ACCO Brands Corp (ACCO) 2007 Q4 法說會逐字稿

Good morning. My name is Julie, and I will be your conference operator today. At this time I would like to welcome everyone to the ACCO Brands Corporation fourth-quarter earnings release conference call. (OPERATOR INSTRUCTIONS). Thank you. Ms. Rice, you may begin your conference.

Good morning, everyone, and welcome to our fourth-quarter and fiscal 2007 conference call. On the call today are David Campbell, Chairman and Chief Executive Officer of ACCO Brands Corporation, and Neal Fenwick, Executive Vice President and Chief Financial Officer.

We have posted a set of slides to accompany this call to the Investor Relations section of ACCOBrands.com. These slides will provide detailed information to supplement the call.

Our discussion this morning will refer to our results on an adjusted basis, excluding restructuring and non-recurring items. A reconciliation of these results to GAAP can be found in this morning's press release.

During the call we may make forward-looking statements, and based on certain risk factors, our actual results could differ materially. Please refer to our press release and SEC filings for an explanation of those factors.

Following our prepared remarks, we will hold a Q&A session. Out of courtesy to others, we ask you to please limit yourself to one question.

Now I will turn the call over to Mr. Campbell.

Thank you, Jennifer, and good morning, everyone. Operationally 2007 was a very strong year, although our results ended slightly below our original 2007 guidance due to lower sales volume and challenges from our commercial laminating business. 2007 sales declined by 0.6%. Pricing was positive, adding 2 points while volume declined 3%, the result of slower consumer demand and wealth market share. However, we believe market share declines are reversible as we work through our onetime customer disruption created during the integration process.

To face these disruptions, operating income increased 27%, the result of two years of integration improvement. Particularly heartening, Office Products led the way. Its profits grew 36% as price recovery and synergies took hold. Third-year EBITDA increased 11% to $220 million, the midpoint of our guidance range. Earnings per share were up 37% to $1.37. Our cash flow remains strong, allowing for our capital plans and cash restructuring expenditures and a reduction of $40 million of debt.

Finally, our pretax return on invested capital increased 290 basis points to 14.7%.

We enter 2008 a stronger Company as a result of the many actions that we have taken over the past couple of years and with the benefits of much of this work yet to flow through into 2008.

As highlighted on slide four, two years ago ACCO Brands embarked upon a 36-month merger integration process. Since that time, we have made material progress in streamlining operations, improving our margins and reducing costs. The vast majority of these actions required to realize our $40 million of annual synergies in 2008 will actually be completed in the next couple of months. In fact, we are now already winning progress necessary to yield an additional $20 million annual savings targeted in 2009.

Let me provide more detail of what we have already accomplished over the past two years. First and most importantly, we have developed a foundation for improving our customer reliance and response capabilities. Additionally integrating our sales force, customer service organizations and supply chains operations are already resulting in synergies.

Second, we have built a stronger, simpler, more streamlined business model. We are improving the way we conduct business globally, particularly in Europe by creating a new pan-European operating model much more in sync with the growing larger customers.

Third, we continue to simplify and strengthen our product portfolio, setting nonstrategic and low return businesses. Through 2007 we have eliminated approximately $90 million of low quality sales. Our increased new product development spend is now squarely focused on our future growth and high return categories.

Fourth, since 2005 we have sharply stepped-up our investment in core brands, increasing focus on end-user and ramping up the amount of go-to-market spend by $30 million annually or 1.5% of sales.

Slide six provides details of some of the actions that we have taken most recently.

I'm very excited about our long-term opportunities and significant potential our business holds. We entered 2008 in a position to drive continued earnings expansion and lay the foundation for topline growth as the economy turns. For 2010 we are targeting to ramp up our organic sales from a flat or slightly down position in 2008 to a 3% to 5% growth in 2010. We expect ongoing margin improvement of at least 350 basis points over the next three years.

Together these achievements should enable us to deliver double-digit organic or earnings per share growth. Our strong free cash flow generation is expected to improve as capital and restructuring needs subside, creating additional opportunities to reduce debt and undertake other actions focused on building shareholder value. We anticipate approximately 90 to $110 million of debt reduction capabilities in 2008.

Disciplined asset management and prudent reinvestment will drive continued increases in our return on invested capital, allowing us to achieve our targeted 20% pretax long-term rate of return. To deliver this, we have specific sales and margin plans.

To drive the topline, the strategies that we need to execute against are clear and highlighted on slide eight.

First, step up our focus on core brand innovation. Based on consumer research, focus and insights, we have honed in on specific channels and product opportunities. We have created global development centers with focused expertise to drive product development and make sizable investments in engineering talent and resources.

A great example of a business receiving this kind of focus and investment is our Document Finishing segment. Insight into markets have identified significant consumer needs that are not being addressed by any of our current products. We are reengineering our binding and laminating machines and suppliers to address these needs, and we have incorporated intellectual properties into our designs that will recapture lost market share.

Our plan is to roll out several new products through our direct sales channel at the end of 2008 and early 2009. We expect that in 2009 Document Finishing will be a strong contributor to our growth, just as our Computer Products business is today.

Second, we are changing the emphasis of our go-to-market investment and the mix of our SG&A spend to drive greater end-user awareness.

Historically, our industry has focused on customers through rebate programs. We need to work with our customers to show them the value of putting more emphasis on consumers to drive traffic. We have also internally focused on remixing the composition of our SG&A spend by creating global product design centers.

At the end of the day, this will result in more global product appeals and develop leverage while we reduce our G&A spend, enabling us to increase the proportion of marketing and product development investment.

Third, we must increase the penetration of our key channels. Using Document Finishing as our example again, in this business we will be increasing the size of our direct sales force in Europe significantly with the ultimate aim of expanding it to an equivalent size of our North American sales organization.

Our recent experience is that for each salesperson we have added, the number of accounts we pick up increases 10%. We are refocusing the deployment of our direct sales people in North America as well to make them more effective. Once we are able to offer new products currently under development, we expect North American sales in the direct sales channel to increase as well.

And fourth, we're positioning ourselves to gain sales in key geographies. Using Europe as an example today, more than a third of our European sales aren't in the UK where only 12% of the European population resides. As we begin to leverage our new pan-European infrastructure, global products and a larger European coverage model, we will look to increase the presence on the mainland of Europe. Over time we also believe the European market will provide attractive customer acquisition targets.

In summary, we believe steady execution against these strategies will enable us to increase our long-term organic sales growth to 3% to 5%.

Now let me spend a moment on operating income and margin, an underlying principle of our future if it continues to drive profitable growth. Our target is to grow our operating income double-digits over the next three years and high single digits thereafter. To do so, we also have clear strategies.

First, continue to improve upon our supply chain effectiveness. While much initially has been accomplished in the reconfiguration of our supply chain, we are still in our early days. Significant further efficiencies exist to be captured. As more of our our product offering becomes global, we can better leverage the coordination of our global purchasing scale and the progressive introduction of common IT systems and standard processes across our global operations.

Second, we have increased the level of investment in new products over the last two years. This investment has so far only yielded results in our Computer Products and Digital Communications categories. Over half of our increased investment has yet to have any impact on the remaining business.

As the fruits of this investment begin to flow, we will see both higher growth and expanded margins into our Document Finishing and other areas of Office Products.

In addition, we have taken steps to reduce our SG&A costs. Near-term selling erosion has offset some of the benefits. On an ongoing basis, we will seek to reverse volume erosion and grow, gaining margin leverage as a result.

And finally, we will create a more efficient organization by simplifying and fine-tuning our processes. The term organizational effectiveness captures a lot of what we have already done to lower our supply chain and SG&A costs. But it also captures everything from improving our customer interaction and customer service to fine-tuning our new systems and further reducing our cost base.

Now let me put this into some context in terms of what you might expect to see in 2008. Our growth in 2008 will still be bottom-line driven. Given the uncertainty of consumer and business spending in 2008, the completion of $20 million of product exits, a $45 million full impact from 2007 share loss and the timing of new products, we anticipate our topline to be flat to down mid single digits in 2008. We believe the first half of the year will be particularly tough with sales 2 points lower than the full-year rate. We then expect to start to recover share in the back half of the year and see an improving economy.

2008 operating income growth of mid single digits to low double-digits is expected, a wide range caused principally by economic uncertainty. We expect to realize $25 million of synergies, as well as a positive price contribution but believe flat to shrinking volume will subtract from this. We still anticipate substantial underlying margin growth, but volume and the timing of the capture of anticipated raw material inflation could create challenges. This would translate into earnings per share growth of flat to low double-digits.

Our cash flow will be strong. We believe 90 to $110 million as our capital expenditure levels and cash restructuring costs decline from 2007 by about 45 to $50 million.

2008 will be a challenging economic environment. Our key issue is to complete the repositioning of the business, both restructuring and new product development so that we can start to regain the share and benefit that the economy turns.

Now I will turn the call over to Neal to walk you through more financial details. Neal?

Thank you, David, and good morning, everyone. I will be starting with slide 11. As already noted, comparable sales in the quarter were down 1% year-over-year, driven by lower consumer demand and through multiple product placement. Despite this, we grew operating income a strong 32% and with our three most important businesses delivering the improvement.

Healthy gross margins increased 170 basis points. The improvement was once again driven by price increases, integration synergies and favorable product mix. However, the improvement was tempered by the continuation of supply chain startup expenses at our new Booneville facility.

Energy and commodity costs continued to increase in the quarter. To offset this significant cost pressure, we have announced price increases going into the (inaudible) third quarter. We anticipate inflationary pressure will continue, and these may also lead to additional price increases later in the year.

SG&A benefited from a 3 million reversal for previous (inaudible) incentive accruals related to performance share plans, and go-to-market expenditure was down $3 million for the quarter. Adjusted operating income was up $16 million, of which $5 million is the benefit from foreign exchange. Operating margin was 12.5%, up 280 basis points. This operating margin improvement was achieved without underlying volume growth. Adjusted earnings per share for the quarter was up 32% to $0.66. Our tax rate for the quarter came in at 29.5%. This was slightly lower than our anticipated rate of 31%, due largely to the higher mix of (inaudible).

As expected, we once again had one-time charges in the quarter. Restructuring charges were $9 million, and associated non-carrying charges were $10 million. We also booked a non-cash goodwill impairment charge of $35 million in recognition of our commercial laminating business' deteriorating performance.

Slide 12 shows you the drivers for our margin improvement for the year in more detail. You will note that price increase is a healthy 120 basis points, and overall synergy contribution was 80 basis points or $15 million, lower than our $20 million estimate due to $5 million in startup issue.

Now let's turn to slide 13 and our adjusted pretax return on invested capital. We continue to make great progress improving our return on invested capital, which has increased over 300 basis points since December 2005 to 14.7%. Our improved adjusted operating income and received debt level drove this improvement. Our working capital sales ratio came back into line by year-end. Even our inventory balances remained high. These were offset by higher payable days.

Capital spending was $21 million in the quarter and $59 million for the year, largely our new US distribution center in Booneville. We reduced debt by $50 million in the quarter, resulting in a net reduction for the year of $40 million. The repayment included all mandatory debt repayment through 2008, but we obviously expect to continue to reduce debt in 2008 as our free cash flow will be even stronger, particularly in Q3 and Q4.

Strong return on invested capital is a good indicator of future sustainable cash flow capabilities, one of ACCO's great strengths.

Moving on to the discussion of our business segment in the quarter on slide 14. Office Products sales increased 1% with underlying volumes down 4%. Share loss has been slower in user demand, which represented about half of the decline. Despite the volume decline, adjusted operating income increased 23%, and margin expanded 210 basis points. The improvement was due to price increases, lower volume rebates and lower product costs from, of course, manufacturing, reduced go-to-market investments and favorable mix.

Document Finishing sales were roughly even with underlying volumes down 7%. Low demand in inventory destocking (inaudible) about one-half of the decline. This business is one of our more economically sensitive businesses with heavy user groups in the financial and real estate sectors. Despite the volume decline, adjusted operating income increased a strong 43%, and margins expanded 420 basis point. The improvement was due to price increases, reduced volume rebate, lower product costs resulting from outsource manufacturings and favorable mix.

Computer Products sales increased 12% from the expected year-over-year improvements in the United States and continued growth in international markets. Adjusted operating income decreased a strong [65%], and margins expanded 750 basis points to 26.6%. The improvement is due to a favorable mix, expense management and $1.2 million income from prrior periods royalty claims.

Commercial laminating comparable sales were up 1% with volumes up 3%, driven by higher sheet sales. However, as expected, adjusted operating income and margins were still down because of low-cost import competition, which continued to impact pricing, while raw material costs have increased.

Before moving on to Q&A, slide 16 will provide you some more detail to help model in future years. We will have significant reductions in capital expenditure and cash restructuring used in 2008, which along with improved operating performance will drive very strong improving free cash flow. We expect free cash flow to be 90 to $110 million in 2008.

Now David and I will be happy to take your questions.

(OPERATOR INSTRUCTIONS). Arnie Ursaner, CJS Securities.

The first question I have, you mention several times, Neal, in your segment comments the impact of less rebate expense due to volume shortfalls. But on your slide 12 where you discuss margin, you did not separate that out at all. Should we assume it did not -- was not material enough that it warranted a separate line item on slide 12?

It is actually included in the line that is called Price, and the effect of those lower rebates included within Price would have been about $4 million, and fundamentally it is part of the price mix in the way the business operates.

Okay. My second real quick question, you obviously mentioned you are trying to get price relief to cover your raw material costs, and I know at year-end going into the new year it was very important. The price increases you have put in, are they sufficient to fully recover all of your raw material costs?

Yes, I believe at this point they are. You know I think this is going to be a year we believe that with petroleum and with some of the tax changes in China that there could be greater increases than one might anticipate. It is a little bit ambiguous.

So what we have done is we have put price increases through in January that we believe should cover us. We have got a window here in June sort of midyear of '08 where if we find they are not, if we find that raw material increases have increased greater, that we can catch up.

We also have sort of a natural buffer with our inventory and the leadtimes that we place orders. So I think at this juncture we can say that we are well covered. This is something we will monitor very closely, though.

And my final question is a little more strategic. Obviously you have in the past given exiting year-end '08 guidance for operating margins and some things like that. The range of guidance you have given for '08 is quite broad. And I guess the question I have is, as you think about running your business, is it fair to say you are just shifting the timing of when you reach these goals, or is there something more structural that says it's a lot more challenging to reach these goals?

I guess what I believe is fundamentally we have got some macro indicators here that are making it a little bit difficult. I think if I could just comment, one of the things that we have sort of consistently talked about is white-collar employment, and I don't know if you have followed it, but there has been some restatement of white-collar employment numbers for '07. And I think what we're seeing there is that the restated numbers are really reflecting that there is sort of less growth going on in white-collar than maybe previously thought, that we are seeing actual sort of declines now as we hit year-end and into January.

So I think because of the weakness or ambiguity I think is a better word, ambiguity of the economic situation, we're putting broader spreads on our guidance. I don't think fundamentally anything has changed about our business. I think we feel that we are well positioned. I think we're going down the right direction, all of that. What is new news here is I think there's sort of a more ambiguous sort of macroenvironment.

Yes, I would also say that all of our customers are indicating that they think it's going to be a very tough first half of the year. And so what we would plan to do is narrow our guidance range as the year goes on.

Reza Vahabzadeh, Lehman Brothers.

On your sales guidance, the flat to mid single digits, is there price component in there and an FX component that you can also separate out?

At the moment it would include about an 1% overall price increase, and FX assumption I have assumed at the moment is neutral with '07 average.

Okay. And would this sales guidance be roughly about the same for the whole first half and the second half, or is it do you expect more weakness or strength in one part or the other part of the year?

We would assume the first half is down at least 2 points more than the average for the year and, therefore, the second half less severely down. And part of the reason for that is we actually started experiencing weakness in our business throughout the last four months of 2007. And so we actually think we will start to anniversary some of the slowdowns that we have been seeing.

And then as far as cash restructuring and CapEx, do you have exact numbers for 2008?

In fact, we have put them on the slide. They are actually, the last slide we put out has got the financial modeling assumptions. So it's got cash restructuring charges of around $25 million for 2008 and P&L charge of around $40 million.

And then the free cash flow number that you put out there, and you may have talked about this, but is it going to be largely used to pay down debt?

You know, at this point in time, that would be the main use of cash that we would have in mind. But obviously you change your mind depending on what is available to drive shareholder value at any point.

Gary Balter, Credit Suisse.

It is actually Seth Basham, and I think Gary is on the line as well. A couple of questions for you guys. Could you differentiate between trends you saw in the US versus Europe on the office supply side?

Yes, obviously there is a lot more market data that you're able to get in the US than for Europe. But fundamentally what we are seeing in Europe is that the UK economy is the weakest link in the Europe, and that is about a third of our European sales. Coupled with that is the French economy, which will be the second weakest. And unfortunately that is our second biggest market in Europe.

So what we're really seeing in Europe is really our two major exposure economies are the two weak ones. Neither of them I would say is quite as bad as the United States. And so the impact we're seeing is predominantly a US-driven one followed by UK followed by France. We're actually seeing the rest of our global world doing very well, thank you, and that is a little bit of a positive offset for us.

Understood. Going forward would you expect Europe to sort of catch up with the weakness in the US, or how do you think about that in forecasting the business?

You know for us, most of our, let's call it our non-US/French business is really about market share gain. We are so small with our market share in those economies that quite honestly our experience will be different to the economy because it's about gaining share as opposed to necessarily going up and down with the economy, which obviously has an impact but less of an impact than share gain for us.

So my belief is the UK has already got about as bad as it is going to get. I think that you will see -- at the moment you're seeing a lot of fiscal stimulus coming from the US government. You have not seen that same fiscal stimulus get enacted in Europe yet. So my guess is they are four or five months behind the US in terms of the curve.

Got you. And in terms of the US's curve, do you expect it to get a lot worse before it gets better in the second half, or how do rate the first half of 2008 compared to the second half of 2007?

Our experience in January, just to give you some idea, is that our sales are down about 4% in January. And so it is very much reminiscent of what we have really seen over the back half of 2007. But my guess is that it will get a little worse in the first half compared to the second half of '07 in overall times.

And part of that is, as many people have indicated in this industry, we think there is some inventory that will come out of our customers. I would estimate there is about $10 million of inventory that would need to come out from our bigger customers. They did not want to get their inventory for us, so you could maybe double that to get an overall macro effect.

And then in addition to that, we lost share in the second half of 2007, and we have share lost that will continue in the first half. And in the second half, we have the real opportunity to regain share, and that would be our desire and intention.

If I could just make some comments, I think one of the things that I would sort of in contrasting '07 and '08, I think if you recall in '07 we really put through some pretty significant pricing increases and rebate readjustments for our customers, both in Europe and in the US. I do not think we will be seeing that obviously in '08. That was really a onetime adjustment. The price increases we're putting through at this juncture are much more in line with just basic raw materials increases.

I would say that over the course of '07, as we were introducing new distribution both in Europe -- centralized European distribution in Europe in our Born facility and making changes in our Booneville facility here in the US, there were shipping disruptions that again I do not think we will see in 2008. I think particularly in the second half of 2008 we can expect to see benefit from the new product development spend that we have been making through '07. I think that will flow through.

So I think there are some real good things that have gone on in our business that particularly in the back half of '08 should be positive, but even in the first half to some degree.

Very good. And one last question related to a comment you just made, David. Can you give us some more thoughts on how you are grappling with inflationary pressures out of China, not so much on the raw materials side, but on the labor side and really to the VAT rebate?

Sure. Well, I think that is an excellent question. And I particularly -- you know, people who have done a great deal of offshore sourcing and frankly I think with private-label are dealing with vendors in China that are going through a lot of change and certainly under sort of tax pressure, things like that, I think we have tried to be very selective about who we deal with. We do not deal with a large number of vendors in China. It is really quite focused.

We have spent a great deal of time working with them. I feel at this point fairly comfortable and confident that because we deal with few, because they are custom manufacturers, we have a very close relationship with these people; I generally feel for us fairly comfortable that we are well-positioned from a cost position and a supply position.

I think there's going to be a lot of uncertainty in China as the year develops and as economic policies in China start to bite, and they are not just VAT that you mentioned. They are also to do with export, cash subsidies, and I think that will actually create a lot of churn in the supply reliability of some vendors in China, which will particularly hit people who don't have good relationships with Chinese vendors.

I think it is important to remember we have been working now with Asian vendors for over 10 years. This is not a new thing for us. A lot of relationships are very well entrenched.

Bill Chappell, SunTrust Robinson.

I guess the first question on your expectations for 2008, what are you expecting for the currency benefit to the topline?

In terms of my forecast, I have put no benefit in at all. So to the extent that currency ends up being a benefit, it will be a benefit, Bill. At the end of the day, I don't know if today's foreign exchange is going to be tomorrow's foreign exchange, and therefore, I do not try and forecast it.

Sure. But we would think that it would have at least some benefit in the first quarter since we are about half way through.

That is true, and it could have a negative detriment in the second half, and that is why I don't model it in. But at this point in time, you are correct. It will benefit it in the first half.

So that topline expectation of kind of flat to down, it does not in too many benefit at this point?

Correct.

Second, I'm just trying to understand strength in the December quarter versus kind of what you're seeing in January. Is that more of a catchup from the September quarter on retailers holding back shipments, and then it has kind of finished out as we have gone into January, or was there something different there? And also kind of with that in mind, do you expect Computer Products, are you seeing the same type of trend from the fourth quarter to the first quarter?

I see you have asked several different questions. I will try and pass them for you. (multiple speakers) in our industry as incumbent with all the other players in our industry do offer annual volume-related rebates. What you do see a little bit of in every December of every year is people putting some inventory into the channel in order to make sure they secure those rebates. We did see a number of our large vendors forego that this year-end, and they bought to actual demand. But some of the sort of vendors' customers, but some of our customers still obviously follow that tradition.

We would actually estimate that this December it was lower than in previous Decembers, but we do believe that there is about $10 million of inventory that will come out of the channel through the first half of 2008.

The second question you asked was about Computer Products. The key thing with Computer Products is really to understand that the demand that we have been seeing for the first three quarters of the year was heavily impacted by the channel shift that we have been reporting all year and changing CompUSA as a customer.

Most of that had annualized out when we got into the fourth quarter. So you finally saw the fourth quarter display an impact that no longer included the situation with the channel shift. It still included a bit of CompUSA. But then what you then really saw was the benefit we have been getting of getting new products and new listings. And so that should, of course, continue, and we would anticipate that as the segment, the Kensington segment, would still end up with mid single digit growth at least if not slightly better than that as we go through 2008, even with softening demand.

Okay. And then the final two questions and then I will turn it over, on the cash flow, I think you are now at 3.2 times debt to EBITDA, and you could start repurchasing shares at to 2 3/4. Does that mean you would during this year get to that point where you would look for share repurchases, or is it not until year-end that you have the cash flow to really get to that point?

You know, as you will be aware because you follow us very well, our cash flow really comes in the third and fourth quarter. Again, we spoke about these volume rebates earlier. They will get paid out in January, and that is one of the big things that gives us negative cash flow in Q1. In Q2 you end up with a need to rebuild inventory levels, part of back to school, and working capital absorbs cash in Q2. So Q3, Q4 is when this business has always generated its cash on a long-term basis. I know in some quarters historically we did a little better than that, but that was really about squeezing GBC's balance sheet when we first acquired it.

And on the tax rebate, you might have mentioned it, why was it a little bit lower in the December quarter, and have we given up on getting the reversal in the UK?

No, we have not, and we have made a little bit of progress there, which was a little bit of what came through in at the end of the year. Fundamentally it is about mix. At the moment we're not paying any US tax, and we're not paying any US tax fundamentally because of the level of restructuring charges that we have taken. So we have NOLs that are effectively using up their US tax.

So our tax rate is fundamentally a function of what foreign taxes we're paying and what the foreign mix is within the overall -- and so that is what causes the variation in tax.

There are no further questions. I would now like to turn the call back over to David Campbell.

Thank you very much. Look, I hope we have demonstrated sort of the progress we are making in the business. Again, as we look at our business, we see a very bright future for ACCO Brands. We thank you for your support, and look forward to our next call in May. Have a good morning.

This concludes today's ACCO Brands Corporation fourth-quarter earnings release conference call. You may now disconnect.