Acco Brands Corporation

Good morning. This is Christine Hanneman, Senior Director of Investor Relations. Welcome to ACCO Brands' third quarter 2021 conference call. Speaking on the call today are Boris Ellisman, Chairman 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. 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 SEC filings or 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 discussing the overall environment we're operating in and how it's impacting our business. Neil will follow me with details on the numbers and provide additional comments on our balance sheet, cash flow, and outlook. Then we'll take your questions. We had a good quarter based on the addition of PowerA, continued strength in EMEA, a solid back-to-school sellout in North America, and improvement in our international segment. All segments posted organic sales growth, including double-digit growth in comparable sales in EMEA. During the quarter, we continue to see steadily improving demand overall, despite higher incidences of COVID-19 during August and September. However, while commercial product sales were up and back to school replenishment orders were solid, the increase in the Delta variant in the quarter resulted in more muted demand for commercial products and less back to school replenishment than we would have seen otherwise. In addition, global supply chain, and semiconductor availability issues kept our backwaters high, which also delayed some shipments in the quarter. Despite those challenges, we saw economic recovery and improving end-user demand throughout the quarter and believe the steady recovery will continue in the fourth quarter. Let me now give you some color on our business. I'll begin with PowerA. We're pleased with the performance of this business which had a good sales quarter, but at the low end of our expectations. Due to chip shortages, video gaming console sales have been hampered by product availability issues throughout the year, and console sales are a major demand driver for the accessories sold by PowerA. We had expected console availability to improve in the third quarter, but it did not to any significant extent. There were few products on retail shelves, and whatever shipments were received were sold immediately, mostly through online channels. There continues to be strong demand for video gaming products, and we expect console supply to improve over time, but console producers are still likely to have back orders in the fourth quarter. As a result, we're reducing our outlook for PowerAid sales growth this year to 20% from 25%. Our business has enough product to sell in its seasonally strong fourth quarter, and we're well positioned to meet demand. We expect to continue to see a strong organic performance domestically from Pare in 2022, and plan to begin incremental expansion internationally in the latter part of next year. Moving on, as we noted last quarter, the U.S. back to school sell-in was impacted by an inventory overhang from 2020. Back to school sell-through was solid this year, with school supply sales growing 27% according to the preliminary information from external sources. Our five-star brand of school products took share again with sales growing 39% according to external sources. We were the leading notebook brand for back-to-school in North America. The inventory overhang from last year's soft sellout has been sold through. Due to increased incidence of the Delta variant, however, our customers were somewhat conservative in making replenishment orders. But we still had a reasonable amount of replenishment in the third quarter and are very pleased with our overall back-to-school performance. We will enter next year in a good position for back-to-school sell-in and have expectations for a strong 2022 season, as the circumstances should be more normalized and the channel finished this season without excess inventory. Moving now to our Kensington brand, you may recall that last year that business had its largest order ever, so we were up against a very difficult comparison this quarter. If we exclude that large sale, Kensington had double-digit sales growth versus last year, and our total comparable sales increased 10% instead of 4%. Kensington continues to focus on development of new products to fuel its growth, and the pipeline for 2022 is robust. Emilia had another excellent quarter with organic growth of 10% on top of a strong third quarter last year. We'll continue to take share in every part of our portfolio with especially strong growth in Kensington, Rapide, Lights, and Derwent branded products. Our team in EMEA is doing an excellent job, and I expect our strong performance there to continue. Finally, let me talk a bit about our supply chain and the high freight and commodity costs we have been seeing. Every business is facing supply chain delays and disruptions, whether it's port congestion, factory closures, truck driver shortages, rail chassis shortages, shipping containers in the wrong places, etc., Logistics and commodity costs have increased rapidly over the past year and are still very high. While it is hard to predict, we don't see the situation improving until perhaps the second half of 2022. Our employees have been managing this difficult situation very well. We're carrying more inventory where possible because of elongated supply chain lead times. It also helps that we manufacture approximately 40% of our products in our local markets. We're taking several price increases across all of our businesses globally to help offset the higher cost, and we will announce additional price increases for 2022. We expect price increases to substantially mitigate the effects of inflation in 2021, but they won't fully offset them until next year because our pricing generally lags cost increases. In summary, we believe that current recovery demand will lead to continued organic sales growth and improved profitability of our business. For the full year, we continue to expect record sales and a strong profit performance. Overall, we continue to focus on executing our long-term strategy of improving sales growth and profitability by shifting our business towards more consumer-centric products and faster-growing channels. 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 are aggressively pursuing and investing in the long-term opportunities we think will grow most rapidly, such as video gaming accessories, computer accessories, and work, learn, or play from home products. We recently made some leadership changes to enhance our execution of this strategy. We have promoted Tom Ketford, who ran our North America operations, to President and Chief Operating Officer, and hired Roxanne Bernstein, who has strong consumer and marketing experience, to run our North America segment. We remain confident in our strategy and our solid financial position, especially our consistent, strong free cash flow generation. I'm pleased to report that our board shares that confidence and has approved a 15% increase to our quarterly dividend to 7.5 cents per share. 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 third quarter reported net sales increased 19% to $527 million, largely due to the contribution of PowerA, which added $57 million. Our comparable sales rose 4% as we saw improved demand in most markets. Third quarter net income was $20 million or $0.21 per share. Adjusted net income was $32 million and adjusted EPS was $0.33 per share. Our adjusted EPS was adversely impacted by $0.03 from a much higher adjusted tax rate than originally forecast. Without the change in tax rate, our adjusted EPS would have been $0.36. Our growth margin rose 120 basis points to almost 30%, compared with roughly 29% in 2020. The increase was largely the result of higher sales, a better product mix, and cost reductions. SG&A expenses were $102 million, compared with $84 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 and also reflect the addition of PowerA. SG&A expense as a percent of sales was 19%, even with last year, as the higher expenditure was offset by higher sales. Reported operating income was $39 million compared with $34 million last year, and operating margin was slightly over 7% versus close to 8% in 2020 due to the dilution from the Power A earn-out and amortization. The Power A earn-out is payable in two equal installments in March of 2022 and 2023 if certain sales and profit targets are met. Each quarter, we recognize any change in fair value of the earn-out as an expense in our income statement. We expect quarterly charges throughout the earn-out period. This quarter, we booked a $5 million expense related to the earn-out, which along with $4 million of amortization related to the acquisition resulted in only a slight operating profit contribution from PowerAid. Without those charges, PowerA contributed 4 cents to adjusted EPS. We increased our full year tax estimate to reflect changes in our forecasted geographic mix of income, interest expense limitations, and our GILTI tax burden. This resulted in a 31% projection for 2021, increased from the previous level of 29%. For the third quarter, The 34.8% tax expense reflects the year-to-date true-up as the first two quarters had reflected the 29% projection. Now let's turn to some details of our segment results. Net sales in North America increased 21% to $288 million, largely due to the $45 million contribution from PowerA. Comparable sales rose 1%. primarily from higher back-to-school and commercial sales, partially offset by the absence of a large Kensington computer accessories order that shipped mainly in the third quarter last year. North America adjusted operating income and margin increased as a result of higher organic sales, Power A, and better product mix, primarily due to the absence of $22 million of lower-margin Kensington sales. Now let's turn to EMEA. Net sales rose 18% to $161 million, and comparable sales rose 10% to $151 million, which are both above 2019 levels. The strong increases were the result of a general economic recovery, as well as market share gains, including the benefit from the acquisition of the Franklin product line. We have now seen five consecutive quarters of strong business improvement in EMEA. EMEA posted a lower operating profit and margin due to higher logistics and commodity costs, as well as more normalized SG&A expenses versus last year. EMEA raised prices effective October 1st, so we should see some margin improvements in the fourth quarter, but EMEA will likely need to take additional price increases in 2022 to offset inflation. Moving to the international segment. Net sales increased 13% due to price increases, Power A, and favorable foreign exchange. Comparable sales increased 5%, primarily because of higher prices. Mexico and Brazil continue to be impacted more by COVID-19, although we are seeing improvement as vaccination rates have increased. Mexico essentially did not have a back-to-school season. We are hopeful that Brazil will fare better with its back-to-school season as more children have returned this fall to in-person education. We expect the back-to-school season in Brazil to be larger than the prior year. However, we anticipate that more sales are likely to move into the first quarter of 2022 and less in the fourth quarter this year, which is the opposite of what historically has occurred. Our business in Australia was negatively impacted by a return to lockdowns. In New South Wales, which has the largest population and is where most of our sales occur, lockdowns impacted the entire third quarter. Despite that, sales in Australia were up mid-single digits in the quarter. The lockdowns are now over and the vaccination rates have improved markedly, so we are expecting Australia to have a relatively good fourth quarter. The international segment posted an adjusted operating profit of $10 million, much better than last year, primarily based on long-term cost reductions and higher pricing. Let's move now to our balance sheet and cash flow. In the third quarter, we generated $99 million in net cash from operating activities and had approximately $94 million of free cash flow. We paid dividends of $6 million and capex was $5 million. To date, we generated 44 million in net cash from operating activities and generated 30 million of free cash flow. We have paid dividends of 19 million and capex was 14 million. Our year-to-date free cash flow is 20 million higher than last year. As we have noted before, the planned use of free cash flow for this year will be to reduce our debt and fund our dividend. Our capex outlook for 2021 is less than $25 million. At quarter end, we had $447 million available on our $600 million revolving credit facility. We repaid $117 million in debt in the quarter. Our bank pro forma net leverage ratio improved to 3.8 times, which is in line with what we expected and results in incremental interest savings of over $400,000 for the next four months. Now let's turn to our outlook. Our fourth quarter demand is expected to continue to improve compared to last year, especially with more companies expected to return to offices, at least in a hybrid mode. Foreign exchange, which has been a benefit, is not expected to add much to our fourth quarter since the US dollar recovered strongly during the third quarter. As a reminder, the fourth quarter is normally very strong seasonally for Power A, EMEA and back to school in both Australia and Brazil. We expect continued pressure on operating margins in the fourth quarter, mainly due to logistics and commodity cost inflation. However, the recent price increases will benefit our results in the fourth quarter, and although they will not fully offset the cumulative impact of inflation, we should see margins expand, but they will still remain below 2019 levels. We have incorporated this into our guidance We are reducing the top end of our sales outlet to reflect the impact of console availability for PowerA, and we are modifying our adjusted EPS to reflect the higher full-year tax rate. For the full year, our outlook is for sales to be in the range of $2 billion to $2.04 billion. Full-year adjusted EPS is expected to be in the range of $1.30 to $1.40 using a 31% tax rate. The impact of the higher tax rate on the full year adjusted EPS forecast is 4 cents. We forecast adjusted EBITDA to still be in the range of 285 to 300 million, which at the high end would bring us back to 2019 levels. 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 PowerA. The full year outlook includes a favorable foreign exchange impact of 2.5% on sales and 5 cents 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 33 cents on an adjusted EPS basis. We feel confident that we can deliver at least $135 million in free cash flow. We expect to generate at least $160 million of operating cash flow for the full year, and CapEx is expected to be less than $25 million. Now let's move on to Q&A, where Boris and I will be happy to take your questions. Operator?