ACCO Brands Corporation (ACCO) Q1 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the ACCO Brands First Quarter 2018 Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Jennifer Rice, Vice President, Investor Relations. You may begin.

Good morning, and welcome to our first quarter 2018 conference call. Speaking on the call today are Boris Elisman, Chairman, President and Chief Executive Officer of ACCO Brands Corporation, and Neal 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 to quarterly results, we may refer to adjusted results. Adjusted results exclude transaction, integration, restructuring and financing-related costs and apply a normalized tax rate of 28% in the current year. 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 this morning'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 adjusted earnings per share or tax rate guidance. For more information, see this morning's press release. 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's date and we assume no obligation to update them going forward. Following our prepared remarks, we will hold a Q&A session. Now it is my pleasure to turn the call over to Boris Elisman.

Thank you, Jennifer, and good morning, everyone. I'm pleased to report that the year got off to a solid start, with net sales up 13% because of the Esselte acquisition and benefits from foreign exchange, and net income up 189% from last year. Those of you who've followed us for a long time know that Q1 is our smallest sales quarter of the year, and historically, we've lost money in the quarter due to lack of scale. While Q1 is still smaller than other quarters, the incremental sales and margins from our 2 most recent acquisitions make it solidly profitable, demonstrating the health and balance of our more diversified business portfolio. We're now also in a much better position to offset revenues and margin declines in one region due to store closures, product mix or inventory destocking with growth in another. We saw this play out in Q1 of 2018. While our total results were consistent with our overall expectations, EMEA delivered significantly higher sales and profits, offsetting expected declines in North America and mixed results in international. I'm going to begin my segment commentary with EMEA because it drove the sales and profit improvements in the quarter. Net sales in our EMEA segment were up 60%, largely because of the extra month of Esselte and improving currencies, but comparable sales stripping out the extra month of Esselte and FX gains were up 2%, despite the negative impact to the quarter of the earlier Easter holiday. In the quarter, we gained new listings at key European customers and grew sales of our Kensington products by 20%. We also saw double-digit growth in our UK business, reversing the trend from last year. EMEA adjusted operating profit grew by over 200%, benefiting from incremental sales leverage and cost synergies. I'm very pleased with our European results, where the integration of Esselte continues to proceed well, and we are beginning to see positive sales synergies. In North America, net sales declined as expected, due to continued inventory reductions by office super stores and wholesalers. Trends at point of sales, or sellout, are better than our reported results. Overall, we continue to manage the channel transition well, but the seasonality of our business causes a larger impact from traditional office channels in the first and fourth quarters. The faster-growing channels, where we're seeing point of sales growth in the low- to mid-single digits, carry a bigger weight during the back-to-school season in our second and third quarters. We still expect North America sales to decline low single digits for the year. We have our initial view on North America back-to-school orders and they are consistent with prior year, when we had a good season overall. Results in the International segment were mixed, with net sales down 3%. While sales and profits in Brazil grew on the back of a good back-to-school season, their improvement was more than offset by declines in Australia and Mexico. In both countries, a few large customers reduced inventories in the quarter. As in Europe, the earlier Easter reduced the number of work days in March, further impacting International segment performance. During the quarter, we distributed the first quarterly dividend in our history, at $0.06 per share. We also repurchased 772,000 shares of stock in the first quarter at an average price of $11.97. My final comments are on guidance. We are reaffirming our outlook for 2018 sales growth of approximately 2% and adjusted EPS growth of 12% to 15%, a range of $1.33 to $1.37 per share, assuming a normalized tax rate of 28%. We'll continue to expect free cash flow of approximately $180 million for the year. In summary, we're off to a solid start and have not changed our review for annual sales, profit and cash flow growth. Now I'll ask Neal to give you a more detailed look at the quarter. Neal?

Thank you, Boris. Good morning, everyone. First quarter sales increased 13%, mainly from the extra month of Esselte. Comparable sales at constant currency decreased 4%, primarily due to expected declines in North America, and to a lesser extent, declines in Australia and Mexico. Net income was $10.4 million or $0.09 per share and included $6.3 million of restructuring and integration charges. Adjusted net income was $8.9 million or $0.08 per share, up from $0.04 per share in the prior year quarter. Looking at specifics. Gross margin improved 60 basis points, including charges and improved 30 basis points excluding charges. The improvement in gross margin is detailed on Page 5 of our slide deck and was primarily driven by cost and synergy savings. SG&A expenses were up in the quarter due to the acquisition, but as a percent to sales, SG&A was lower by 110 basis points on a reported basis and lower by 30 basis points excluding charges. The improvement in adjusted SG&A to sales was due to the acquisition and cost savings, as well as foreign exchange. Turning to an overview of our segments for the quarter. In the North America segment, sales decreased 5%, but on a comparable basis decreased 6%, primarily due to inventory reductions at certain customers and some lost placements, which were mostly low-margin commodity products. Point of sales trends for our measured categories are better than our reported results. The lower sales and a lower segment gross margin caused North America operating income and margin to decline in the quarter. In our EMEA segment, sales increased 60% to $155 million as the extra month of Esselte added $43 million of sales in January and was up 6% over their last January. Excluding the month of January for Esselte and the effect of currency, comparable sales increased 2% or $1.6 million. We have seen an improvement in base ACCO business and positive sales synergies with Esselte customers. However, both legacy ACCO and Esselte had lower March sales, in part, due to the earlier timing of the Easter holiday and 10% less selling days in the month. EMEA operating income increased due to the acquisition and synergies, and both gross margin and operating income margin increased. International sales decreased 3% or $3 million to $86 million and comparable sales decreased 7% or $6 million. Strong growth in Brazil was offset primarily by declines in Australia and Mexico due to the customer inventory reductions and some share loss. International operating income decreased due to lower sales and higher distribution costs associated with warehouse and systems consolidation in Australia. The temporary increase in distribution costs improved sequentially as we are working to optimize combined operations in Australia. The later timing of Easter and reduced selling days was also affected for this segment. Turning now to our cash flow and balance sheet. We had positive cash flow generation during the quarter and adjusted free cash flow of $54 million versus $63 million in the prior year quarter. The timing of Easter affected certain customer's month-end payment cycles. For 2018, we still expect free cash flow of approximately $180 million. Once again, we expect our main cash generation in the third and fourth quarters. Q2 will be a cash outflow quarter, as it was last year, due to the seasonal working capital buildup for North American back-to-school season. In addition, we will make approximately $10 million of U.S. tax payments in the second quarter that we didn't have in the prior year. Our EMEA business will generate more cash this year, but we still have significant cash outflows for restructuring. Boris already commented on our guidance for the year and that initial orders for back-to-school are similar to last year. But just as a reminder, back-to-school season for North America spans the second and third quarters and it's very difficult to forecast exactly how much of our sales will land in either late June or early July. As always, we have included certain assumptions in our slide deck on page 7. With that, I'll conclude my remarks and move on to Q&A, where Boris and I will be happy to take your questions. Operator?

[Operator Instructions] And our first question is from Hamed Khorsand from BWS Financial. Your line is now open. Pardon me. Hamed, your line is now open.

Can you hear me?

Yes.

All right. Can you talk a little bit about the share loss commentary? And if this is competitive, or is this really just downsizing of the shelves in general at the retailer level?

Really what we meant by that comment, Hamed, is last year, we talked about losing some commodity business with some of our customers' business that we viewed as opportunistic. And we try to win it, if we can make incremental profit and we don't want to win it, if we lose money. So this is the tail end of that business that we lost last year. We still had year-over-year declines in Q1 due to that. We're going to anniversary in Q2, so it should not be the issue on a go-forward basis.

And then as far as the sales synergy goes, is this all brand-new for you as far as the product placements is concerned as it is because of the Esselte acquisition?

Yes, it's basically us selling the legacy ACCO products through the new channels, new customers that are opened up due to the new sales force and new relationships that we have because of the acquisition. We consolidated our distribution centers earlier in the year to allow the customers place one order and we were able to deliver one shipment for all of our products, both legacy Esselte and legacy ACCO. And as a result of that, it's really opening up new venues for us to sell our products in Continental Europe. So we are seeing that in Q1.

Are you able to quantify that right now, or is it...

It's very difficult. Let it go on for a couple of more quarters and then maybe we'll be able to do something better.

Our next question is from Chris McGinnis from Sidoti & Company. Your line is now open.

Can you maybe just talk about maybe the e-commerce business and the customers and trends you're seeing from there?

Yes. E-commerce business continues to do very well for us. Last year, e-commerce was around 13% of our North American business and it's doing better, it's better this year. So we are continuing to see unabated growth. E-commerce is less developed internationally, but we're seeing strong growth there as well. I'm very pleased with the e-commerce results and what's also encouraging is, we're getting to fairly large numbers now, but we're not seeing a slowdown in growth. So it's a continuation of the transition that we talked about from more of legacy channels to newer channels of mass and e-commerce and it's going well. And as we said in our prepared remarks, we really expect that to be fairly significant in our second and third quarters.

Great. And just quickly to follow up on that, is the, are the margin profile still a little bit better versus traditional business? Or, can you just maybe touch on that?

Yes, it's still a little bit better. But as I said, over time that's going to neutralize, but it's still a little bit better right now, yes.

Our next question is from Kevin Steinke from Barrington Research. Your line is now open.

So you mentioned that you had really nice growth in Europe despite the early Easter. Do you have any sense as to how much of an impact that early Easter might have had on your growth?

It's hard for us to quantify that, Kevin. But as Neal mentioned in his prepared remarks, there were two less selling days in March, which is roughly 10% of the month. And some of that was just the calendar and some of that is Easter. What is not captured in that is additional time that just people take off around Easter that has impacted the month. But we can't quantify that.

Okay. And then you talked about sales in the UK being up. Is that a function of just kind of easier year ago comparisons? Or are you starting to see some synergies in the UK? And just anymore commentary on what's going on there.

Well, some of that is easier comps obviously, because the business was down last year. But I think a lot of that is, our team doing a really good job engaging the customer base and pretty much relaunching our business in the UK on a combined basis as new ACCO Brands. We've had several customer events that were very, very successful. And I really attribute the growth, double-digit growth in the UK business to the work that our team has done for the first 3 months of this year.

Okay. Great. And then you mentioned Mexico, you called it out some reduced inventory by customers there. Anything specific to expand on there, or what do you see is the prospect for Mexico as you move forward?

Yes, Mexico was a little bit of a surprise in the quarter. We have a very strong business in Mexico. The economy in Mexico is doing quite well. We had a very strong Q4. So I think some of the Q1 was just a hangover from a lot of inventory being in the channel at the end of Q4. And then we have a large customer that changed their management and implemented new inventory carrying policy, reduced the number of weeks that they want to carry as a customer and that had an impact in the quarter. I do expect that this was more of a one-off in the quarter in Mexico. I do expect Mexico to do well in the remainder of the year.

Okay. Good. And just lastly, on the Pelikan integration and you talked about some higher distribution cost still ongoing there. Should we just expect that lessen as we move kind of move throughout 2018?

Absolutely. I certainly expect it to lessen as we move through the year and I think you should as well, yes.

Our next question is from Bill Chappell from SunTrust. Your line is now open.

Boris, just, can you just give us a little more color in terms of the merger between S.P. Richards and Essendant? And just how much of that your combined is? Are they the customer? Whether do you expect any changes as they merge together? Any impact to your business?

Yes, thanks, Bill. Essendant and S.P. Richards are about 5% of our global sales on a combined basis, which is significantly smaller than they used to be. They serve an important role of consolidating shipments from multiple vendors and shipping it to smaller resellers. They also need to provide a good value proposition to their customers. If they can provide good pricing and good deliveries, their customers, which are independent dealers, buy from them. If not, they buy directly from the vendors. So if those companies merge, I certainly do expect that they will take some inventory out as a result of their consolidation. But I think it will have a minor impact on our sales. One, just because that they're small on a combined basis and two, a lot of their customers buy from us today, and if they will not get the level of service or level of pricing as a result of the combination, they'll just buy from us in larger quantities. So they are an important customer, but this is something that we could definitely mitigate through the work that our team is doing.

Great. And then in terms of costs and you touched on it a little bit, but in terms of freight rates, I mean how that affects you? And also is there a thought of taking pricing midyear for that or other commodities? Or is pricing pretty much set for this year?

Yes, costs are going up. We are seeing a little bit of inflationary pressure, not just on freight but also on some of the raw material and commodities. And we are taking pricing up throughout the year. We're not just limited to January 1. In some countries, it's more of a practice to do it on January 1, but in other countries, we're trying to do it midyear. We are planning for an increase in U.S., where we're seeing most of the inflationary pressure. We are planning to do a midyear price increase in the U.S.

Got it. And that's reflected in, you would expect maybe a few percentage points in price affect the top line this year?

Everything is reflected in our guidance number, yes.

Got it. And then last one from me, just kind of any initial read, I know it's, we're a few months away in terms of back-to-school, but as you look back to last year, it was, last couple of years have been both good back-to-school seasons in the U.S. Are you expecting good placement or meaningful shared gains this year or more kind of riding the growth of the overall category for back-to-school?

Yes, last year, both years were very good. '16 was phenomenal and '17 pretty much matched where we were in '16. We have preliminary orders for this year, this year's back-to-school. So it's quite early, but based on these preliminary orders, we expect '18 back-to-school to be similar to the last couple of years. So I'm encouraged. There may be some upside, but I think right now, it's a little bit too early to tell.

Our next question is from William Reuter from Bank of America. Your line is now open.

Can you talk about your expectation, both in the U.S. and then, I guess, globally in terms of consumption, in terms of volume and units for, I guess, the categories that you are serving at this point?

Yes, if I look at North America or Western Europe, our expectation is that units are going to be down low single digits and price will be up a little bit to offset. And overall sales demand is roughly flat in our mature markets. And if I look at emerging markets, I expect units to be up low to mid-single digits and pricing up a little bit as well. So the overall growth in emerging markets would be up mid- to high single digits. For example, last year, we saw 7% unit growth in Brazil, where our team does a very good job of measuring unit growth. We don't have exact measures in other parts of the world. But I think the trends are similar in other emerging markets to what we saw in Brazil.

Okay. And then I know it's been asked on calls in the past, but the impact of AmazonBasics, are there many of the categories in which you compete where you are seeing introduction of new products, I guess, there?

Amazon has been a great customer of ours for many years now. They are very big for us, and we're still seeing double-digit growth from them, not just in small countries but in the U.S. as well. They have a small assortment in our categories with AmazonBasics. We have not seen meaningful disruption to our assortment or our sales as a result. I think they will continue to offer some things in our categories, but I think they have a lot of other bigger things going on in the company to focus on our particular business.

Okay. And then just lastly, you still have relatively substantial share repurchase capability authorization. I guess, how are you thinking about that for the rest of the year?

We have $175 million left in the share repurchase authorization. As we mentioned before, we plan to be balanced in our capital allocation and also as we mentioned before, we will not be specific about any time we're in the market or not. In the first quarter, as I mentioned, we repurchased 770,000 shares. And if the price is at $12.05, I'm sure we will be repurchasing shares in the remainder of the year.

Our next question is from Hale Holden from Barclays. Your line is now open.

I had two clarifications. The inventory destocking, was that only in Mexico and Australia, or is that more broad-based?

Inventory destocking was Mexico, Australia and then wholesalers and office super stores in the U.S.

Got it. And then the two days of lost selling from Easter in the quarter, does that flow back in the second quarter? Or is that just simply lost opportunity?

It should flow back, yes.

Okay. And then my last question is on the potential pricing increases, is your expectation that your retail channel partners will take those pricing increases alongside of you and pass them through? And then any thoughts on how that might widen your brand SKU versus some of the private label offerings that you're now providing.

Yes, our costs go up commensurate with the rest of the market. So I do expect that our channel partners will take those price increases and I do expect that they will pass them through just like I expect that the cost in the private label products are going up and they're passing those costs through as well. But I don't see any change in the competitive position as a result.

At this time, I'm showing no further questions. I would like to turn the call back over to Boris Elisman, Chairman and CEO, for closing remarks. End of Q&A:

Thank you, operator. To summarize, we're pleased that the year got off to a great start with our European results the highlight of the quarter. The greater diversification of our global business and the strength and balance it provides is paying off. I'm confident that 2018 will be another solid year for ACCO Brands, and I look forward to speaking with you again after we report our second quarter earnings. Thank you.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect.