million remaining on our $600 million revolving credit facilities. We also had $78 million in cash on hand. Our bank pro forma net leverage ratio improved to 4.2 times, which is better than we expected due to our stronger earnings. Now let's turn to our outlook. We now have greater visibility to the rest of the year. Therefore, we are enhancing our guidance to provide both a third quarter and full year outlook. Our second-half demand is expected to continue to improve compared with last year, especially with more companies returning to offices, at least in a hybrid mode. We expect a good sell-out of back-to-school products, and foreign exchange should continue to be a benefit. Likewise, the second half is seasonally strong for Kensington, and especially PowerAid. Our third quarter outlook is for sales to be in the range of $515 million to $545 million. Third quarter adjusted EPS is expected to be in a range of $0.30 to $0.35. The third quarter outlook includes a favorable foreign exchange impact of 2% on sales and $0.01 on adjusted EPS. We anticipate approximately $12 million of pre-tax intangible amortization will be excluded in the third quarter based on our definition of adjusted earnings, which represents approximately $0.09 on an adjusted EPS basis. Compared to the second quarter, we expect additional pressure on operating margins in the third quarter, mainly due to cost inflation. much of which hit inventory values in the second quarter and will impact the bottom line in the third quarter. Most of the incremental price increases to affect inflation will not affect our results until the fourth quarter. All of this is baked into our guidance. The fourth quarter will also incrementally benefit from strong Power A sales due to its typical business seasonality. For the full year, our outlook is for sales to be in a range of $2 billion to $2.07 billion. Full year adjusted EPS is expected to be in a range of $1.35 to $1.45. This translates to adjusted EBITDA in a range of $285 to $300 million. And with our expected use of free cash flow to mainly reduce debt, we expect to achieve our leverage goal of 3.5 times or lower at year end, similar to where it was before we purchased PowerAid. The full year outlook includes a favorable foreign exchange impact of 3% on sales and $0.05 on adjusted EPS. We expect our normal productivity programs will deliver approximately $30 million in full year expense savings. The pre-tax amortization exclusion for the full year is estimated to be $47 million, which equates to approximately $0.34 on an adjusted EPS basis. We feel confident that we can deliver at least $165 million of operating cash flow for the full year, and with CapEx expected to be less than $30 million, we will generate at least $135 million in free cash flow. That means we expect to generate approximately $220 million in cash flow in the second half. That type of performance has been a regular occurrence in our seasonally strong second half. Now, let's move on to Q&A, where Boris and I will be happy to take your questions. Operator?

At this time, ladies and gentlemen, if you would like to ask an audio question, please press star, then E1 on your telephone keypad. We kindly request that you ask one question, and then you may return to the queue. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Our first question comes from the line of Chris McGinnis with Sodoti and Company.

Good morning. Just taking my questions in the next quarter. Would you mind expanding on the growth in the commercial? How much of that is just that they haven't been spending in the course of the pandemic? And how do you think that should hold up for the rest of the year? Thanks.

Hi, Chris. Thanks for the question. Yeah, the growth in the commercial channels was pretty strong. You have to keep in mind that last year in q2 um they really shut down purchases uh so it's really a a compare story uh we do see more offices reopening uh they're expecting more offices to reopen uh in the near future so they're buying both for a demand they have today as well as uh staging inventory for the demand that's going to come for the remainder of the year so the growth throughout all segments of our commercial channels were very strong, whether it's independent or contract stationers. We saw a very strong growth throughout. And we think more or less that story will continue for the remainder of the year. Obviously, the compares will be different versus the worst quarter of the pandemic, which was Q2 of last year. But still, from a sequential standpoint, we expect sequential growth for the remainder of the year.

And if I could just add one follow-up, if it's all right. Just on the PowerA, nice growth. Can you just talk about from EMEA, you know, how much that was up, and are you starting to gain traction there? I know it's very early on in the integration.

Thanks. PowerA and EMEA had a good quarter, but, you know, they're still pretty small numbers. So that business is still driven very much by North American demand. We still have not implemented greater expansion plans for PowerAid in EMEA. That's something that's going to come over the next several quarters. There's still significant upside in that business in EMEA. So despite that, we grew 19% in the quarter and 53% year-to-date with PowerAid globally.

Thanks for taking my question. Good luck to you three.

Thank you. Thanks, Chris.

Your next question comes along to Bradley Thomas with KeyBank Capital Mark.

Hi. Good morning, Boris and Neil. This is Andrew for Brad. Congratulations on the strong results here. Now that we're hopefully, you know, through the worst of the pandemic and it appears that you are starting to benefit from, you know, populations returning to the office and in-person learning at school, Have you noticed any changes in the competitive environment for office products, particularly when you compare this environment to the pre-pandemic environment?

Nothing meaningfully so. I mean, we're still in a competitive industry. You know, we're benefiting from, you know, very strong brands that we have and strong distribution that we have. But the competitive environment is, you know, very similar. And I'm looking at Neil. Anything that Neil could add versus pre-pandemic levels? I don't think that there's anything.

There's no change in competitiveness. There's probably a change in which products are less popular and more popular as a result. So some of the paper storage products are less popular. People move to more electronic storage and – Products that are used more for teamwork are showing strong signs.

Understood. Thank you. If I may add one quick follow-up. Given the industry-wide supply chain constraints, which you noted in your prepared remarks, are there any areas which you are facing issues with product availability?

We have generic issues with product availability for everything that we bring in from Asia. And that's not just us. That is a global phenomenon with everybody. It's a function of logistics constraints, both on just the availability of containers as well as sporadic shutdowns due to COVID-19. in Asian countries. So this is something that we're dealing with and I think managing quite well, but the whole world is dealing with that. It had an impact on some of our product availability in Q2, and we do expect sporadic issues throughout the rest of the year. And as Neil mentioned, all of that is already baked into the guidance that we provided.

I understand. Thank you.

Thanks, Angela. Your next question comes from the line of Joe Gomes with Noble Capital.

Good morning. Nice quarter. Thanks, Joe. So quick question on the cash flow. You really knocked the ball out of the park this quarter, you know, first quarter. You're raising or putting out some nice numbers for the second half of the year, but you really haven't raised your cash flow guidance. And I'm just wondering, is that just you being conservative or what's behind that?

That's a good question. One of the reverse challenges people – don't always focus on when you get a lot of return to growth is we need a lot more accounts receivable on the balance sheet at the end of the year. And so particularly around South America, a lot of our business there is very Q4 centric in Brazil. and drives them all into receivables at the end of the year. So although guidance is increased, we have two negative issues. We have more AR, and we're also seeing a lot more dollars having to go into inventory. As we've always mentioned all year, it's not changed. Power A is a use of cash for us for the year as opposed to a normal source, and their big quarter is Q4.

Right, right. Okay. Okay. And one quick follow-up, if I may, also on PowerA. Sequentially, revenues declined. I think in the first quarter, PowerA revenues were north of $60 million. In this quarter, they were $50 million. Is that just, as you mentioned before, some of the seasonality in the business and the fact that there has been some outages in terms of the consoles, or is there anything else there? Thank you.

Yeah, that's right, Joe. A little bit of seasonality, but probably a bigger impact is the fact that the console makers have a difficult situation meeting demand due to the semiconductor chip shortages. So their shipments were affected and that affected the sales of the accessories. Our expectation is that there's going to be a partial recovery of that in the remainder of the year. There'll still be some shortages, but it should be better than Q2, which should drive incremental sales of Par A, as well as just normal seasonality of the business, which improves in Q3 and Q4.

Thank you.

Thanks, Joe.

Your next question comes from the line of William Bruder. The Bank of America.

Good morning. In your gross margin reconciliation, there doesn't really seem to be any meaningful headwinds in terms of margin pressure from inputs nor transportation. I guess, can you talk a little bit about whether this is the use of third-party manufacturers or whether you've contracted your ocean freight some way you know, length of time in advance or what's contributing to the lack of pressure?

So we raised prices at the beginning of the year to offset the ocean freight issues. And so those were largely an offset to each other. They were a small drag of about 30 basis points adverse in the overall, you know, But in Q3, as we kind of highlighted on our call, we expect, because we've seen it already go into our balance sheet in Q2, significant increases of commodity costs. So it's just the way, you know, we have about three months' worth of inventory, and so all the purchases in Q2 basically go into inventory, and they will hit the P&L in Q3. And so we will see a lot more margin pressure in Q3, and that's part of why we also need to raise prices again. in the late summer.

Okay. And then I guess just as my follow-up to that, given that you guys were successful in pushing through sufficient price increases here for the second quarter, will these next round of price increases largely make it so fourth quarter we shouldn't see much margin pressure at that point?

Obviously, It would if we see stability through this quarter. If we see more surges in commodity costs, then that would be a different story. But we're always, unfortunately, lagging what happens in the real world. But we currently think commodities hopefully have stabilized roughly where they are. That's our assumption in our forecast.

Makes sense. Okay, I'll pass to others. Thank you. Thanks, Jeff.

We're ready for the next question.

Yes. Your next question comes from Hamid Khorsan with BWS Financial.

Good morning. Question on the supply chain and what you're seeing in terms of pricing pressure, not just for Q3, but how, expanding on what you said, but how is that impact, the impact there competing for space on Q3? cargo carriers to bring product over, and do you see that as an obstacle in the second half of the year?

Yes, we do. It continues to be an issue. There continues to be container shortage in Asia. It's difficult to reserve space on ships, so we continue to have um, elongated lead times as a result of that. And we don't see a, um, near term resolution to that. So that's, we expect that to continue through the second half of the year.

I guess my, my question on a follow up is, um, I mean, that's pretty much what she said in your prepared remarks, but my question is mostly about, uh, in terms of capacity and space to get products over, are you bidding higher to make sure your products are, arriving in time, or is it just first come, first serve that you're just, and you're not quite sure if your product, if you'll have enough inventory in the second half, is that an issue at all?

Well, you know, we have long-term contracts with our logistics providers where the price is agreed to, but sometimes we do have to bid or get a spot rate, which is significantly higher in order to get products here in time for a um retail set or back to school seasonality so yes we do have you know we we try to be strategic about it uh but uh sometimes we do have to bid a higher price and incur a higher cost in order to get a product here uh earlier and expedited fashion thank you as a reminder to ask a question you will need to press star 1 on your telephone

We kindly request that you ask one question and then one follow-up, and you may return to the queue. At this time, there are no further questions. Do you have any closing remarks?

I do. Okay. Thanks, Christy. Thank you for the interest in Acker Brands. To summarize, as the economy has improved, We saw a very good recovery from the impacts of COVID-19, the strong increases in many of our product lines, particularly on the commercial side. PowerA continued to post significant sales contributions. We're expecting a strong second half. The business has momentum, and we should continue to see strong economic growth, back to school replenishment, and the traditional seasonality of Kensington and PowerA. We look to generate a significant amount of free cash flow and we'll use it to reduce our debt. We remain confident about our longer-term future as we continue to position the company for higher growth and strong returns for our shareholders. We'll update you on our progress next quarter. Thank you, and have a great day.

Ladies and gentlemen, thank you for participating in today's conference. You may now disconnect.