ACCO (2019 - Q1)

Good day, ladies and gentlemen, and welcome to the First Quarter 2019 ACCO Brands Corporation Earnings Conference Call. [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 of Investor Relations. You may begin. Jennifer

Good morning, and welcome to our first quarter 2019 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 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 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 forward-looking adjusted earnings per share, free cash flow, net leverage or adjusted tax rate guidance. Forward-looking statements made during the call are based on certain risks and uncertainties and our actual results could differ materially. Please refer to our press release and SEC filings for an explanation of certain of these risk factors and assumptions. Our forward-looking statements are made as of today'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.

Good morning, everyone. I'm pleased to report that the year got off to a solid start with higher constant currency sales, stable comparable sales and improved margins, driven by great execution in North America, continued organic growth in EMEA, a good back-to-school in Brazil and strong performance of the recently acquired GOBA business in Mexico. We were disciplined in implementing price increases, which is enabling us to begin to recover the lost margin from inflation and tariffs. And we started to see some benefits from the additional cost reduction actions we began late last year. While Q1 is still our smallest quarter, the stronger start gives us confidence in meeting our goals for the year. I'm going to begin my segment commentary with North America. Sales in North America declined at a much lower rate than what we saw in the back half of 2018, down 3.1% on a reported basis and 2.5% on a comparable basis as orders in the wholesaler channel stabilized, and we saw a double-digit growth in Kensington computer products and modest organic growth in the Canadian market. The decline that we experienced was due to the timing of orders and the continued effect of the lost placement of certain calendar products last year. Overall, we continue to manage the channel transition well. Q1 is typically a challenging sales quarter in North America, and I'm very encouraged by our strong start. In the second and third quarters, the faster growing channels such as e-tail and mass merchants carry a higher proportion of sales due to back-to-school shipments. Our initial view on our North America back-to-school season is that sales growth should be consistent with prior year when we had a good back-to-school season overall and grew sales 2%. In addition, we expect to ship back-to-school orders earlier this year. Overall for the year, we still expect North America sales to decline low single digits. Beyond sales, North America operating margin increased as new pricing started to recover higher product costs and due to tight management of expenses, manufacturing and distribution efficiencies, and as the incremental cost reduction initiatives we put into place late last year and early this year begin to take hold. Overall, I am pleased with the improved performance in our North America business and the execution by our team. Turning to EMEA. Once again, this region delivered strong top and bottom line results. While reported sales declined 5% entirely due to currency, comparable sales increased 3.5% as we continue to see the positive sales effects of cross-selling legacy ACCO and Esselte products and due to new product launches. The sales and marketing teams have done a great job in this region. In addition to strong go-to-market execution, the operations teams in EMEA have continued to deliver. Excluding a $1.6 million adverse impact of foreign currency, EMEA's underlying operating income increased, driven by cost savings and synergies. I remain very pleased with our European results. Results in the International segment were again mixed. We had a good quarter in Brazil with growth in Tilibra notebooks during a strong back-to-school season. We did well in Mexico driven by the strong performance from the recently acquired Barrilito business. The results in Brazil and Mexico were more than offset by the declines in Australia. The overall market in Australia is soft, and we'll continue to work through the impact of customer consolidation. In total, I am pleased with our start to the year. As we enter the early phases of the back-to-school season in North America, we have taken prudent steps beginning in Q4 of last year to prebuy raw materials and certain inventory to secure availability and avoid further tariff and inflationary increases. We also began production of manufactured back-to-school products earlier to maximize our product availability during the peak season. These actions, in combination with anticipated earlier back-to-school shipments, had an impact on our operating cash flow this quarter and will continue to have some impact in the second quarter. This is consistent with our expectations, as communicated on our call in February. For the full year, we'll continue to target $165 million to $175 million of free cash flow. Now I'll ask Neal to give you a more detailed look at the quarter. Neal?

Thank you, Boris, and good morning, everyone. First quarter sales decreased 2.9% due to the adverse impact of foreign currency, which more than offset growth from the GOBA acquisition and growth in EMEA. We had a net loss of $600,000 or $0.01 per share. This included a $5.6 million adjustment to tax expense related to reserve for our Brazilian tax dispute that needed to reflect a step-up in potential liability as we enter the judicial courts. And also included $3.2 million of restructuring and integration charges. Adjusted net income was $8.8 million or $0.08 per share, similar to last year despite a $0.03 headwind from FX, a higher adjusted tax rate and higher interest expense. Gross margin improved 50 basis points to 31.9%, and adjusted gross margin improved 60 basis points to 32% primarily driven by costs and synergy savings as well as price increases. SG&A expenses were down in the quarter, and as a percent of sales were lower by 80 basis points on a reported basis and lower by 50 basis points on an adjusted basis. The improvement in adjusted SG&A ratio was primarily due to the cost savings and the acquisition benefits. All in, operating income increased, and operating margin expanded 160 basis points on a reported basis and 100 basis points on an adjusted basis. Our adjusted tax rate was 33.3% in the quarter and reflects the geographic mix of earnings and the small quarter. We still expect our full year adjusted tax rate to be in the 30% to 31% range. Turning to some additional details of our segment results. In North America, segment sales decreased 3.1%, and excluding currency decreased 2.5%. Pricing added 3.5%. Volume was lower due to the timing of orders and the lost placements of calendar products that began last year, as Boris mentioned. Despite the lower sales, the strong gross margin and lower SG&A drove improved operating performance in the quarter. North America operating income margin improved 240 basis points and on an adjusted basis increased 230 basis points. The increase was driven by cost savings and pricing actions. In our EMEA segment, sales decreased 5% due to currency which reduced sales by nearly $13.5 million or 9%. Comparable sales increased 3.5%, the strongest rate we've seen recently driven by growth mainly in computer products and shredding due to new products and cross-selling. The timing of the Easter was also a benefit as it was later this year falling in Q2 whereas last year, we felt some effects in Q1. EMEA operating income was adversely impacted by $1.6 million of foreign currency. Excluding this, EMEA operating income increased, and margin expanded due to cost savings and synergies, which offset higher product costs. International sales increased 1.5% due to the GOBA acquisition in Mexico, which added $11.8 million in sales. Excluding the acquisition and the impact of currency, sales declined 4%. We continue to see good results out of Brazil where the back-to-school season was strong. Mexico also had a good quarter, aided by the great performance with the Barrilito branded products that we recently acquired. However, as Boris noted, Australia results were lower. The overall market is soft in Australia, back-to-school was soft, and customer consolidation continues to play out. International segment margins contracted, driven by Australia. We are further reducing our cost structure in Australia in order to better weather conditions there. Turning now to our balance sheet and cash flow. Our inventory balance is up $105 million year-over-year driven mainly by last Q4 as we forward-bought materials to secure supply, support new product launches and mitigate the risks of both known and anticipated inflation, including tariffs. We also expect back-to-school to be more seasonally weighted to our second quarter this year, requiring the earlier production of certain products. We expect inventory to further increase for the seasonal peak in Q2, but then to step down in Q3 and further in Q4, particularly, as we do not anticipate repeating the Q4 2018 advanced purchases. We used $61.3 million of net cash from operating activities and including CapEx of $7 million, therefore our free cash flow was a use of $68.4 million in the quarter. The large cash outflow was expected as we paid for the increased inventory. We expect less cash use in Q2 of this year than we had in Q2 of 2018, but it will still be a seasonal outflow as back-to-school ramps up. In the quarter, we repurchased 1.3 million shares of stock for a total of $10.5 million and paid $6.2 million in dividends. For 2019, we still expect free cash flow of $165 million to $175 million with our cash generation in the third and fourth quarters. We are reiterating our revenue, adjusted earnings per share and free cash flow guidance for the year. And as always, we have included certain assumptions in our slide deck on Page 13. 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 Bill Chappell from SunTrust.

Just a couple country questions. First, on the U.S. kind of maybe you talked about a little bit earlier back-to-school, I mean, can you give us some quantification and qualification of why that would be the case and if that bodes well for a better back-to-school season if you were to have products on the shelf earlier.

We believe that the back-to-school season will be good from a sell-in perspective. Obviously, we don't have visibility to sell-out yet. But based on customer orders, we believe that we'll see a growth this year -- sell-in growth this year compared to last year, roughly similar to what we saw last year. We saw a 2% growth last year. We kind of anticipate about that level of growth this year. We're also seeing that customers are requesting shipments earlier than they did last year. So we anticipate that Q2 will be larger from a relative weight perspective but maybe offset some in Q3. Again, we have less visibility into Q3. So in overall, we're very pleased with where we are with back-to-school. We believe will be a good season, and we anticipate a pretty good Q2.

And then sticking with the U.S., I mean, you -- where do you think we are on kind of destock from some of the key retailers. I mean do you expect another round effectively 4Q or are we largely past that?

I think overall, we're pretty much done, Bill. Inventory is at fairly low levels with the customers. The only thing to pay attention to for us probably in the Q4 timeframe is what happens with Staples and Essendant since they're now 1 company and leveraging -- certainly, leveraging back ends. There may be some additional action that they're taking, but we haven't heard anything yet, and we haven't seen anything yet. So for now, things are in a good position, but we will -- still paying attention to this stuff.

Got it. And then last one for me. Just on Australia, I mean, that's been a challenging market for at least a year now and so just trying to understand. Has something changed? Or we're just bouncing along the bottom? Or -- obviously, you're taking some more strategic actions in cutting costs there. So I'm just trying to get a sense of where it stands and even if there's a sign of it will start to improve at any point this year.

Yes. Australia has been a difficult market for at least a year. There have been 2 major customer consolidations there. So there's a bunch of inventory takeout action that is happening in that market. And the Australian economy overall is fairly muted. As Neal mentioned in his prepared remarks, the back-to-school season we just ended was weak overall not just for us but for the industry overall. So we think Australia will have muted growth for the next year or so, and we are preparing for that by just fine-tuning our cost structure to make sure that our cost are aligned to the revenue projections that we have.

Our next question is from Hamed Khorsand from BWS Financial.

So first off on the Kensington line. Is that just an anomaly within the quarter? Are you seeing progression on those orders from, let's say, Q4 of last year, Q1 of this year and then going into Q2?

No. It's not an anomaly at all. We have seen consistent growth out of Kensington at least for the last 18 months. In 2018, we saw a double-digit growth there, and in Q1, we are seeing double-digit growth. So I believe we have reworked that line to move away from the consumer market and focus on the B2B market. We also got out of from a lot of commodity products and moving to more value-added products. We fine-tuned our go-to-market. We fine-tuned our product development, and it's bearing fruit. So we are seeing good results, and we anticipate that we will have a good year from Kensington.

Okay. And then as far as the inventory balance goes, it went up by about something like $50 million between Q4 and Q1. Is that all back-to-school?

It's mostly back-to-school. There is some inventory that's associated with us prebuying raw materials ahead of projected tariff increases and some inventory step-up just because of the cost inflation, but the majority of it is back-to-school.

Okay. But do you think you have better controls over your cost because you have this much inventory right now?

Well, yes. Certainly, we have. We have inventory -- mostly inventory to ship for back-to-school, so if they are changing in cost, they will not affect us.

No. What I was asking like as you deplete this inventory levels, how much of a buying power do you have with your vendors, right? I mean do they give you better deals, or you're forced to take higher prices because you're not buying as much anymore this year?

I don't think our ability to negotiate has changed at all, Hamed. I don't anticipate any dilution of our buying power as a result of us holding inventory. I think we're in a good place.

Okay. And the last topic was on Europe. I know that it's a lot of FX there. How much traction do you have as far as growing Esselte further from the sale synergies -- synergy standpoint without -- on a constant currency basis?

I am very pleased with our results in Europe. I think the team there is doing great. As Neal mentioned, we've had the highest growth there at 3.5% -- organic growth at 3.5% that we've seen in a very long time. I can't remember how long. It's hard to predict the future, but we are in a good position to continue to grow the business, and I think the team is executing really well not just on the revenue side and growth side but also on the synergies side. So if there's 1 business that's operating on all cylinders for us, it is definitely Europe.

Our next question is from William Reuter from Bank of America Merrill Lynch.

So it seems like the last couple of years, we've seen better back-to-school trends than the underlying growth rates that we're seeing in North America in general. Can you help me understand the difference between the trends during that period and then the remainder of the year?

Sure. The back-to-school business is largely driven by mass merchant and e-tail channels. Those channels are healthier. They're seeing better growth overall. They're getting the consumer traffic, and as a result, they're doing better and we are doing better. And the categories they sell in -- specifically consumer categories or school categories, are also faster growing than some of the office categories, specifically storage and organization, for example. So we've talked now for several quarters that our North American business is going to be more weighted towards Q2 and Q3 and more challenged in Q1 and Q4 just because of the seasonality of the business and which channels get to participate in which parts of the year. So it's natural that businesses are doing -- back-to-school is doing better, and it's natural that we do better during that time of the year. Did that make any sense?

You did. Absolutely. And then with regard to your outlook for inflation of inputs, you mentioned that you have prepurchased some of your inputs ahead of what could be potential tariffs. What is the outlook in terms of the inflation you're seeing on a dollar basis globally for 2019 if we include transportation as well as the -- your other inputs?

We are projecting inflation -- year-to-year inflation. The costs right now are fairly stable, I would say from Q4 on, but if I look on a year-to-year basis, it's still fairly significant. If I look at North America, for example, we're talking about probably in the $30 million incremental range, and we are projecting inflation in EMEA and International as well. We have taken pricing action as we normally do to offset the impacts of commodity inflation. So from a margin perspective, I still expect us to be a -- gross margin perspective, I still expect us to be in that $33 million to $34 million range that we gave guidance on.

Bill, and with regards to the inflation we saw last year, it was actually impacted at the very back end of the year. We got the annualization of that inflation, it hasn't necessarily gotten any worse. It's just much higher than it was at the beginning of the year. And obviously, for half of our business, they buy a lot in China, in USD and sell in their local currencies. And particularly in places like Europe, where you've had a big currency movement that's also inflationary for them in terms of cost of goods.

That makes sense. And then just lastly, if you could provide a little bit commentary around M&A, and what you're seeing right now in terms of, I guess, the amount of opportunities, I guess, valued acquisitions and whether they seem attractive to you at this point.

Yes. There's really nothing new to report. Same as we have discussed before, the funnel remains robust. The opportunities are there. We think we have -- all the funnels probably $3.5 billion of opportunities, only a portion of which are actional, but it's certainly -- they're big enough to move the needle for us. But we're being very disciplined on how we go about it and if we find something that makes sense from a strategic and financial perspective, we certainly have the capacity to act on it, but we also have a good business, good organic business and can grow shareholder value just by driving organic growth and margin expansion.

Our next question is from Chris McGinnis from Sidoti & Company.

I was wondering -- just as a follow-up on Australia. When you talked about the industry consolidation there, is that similar to what North America experienced? Can you just elaborate a little bit on that?

I would say it's actually probably worse than North America experienced. You had number two and number three, our biggest customers were merged and then probably number four and number five merged as well. So you have a real consolidation going on especially in the commercial channel in Australia, and those customers are obviously working through their integration activities and taking a bunch of inventory out. So Australia has their local issues that they're working through from a market perspective. But we have really good market position. We have very broad distribution there. I'm very happy with our business in Australia overall. But as the customers consolidate and the industry evolves, obviously, it has an effect on our business.

Sure. And then, I think you referenced maybe some concern in Q4 around Staples and Essendant. Have they been -- is there any concern of now that they have more buying power, they're coming to you asking for price concessions?

Chris, that happens every day with every client. So yes, of course. Of course, that happens, and we expect them to do that, but we'll run our business for our shareholders, and I have a lot of confidence in our ability to do what's right for our shareholders. It may take us a quarter or so to respond, but as we're seeing with the Q1 results, we do respond, and we adjust, and we react and we reorient our business in such a way that it delivers for our shareholders. So I'm very confident, and I will continue to do that no matter what happens with the Staples and Essendant.

Our next question is from Kevin Steinke from Barrington Research.

In terms of the price increases you implemented in January, just wondering what the realization was on those price increases -- if you were able to get pretty much everything you asked for? And should we see more benefit from pricing as we move throughout the year?

The answer is yes and yes. Yes, we've got everything we wanted. It takes time to see the realization of price increases because not everything happened specifically on January 1. There is a progression through the quarter of when some of the pricing goes into effect. So we saw, I believe, 2.9% in the first quarter, but we do expect to see incremental effects from pricing in Q2 in North America as it's fully now rolled out, effective end of Q1. So yes, we will see incremental benefit.

Okay. Great. And then it sounds like Mexico had a good quarter. I know conditions were a little more challenging in Mexico last year, I believe due to a customer changing its -- their inventory management strategy. Are we kind of past that headwind now? And what are you expecting for the rest of the year in Mexico?

Yes, Kevin, you're exactly right. We had a customer that was taking a lot of inventory out, especially in the first half of last year. So we obviously anniversaried that situation. We don't have that anymore. Mexico did have a good quarter. It was especially driven by our acquisition that we made in July of last year via the Barrilito branded products. I expect Mexico to have a good year. We don't have the inventory headwind that we faced last year, and I expect Mexico to deliver good growth.

Our next question is from Joe Gomes from NOBLE Capital.

I was wondering if you might be able to talk a little bit on some of the other channels, what kind of growth rates we're seeing there, what percentage of the business they take up specifically like Amazon and e-tail overall. And maybe a little bit more color on the dollar store channel, which is something you've talked about in the past and how that is growing.

Sure. Let me start with our biggest channel, which is independents. Independents have done really, really well. It's a majority of our business in Europe. They are taking share there. It's a majority of our business in Brazil. They're taking share as well. And independents had a really good quarter in North America as well. So that channel is doing extremely well and taking share from some of their larger competitors. E-tail continues to grow fast. We had really good growth internationally with e-tail. It was a little bit slower in North America as we work through some of the pricing implementation issues in North America. Mass is doing well. It's very customer specific, but overall, mass is doing well, and we continue to see mass take customer share, take consumer share in the overall industry. Now from a dollar store perspective, we are fine-tuning our participation in dollar stores. We had rapid growth last year. It's still a fairly small part of our business less -- certainly, less than $10 million a year but fairly rapid growth last year. But it was very margin dilutive for us. So this year, we are fine-tuning our assortment to make sure that we could have profitable growth. So I expect this year to have less sales in dollar store, but certainly deliver more gross profit dollars to the company than last year. And OSS, office product superstores, it really depends on the particular customer that we're talking about. Some of them are more in the consolidation mode and driving more private label and others have played that game, they did not deliver the results. So now they're more embracing branded products and growing with us. So overall, there are puts and takes in that channel. And then the other channel that we are seeing good growth in is direct-to-consumer channel. We have an existing roughly $40 million business that is growing. And plus, we're introducing new products and new categories that are primarily targeting direct-to-consumer channels to reach their consumer. And we recently issued a press release about TruSens, a line of air purifiers that we launched a couple of months ago and those products are going primarily through direct-to-consumer channels. So overall, we're seeing good growth in the majority of our channels and some consolidation in the kind of more mature channels. And by the way, this is no different than the industry overall. There's all of these channel shifts that are happening from specialty retail to mass retail, from retail in general to online, and it affects us like it affects everybody else.

Okay. Great. And I was wondering if you could just provide a little more color on the Brazilian tax reserve. What is going on there? Is there the potential for more? Do you think that you've covered it with the recent one that you took in the quarter. Any additional detail there would be appreciated.

Sure, Joe. Let me give you, actually Neal will give you a short summary, but I would also encourage you to read both the 10-K and the 10-Q, which will be published later today, which will give you a more robust description, but Neal will give you a quick high level summary. Go ahead, Neal.

Well, first of all, this dates back to our acquisition of the Mead C&OP business and taking tax depreciation within the business, which predated our ownership and what we have fundamentally is a dispute that we knew would take a long period of time to resolve. We just completed for some of the years that are in dispute the administrative court proceedings and now moved to the judicial level. When you make that transition, there's a natural increase under Brazilian law of the potential penalty if you lose. Obviously, we are fighting it because that's not our anticipation. There is 1 more year where we are still in the administrative courts, and therefore that size of the liability will change. And every year, the liability does increase because we have to add interest to it, and it's tended to then be offset because FX has reduced it. So you get interest and FX every year, but there will be 1 more step-up for 1 more year of the dispute that will occur as and when that transitions to the judicial level. And it's probably going to be at the judicial level for many, many years. So this is nothing that's going to have a result anytime soon.

Our next question is from Brad Thomas from KeyBanc Capital Markets.

I got in a couple of minutes late from another earnings call, so I apologize if this has been addressed. But I wanted to just talk a little bit more about the profitability in the North America business. I was encouraged to see those results and hoping, Boris, you could just share a little bit more about the opportunity to continue to enhance margins and improve operating income dollars in the North America business?

Yes, in North America, as we said over the last couple of quarters, we saw fairly significant inflation last year. The cost increases, and we weren't able to adjust pricing on a timely basis due to the commitments -- contractual commitments we have with customers. So we raised prices twice in North America in the last several months: once in October of 2018, and once in Q1 starting in January of 2019. You're seeing margin expansion and recovery of margin as a result of that. We expect incremental benefit just due to the pricing working its way through all of the customers -- incremental benefit in Q2 as well. And right now, we're seeing the inflation across states stay fairly muted in North America. So if things stay as is, we will not be needing to do another price increase until probably next year. I mean, obviously, there is inflation. So I do anticipate a price increase next year, but we will be -- we should be all set for 2019. In addition, in North America, we have taken incremental productivity and cost reduction actions both in 2018 and in 2019, and the team's been implementing those, and as a result of that, we're seeing improved manufacturing efficiencies as well as lower SG&A in North America. So margins have expanded, profitability has improved, and given what I'm seeing from North America and the earlier back-to-school that we anticipate in North America, I think in the near term -- the margins will continue to be very, very good in that region.

That's great. And so just to address the back-to-school sell-in, you alluded to some of the different channels you sell to and some of the changes that are happening. But I guess as you try to net it all out, Boris, you think this year's sell-in for back-to-school, you all are share gainers across the industry and have a better sell-in than last year? Or is it similar? Or how should we think about it?

The sell-in should be better than last year. We anticipate roughly 2% growth from last year. So we do anticipate a better sell-in. Share gain would depend on what the market does, so I can only tell you that in hindsight. I can't predict what the market's going to do. But I'm very happy with our sell-in position, and we also said in both prepared remarks and on the call that we anticipate back-to-school shipments to be earlier this year than we did the last year which should benefit Q2.

Great. And then on the TruSens air purifiers, I thought the launch looked very well done. How do you think about the revenue opportunity for that category and then how much it might be able to contribute to growth?

It's a very big category. We estimate the category to be around $2 billion, and it's growing at about 13% per year. This is worldwide. Obviously, we just entered the market, so we're very small. But it has an opportunity to be a big category for us. We've just been selling the product on our own site and through Amazon for the last few weeks, and we have very, very happy participants. We also began to sell in Canada and then Japan in the last few weeks, and we have a plan to roll it out in Europe and the rest of the world in the second half of the year. So we have high hopes for it. The product is great. I think the team has done a great job with marketing and merchandising it on our website, and we're excited. We'll see what happens, but there's -- the opportunity is large, and we just have to deliver.

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

Thank you, Gigi. Thank you, everybody, for joining us this morning. To summarize, we are pleased that the year got off to a good start, and we remain confident about our future and continue to position the company for growth and strong return for our shareholders. I look forward to speaking with you again after we report our second quarter earnings results. Have a nice day.

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