Good day, ladies and gentlemen, and welcome to the Third Quarter of 2018 ACCO Brands Earnings Conference Call. At this time, all lines are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be provided at that time. [Operator Instructions] And it is a reminder today's call is being recorded for replay purposes. I'd now like to turn the conference over to Jennifer Rice, Vice President, Investor Relations. Please go ahead.

Good morning, and welcome to our third 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, and restructuring costs and apply normalized tax rate, which was 30% in the current quarter and 32% in the prior year quarter. 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 inherent difficulty in forecasting and quantifying certain amounts, we do not reconcile our forward-looking 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. Our third quarter results demonstrated momentum in some areas and continued headwinds in others, reflecting diverging environments in the U.S. versus the rest of the world. We saw accelerated growth from strong profitability in EMEA, good improvements in revenue trends and profit growth in International and very mixed results in North America. I'll begin with the highlights. I'm very pleased with a strong performance in EMEA, where our comparable sales increased 5%, as we successfully expanded the distribution of legacy ACCO products with a broader customer base of former Esselte for cross-selling. We had double-digit sales growth with Rexel shredders and Kensington computer accessories, both for the quarter and year-to-date. This was driven by the increased distribution as well as strong underlying demand and new product introductions. We also saw solid performance of Leitz, Esselte and Rapid branded products. We are seeing better growth from our branded products in EMEA and from private label. In addition to executing on sales growth initiatives, the European team is doing an excellent job of driving profit improvement, capturing cost synergies related to the integration of the ACCO and Esselte businesses. 20 months into the acquisition, we are on track to deliver at least $23 million of committed synergies on time and at a lower cost. EMEA gross and operating margins were up during the quarter due to higher sales, better product mix, acquisition synergies, and expense leverage. It was an excellent quarter in EMEA by most measures. And I'm very pleased with and appreciative of the work our team is doing there. We also posted improved results in our International segment driven by another good quarter in Brazil, sequential improvements in the rest of International, and good contribution from our acquisition in Mexico. Constant currency sales…

Thank you, Boris, and good morning, everyone. Third quarter sales decreased 5% and comparable sales decreased 4%, primarily due to lower sales in the U.S. Net income was $35.6 million or $0.34 per share, an increase of 21% over the $0.28 in the prior year, due primarily to lower charges and accretion from the GOBA acquisition in Mexico. Adjusted net income was $35.7 million compared to $38.8 million last year. The decline was primarily driven by the lower gross profit in the U.S. Adjusted EPS was $0.34 in the quarter, compared to $0.35 in the prior year. Our normalized tax rate for the quarter was 30% instead of the anticipated 28% due to a true-up of our revised expectations for the year. We now expect our full-year normalized rate to be 29%, due to less of our earnings coming from the U.S., which has a lower tax rate. Our gross profit was lower in the quarter due to the U.S. business. Overall, our reported and adjusted gross margin declined 180 basis points to 31.7%. The details that I'm about to review are on Page 7 of our slide deck. Product and customer mix accounted for 150 basis points of the decline. Increased inflation drove a further 100 basis point reduction in gross margin year-over-year. Cost savings and synergies improved gross margin by 80 basis points compared to the prior quarter. We expect to continue to offset higher costs in future quarters with price increases and cost reductions. But there is a lag before pricing can catch up to the rapidly rising costs. Reported SG&A and adjusted SG&A were both down in dollars and in rate. As a percent of sales, reported SG&A declined 230 basis points, and adjusted SG&A declined 160 basis points. Excluding charges, the year-over-year improvement was due…

Thank you. [Operator Instructions] Our first question comes from Bill Chappell with SunTrust. Your line is now open.

Thanks. Good morning.

Good morning, Bill.

Hey, Boris, just talk a little bit more about the commercial destock. Just trying to understand, how this is different, was it just different timing you were expecting? I mean, typically, these are more in the fourth quarter than the third quarter. Was it a greater magnitude, just because this has been going for several years and surprised that there's kind of a more of a kneejerk reaction, and so didn't know if it had to do with the consolidation of a couple players there or just help us understand why now and why it was such a surprise.

Sure, Bill. Typical cycle that we see out of the commercial wholesalers - office wholesalers is they order up in Q3 and especially in Q4 to prepare for their strong selling season, which is the first quarter of the year and also to hit their annual volume target to be able to achieve a certain rebate level. And that's the pattern that we've seen for many years. It varies a little bit player-by-player and year-to-year, but in general, that's the pattern that we've seen. That's also what happened at the end of 2017, when both wholesalers ordered a bunch of inventory to hit their volume rebate and prepare for the strong selling season. Our sales to them were pretty low in the first half of 2018, as we bled down the inventory, so we anticipated replenishment in the beginning of the cycle that we've seen in prior years. We didn't see that at all. So we saw in Q3, which was not what we expected, where a continued reduction in purchases from both wholesalers. The industry is going through a consolidation, as you mentioned, so that has probably something to do with that. Also, potentially them losing share to other players in the industry has something to do with that. We don't have the specific answers as to why, but certainly the facts are that they've ordered significantly less than we expected in Q3. And given what we saw in Q3, we anticipate that that will continue in Q4. That's the basis for our guidance.

Got it. If I'm looking at the guidance for the full-year, I mean, it appears the majority of the impact was in 3Q. Is that fair? Or do you expect more of a similar to carry into October, November?

The majority of the impact was in Q3, but we do expect a further drag in Q4, not by the same magnitude, but it will still be there.

Got it. And then the other question. I'm surprised, I guess, glad to hear about your kind of gross margin outlook for next year. But with tariffs, with currency, I mean, that implies a pretty meaningful price increase that you'll probably have to take to at least expand gross margins. Is that the right way to look at it for next year?

Yes. The price increases will be pretty meaningful. We took about a 3% price increase in October and this - a larger price increase coming in early 2019 to make up for all of the inflation in tariffs that we are seeing already.

Got it. Thanks so much.

All right. Thank you, Bill.

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

Good morning. Hey, could you talk a little bit about the 150 basis point gross margin headwind from product and customer mix in the third quarter?

Yeah. Neal will reply to that, Kevin. One second.

Sure. So in terms of the mix issues, we actually had two reverse things going on. We had favorable mix in Europe, but we had very adverse mix in North America. And it was a combination of the products that we were selling and the customers that we were selling them to. So as an example, some of our back-to-school sales went through dollar stores. They weren't as profitable as we would have typically had for other customers. It's a new channel for us. We were doing a bit of experimentation and didn't quite necessarily get right. Also, wholesalers typically sell a lot of - or carry a lot of inventory of products, which tend to have high margins. So when they take a lot of inventory out, it takes a lot of high margin products out. And then additionally, paper became very scarce in North America. Paper prices went up significantly, particularly spot prices at a low. We forward buy a settlement of paper. We had to take a lot of it in the spot market, and prices went up more than 30% for paper. And additionally, as you know, tariffs came into the U.S. too. So there was a lot of cost issues, and the mix of what we sold skewed to a lower margin mix.

Okay. That's helpful. You mentioned reduced placement of calendar products. Did that factor into that mix at all that impacted gross margin?

Yes. Calendar products are typically high margin.

Yeah. Okay. So you implemented the price increase on October 1, and another one coming early next year. Have the various cost headwinds you cited run ahead of expectations at all relative to what you talked about last quarter? So are you having to implement larger price increases unexpected or is that - have those been in line with your expectations?

The cost increases are higher than we expected, Kevin. Commodities rose through the quarter, through the third quarter, throughout the quarter. So that's higher than we expected. The fuel and transportation costs are higher than we expected. There're also higher inbound logistics right now that's much higher than expected due to accelerated shipments from China, by all of the U.S. to get ahead of the tariffs. And then also, we saw some incremental product costs. So inflation - commodity inflation and the impact of tariffs is higher than we expected. We were not given the lead-time associated with customer notifications for pricing. We did not have all of those costs in the October 1 price increase. So the January price increase is much higher than we planned on before to accommodate these higher costs in tariffs that we're seeing.

Okay. Okay. I think, I wanted to make sure, I heard correctly. You mentioned getting back to the 33% to 34% gross margin range in 2019. Did you also say that you would expect modest sales growth in 2019?

I did say that, yes.

Okay. What do you think will be the drivers behind that growth?

We think that 2018 was a big reset year in the U.S. for the wholesalers, so we don't - we think the comps are going to be easier in the U.S. We have the incremental sales from GOBA acquisition, and then we also have good momentum in EMEA and International, which I also expect to continue. So for all those reasons, I expect to have modest sales growth in 2019.

Okay. Good. And then lastly, I know it's still early, but any initial insights on back-to-school season in Brazil?

It looks really promising. So it is still early, but just based on early shipments that we're seeing, we're continuing to perform really well. Shipments are strong. So - we still have a few months to go, but I'm very, very pleased with the initial signs for our back-to-school in Brazil.

Okay. Great. Thank you.

Thanks, Kevin.

Thank you. Our next question comes from Brad Thomas with KeyBanc Capital. Your line is now open.

Hey. Good morning. I did want to note, you had a nice performance in international, in EMEA, but had a few questions on North America. Thanks for all the color you've already provided. Boris, if we zoomed in on 3Q and thought about that 9% sales decline, you obviously called out the 2 points from paper. But could you give us a better sense to the extent of how much might be transitory and inventory destocking versus the run rate - the organic run rate in the United States?

Yeah. I think most of it, Brad, is timing and transitory. If you look at our back-to-school performance with the end-user, we are winning with the consumer. POS was up 2% with the end-users. So the performance - outbound performance was really good, which is the basis for my saying, I think, there's a bunch of timing things driven by inventory destocking, driven by timing, when some of our big, mass accounts purchased inventory for back-to-school, Q2 versus Q3, some of it by our inability to replenish. So I think longer-term, the business is in a good position. POS is strong. Our brands are doing well. We're definitely seeing a better performance with consumer and retail that we're seeing on the commercial side. The commercial channel is going through consolidation. So I think that is going to cloud the picture over the next couple of quarters and create some uncertainty on the commercial side. But overall, I think, the business is healthy. And it has to do with some of these transitory issues as opposed to some fundamental issues in the business.

Great. And then a question really, I think, the entire United States is going through this issue of pricing. And I'd just be curious with the magnitude of price increases you're putting through. Are you seeing - or at what point do you get worried about demand elasticity? And how are you thinking about that?

Certainly, Brad, that's a worry for us. It's a consideration with not just us, but most folks who are bringing products from China are raising prices. It has to have an impact on the demand. The types of price increases that we are planning for early 2019 are pretty high. And I think, again, most of folks not just in our industry, but in other consumer products will have to do something similar just given the magnitude and the impact from 25% tariffs. So it is a worry. I'm not an economist. I can't tell you what's going to happen. We'll have to wait and see. But it is a concern.

And then, as you think about your strong cash flow generation, how if at all, does this change your willingness to do share repurchase as we move into 2019 and you get access to buying back more shares? And how if at all, does it change your consideration for acquisitions?

Certainly, as we discussed before, it would raise the bar for the types of returns we'll be looking for acquisitions. But strategic acquisitions will still be on the table and will be balanced in our view between share repurchases and debt reduction. Obviously, we have dividends now. And if we see the right acquisitions, and if they provide appropriate return versus alternatives, including share repurchases, we would look at that as well.

Great. Thank you so much, Boris.

Thanks, Brad.

Thank you. Our next question comes from Hamed Khorsand with BWS Financial. Your line is now open.

Hi. Good morning. So first off, do you think some of this pushback in pricing that your increase in Q4 is causing some customers to move away? Is there competitive pressures in the market that you're facing?

Hamed, we always face competitive pressures. I don't think what - it certainly had no impact on Q3, given that we haven't implemented the price increases in Q3 yet. And I'm not seeing the Q4 price increases - or October 1 price increases have a competitive downside on us. I think, we'll have to wait and see what happens in 2019. Again, the price increases are going to be bigger than the ones we implemented in Q4. And I think we have to wait and see what the impact of that is going to be.

Okay. So is there going to be pushback from your customers, because of the price increase? Have you seen any?

Hamed, there's always pushback from our customers. It's 100% of the time from 100% of our customers, there's pushback on price increases. But this is something we negotiate with them and implement every time, just like they do with the consumer. We saw our customers raise pricing throughout the year on the consumer as they saw commodities increase on them. They passed flows through. So this is just something that's just the nature of business and negotiations on pricing.

And on the inventory balance, it seemed like there was an increase. Is that raw materials or is that finished products? And have you been able to secure enough paper?

It's both. And we are buying ahead, given our experience this year with tight paper supply. We are committing earlier to secure paper for 2019 back-to-school. I don't think we've seen much of that yet on our balance sheet. But certainly, it will come in Q4, and part of our guidance for a reduction in free cash flow was, because we have to carry high inventory, both because of the inflation and the step-up that we're seeing in inventory as well as bringing in earlier some of the raw material inventory for 2019 back-to-school.

Okay. My last question was in Europe with this organic growth that you're seeing. How much more do you think you can capture as far as customer penetration with your products into Europe?

Hamed, we haven't seen any slowdown in the momentum. So we think there's still room for growth, both in Q4 as well as into 2019. We have slightly tougher comps in Q4 in Europe. So, I'm certainly not anticipating a 5% organic growth in Q4 in Europe. I think it's going to be probably flattish to up single - low-single-digits, but the momentum in Europe is strong. And I still think that we are in the early innings of getting incremental share from leveraging the Esselte distribution for the legacy ACCO products.

Okay. Thank you.

Thank you, Hamed.

Thank you. Our next question comes from Joe Gomes with NOBLE Capital. Your line is now open.

Good morning.

Good morning, Joe.

I'm just wondering, if you can just remind us what are the bank covenant restrictions on doing more than $75 million in buyback. And would that be something you would try and go back to the bank and possibly renegotiate or would they be willing to renegotiate that given what's occurred with the stock - in your stock price here recently?

So a couple of points. While our leverage is above 2.5 times, we have the restriction of $75 million on share repurchases as part of the bank agreement that we have. In terms of capital allocation, we like to have a balanced capital allocation. So that consists of a certain level of debt reductions, certain level of dividends, certain level of share repurchases. And January 1, isn't far away. And we have a whole new $75 million basket available on January 1. And so, from our perspective, it wouldn't be appropriate for us to go back and renegotiate the bank covenants. I'm sure we could, we just don't think it's the right thing to do.

Yeah, Joe. Given what's happening with inflation and interest rates, the priority for Q4 will be to pay debt down. And as Neal mentioned, regardless of what the covenants say, that's going to be our priority.

Okay. Okay. And on the tariffs, I don't know - if you can just again remind us, roughly what percent of your product line in North America is subject to these tariffs. And would it make sense - or are you guys contemplating looking into the possibility of outsourcing from someplace other than China? I know, I've talked to a number of other consumer type product companies that actually are looking at other places in Asia in order to get around some of these tariffs.

Sure, Joe, that's a good question. About 30% of our U.S. COGS come from China, and right now, half of that is subject to tariffs. So it's a meaningful number. We are absolutely looking to move our supply from China where we can. It's easier in certain types of products, such as paper products. And we already have a large supply from outside of China, but we're moving to move even more. Some of the more complicated or metal products, when you have to move tooling, it's more difficult to do. But we're looking at that as well. It's just something of that magnitude will take a longer time. And it's much more expensive to move. But we're looking at all of those things, especially as time goes on and the likelihood of these tariffs becoming permanent rose, we'll certainly be looking at evaluating the lowest total cost of supply. And if it's not China, we'll be moving our products away from there.

Okay. And one last one for me. You talk about some reduced calendar placements. And I'm just wondering, if you might be able to give a little more detail on that. Is that - are you seeing that, as you think just a one-time event? Or is this something that you think is more extended?

We lost some share this year in some of the retail accounts with fashion calendars. We are trying very hard to win it back, and we hope it's a one-time thing. But calendars is an interesting product line is that there's one time a year, where you can sell it in, and then you have to wait another 12 months before you can try it again. So we saw some share loss this academic calendar year, and we'll certainly go after it for 2019.

Okay. Thanks. I appreciate it.

Thank you, Joe.

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

Good morning.

Good morning, Bill.

So in between the last quarter and this quarter, there would have been a couple things which you couldn't have expected, such as some of the product shortages. I'm sure that you did expect that some of those early shipments that you received in the second quarter would have impacted this quarter. I guess, were there other things that changed, I guess, maybe it's on the wholesaler side - that you were not expecting? Or was the majority of the sales decrease expected?

No. The majority of the sales decrease, I would say, was not expected. And let me tell you the things that we did not expect. We did not expect the wholesaler sales that we had in Q3. We also did not expect that many of our retailers managed to lower in-stock positions at the end of this back-to-school season that did last year. So typically, they would manage to, let's say, 85% sell-through of the inventory that they have because they never want to completely run out. This year, they managed to a 90% sell-through. So there was less orders from them, less replenishment orders from them than we would have expected. And then certainly, we did not expect to have the product shortages and I mentioned that cost us a couple of points of share. So all of those things taken together were the unexpected aspects of the sales decline.

That makes sense. And one of the challenges that has contributed to the, I guess, increased cost of goods sold has been shipping shortages. Do you anticipate, or have you had conversations that might allude to the fact that we could see a little bit more capacity next year to the extent that tariffs reduce the amount of international trade? Have you heard anything about that?

Not yet. We're not in that stage yet. We're hoping you're right, and we're hoping some of the costs associated with tariffs will go down, some of those kind of secondary costs associated with tariffs will go down, but we have not seen that yet, Bill.

Okay. And then just lastly, in an earlier question, when you were asked about thoughts with regard to your free cash flow, you still mentioned M&A. I guess, given the disruption that we're in, in terms of higher costs and price increases, et cetera, has it materially changed your view about how active you want to be in M&A over the next couple of years?

Bill, not really, and I'll tell you why. I mean, strategically, it's still important for us to reposition our business for growth away from some of the more mature and declining categories and toward some of the faster-growing geographies and faster-growing categories. That is an imperative. We have to do this. We've been very, very prudent in how we do M&A over the last few years. So we never bite off more than we can chew, and we'll make sure that it's a right investment with right returns for our shareholders. So as I mentioned, just given where we are, and the uncertainty, and the economic uncertainty, certainly, the bar will rise for some of these things. But we will still be looking to continue to reposition our company for growth, and M&A is a big part of it.

Makes sense. I'll pass to others. Thank you.

Thanks, Bill.

Thank you. Our final question comes from Hale Holden with Barclays. Your line is now open.

Good morning. Thanks for taking the call. On the gross debt pay down on the third quarter, was that all term loan pay down?

Commensurate with the revolver.

Revolver. On the pricing increase, you guys had 3% on October 1 and then a larger one in January. Is it possible for you to give us the aggregate of what the price increase might be flowing through in the first half of the year?

It should be high-single-digits on average. In some categories, it'll be even higher than that, because those categories are more susceptible to tariffs.

Got it. And then the last question I had is on the wholesaler consolidation, it looks like one way or the other, we're going to be near completion on whatever happens with those two companies in the next couple of weeks. This is something that would sort of rebound to a normalized level for you probably in one to two quarters or in the next summer for the next season. Is that the expectation?

Yes. I expect that to be the case. I'm of the same mind you are. I think this is coming to a conclusion one way or the other. And we think the major effects of the consolidation on us are going to be behind us as we enter 2019.

Great. Thank you very much, Boris. I appreciate it.

All right. Thanks, Hale.

Thank you. And with that, I'll turn it back over to Mr. Elisman for closing remarks.

Thank you. In closing, despite several near-term factors outside of our control, including higher inflation in tariffs and ongoing U.S. industry consolidation, we remain optimistic about our future and continue to position our company for growth. Our team is committed to executing through the current challenging environment in the U.S. and is excited about the international opportunity. Thank you for your continued interest in ACCO Brands. And we'll talk to you next quarter. Thank you.

Thank you. Ladies and gentlemen, that does conclude today's conference. Thank you very much for your participation. You may all disconnect. Have a wonderful day.