ACCO Brands Corp (ACCO) 2022 Q3 法說會逐字稿

Ladies and gentlemen, hello, and welcome to the ACCO Brands 3Q 2022 Earnings Conference Call. My name is Maxine, and I'll be coordinating today's call. (Operator Instructions)I would now hand you over to Chris McGinnis, Senior Director Investor Relations, to begin. Chris, please go ahead when you're ready.

Good morning, and welcome to ACCO Brands Third Quarter 2022 Conference Call. This is Chris McGinnis, Senior Director of Investor Relations. Speaking on the call today are Boris Elisman, Chairman and Chief Executive Officer at ACCO Brands Corporation; and Deb O'Connor, Executive Vice President and Chief Financial Officer. Slides that accompany this call have been posted to the Investor Relations section of accobrands.com. When speaking about our results, we may refer to adjusted results. Adjusted results exclude transaction, integration, amortization, and restructuring costs, a noncash goodwill impairment charge and the change in fair value of the contingent consideration related to the PowerA earnout and other nonrecurring items and reflect an adjusted tax rate.

Schedules of adjusted results and other non-GAAP financial measures and a reconciliation of these measures to the most directly comparable GAAP measures are in the earnings release and the slides that accompany this call. Due to the inherent difficulty in forecasting and quantifying certain amounts, we do not reconcile our forward-looking non-GAAP measures. Forward-looking statements made during the call are based on the beliefs and assumptions of management based on information available to us at the time the statements are made. Our forward-looking statements are subject to risks and uncertainties, and our actual results could differ materially.

Please refer to our earnings release and SEC filings for an explanation of certain of these risk factors and assumptions. Our forward-looking statements are made as of today, and we assume no obligation to update them going forward. Following our prepared remarks, we will hold a Q&A session.

Now I will turn the call over to Boris Elisman.

Good morning, everyone. Thank you for joining us. In mid-October, we issued a press release updating our third quarter and full year outlook, highlighting the fact that the third quarter proved to be more challenging given the economic environment, especially in Europe and more cautious inventory replenishment by retailers. Last night, we issued our third quarter results, reflecting sales at the midpoint and adjusted EPS at the high end of our guidance with our full year outlook unchanged.

Let me start by saying the solid fundamentals of our business are intact, and we believe we have the right strategy and team to weather the economic challenges and deliver sustainable organic revenue growth once the economy improves. The transformative actions we have taken over the past few years to be more consumer-centric and geographically diverse have helped us maintain a grow market share in 2022. There were many positives in the quarter. We had a solid back-to-school sell-through in North America. Our Five Star brand grew sales and market share in the back-to-school season and outperformed the overall market in dollars and units.

Sales of our commercial products have benefited from a return to office trend, especially in North America, where office occupancy rates continue to improve and have recently reached a post-pandemic high. Our Kensington brand and computer accessories category grew double-digits globally in the third quarter and year-to-date. Our International segment grew comparable sales over 30% and almost doubled adjusted operating income in the third quarter as in-person education returned in Brazil and Mexico. These successes were more than offset by a more cautious stance than anticipated from retailers on inventory replenishment and reduced sales of gaming accessories in North America, as well as reduced demand from a challenging environment in Europe.

In EMEA, the significant high inflation, war in Ukraine, current energy criss, and the stronger U.S. dollar have weighed on consumer sentiment leading to sales and profit shortfalls. In addition, lower sales volume has resulted in stranded fixed costs in our manufacturing facilities. To counter the high rate of inflation in the region, we will be implementing our fourth round of price increases over the last 18 months on January 1, 2023. In addition, we have reduced variable labor costs and discretionary spending in response to the lower demand and are looking at structural cost reduction initiatives to be implemented in 2023. While the third quarter sales environment was challenging in EMEA, both computer accessories and gaming accessories continued strong comparable sales growth trajectories in that market, and combined, were up low double-digits percent in the quarter and year-to-date. As we look out to 2023, we are still on track to expand our gaming accessories initiatives to strengthen EMEA growth profile.

In North America, the continued strength in back-to-school and return to office trends were more than offset by retailers more cautious inventory replenishment and lower sales of gaming accessories. The North America margin rate in the third quarter was negatively impacted by expense deleveraging from the volume declines and higher inflation related to finished goods, inbound freight and outbound transportation. These costs are currently elevated but are beginning to moderate. We expect higher commodities and freight costs to flow through the P&L in the fourth quarter. While we believe that the overall product inflation in North America has peaked, there are certain commodities that will stay at higher levels in the near and medium term.

Regarding our video gaming accessories category, we continue to believe in its long-term growth opportunity, which will increase our organic growth rate as we expand our product assortment and accelerate growth in our EMEA and International segments. Third quarter sales sequentially improved, but are still down from the pandemic high of prior year. We continue to hold a leading market share position in the third-party gaming accessories controller market and have increased our market share position in 2022, highlighting the strength of the product assortment, placements and PowerA brand. The gaming market is in the midst of a normalization from the high demand related to the pandemic. The market continues to be challenged by the lack of semiconductor chips, which inhibit new console production and the availability of some gaming accessories.

We now expect gaming accessories to be down approximately 15% for the full year, which is at the lower end of our previous expectations. Our longer-term expectation is for sales in this product category to return to pre-pandemic industry growth trends, which historically were at low double-digit growth rates. While ACCO Brand is not immune to the current economic environment, we have the right strategy and an experienced management team to navigate its challenges. We've been aggressive with our pricing and cost actions while continuing to invest in our product development and go-to-market initiatives. We expect the environment to remain challenging and are currently evaluating other cost reduction initiatives, including our geographic footprint and facility rationalization projects. We hope to share more details with you on these initiatives on our fourth quarter call in February.

Additionally, we remain confident in our transformation to drive sustainable organic revenue growth and are well-capitalized with no debt maturities until 2026, fixed interest rates on behalf of our outstanding debt and low annual interest costs. We have taken actions to protect profitability and free cash flow by curtailing hiring, reducing inventory, and limiting discretionary spending and capital expenditures. Importantly, our third quarter cash flow generation was significant, and we prioritize dividend payment and debt reduction. We also amended our bank debt covenants to provide for greater flexibility, which combined with the company's strong cash flow generation to allow ACCO Brands to successfully navigate the current economic environment.

I will now hand it over to Deb and will come back to answer your questions. Deb?

Thank you, Boris, and good morning, everyone. Our third quarter 2022 reported sales decreased almost 8% as foreign currency was a 6% headwind in the quarter. Comparable sales were down 2%. The decline was due to lower volumes in our EMEA and North America segment, offsetting strong growth in our International segment. Adjusted operating income was $43 million, compared with $57 million last year. Adjusted net income was $24 million, compared to $32 million in 2021 and adjusted EPS was $0.25 versus $0.33 in 2021.

In the third quarter, we took a noncash goodwill impairment charge of $99 million. We had a significant amount of goodwill on our balance sheet from previous acquisitions such as Mead, GBC and SLT. This charge represents less than 15% of the overall goodwill balance. Given our stock price, the company's market capitalization is low, which triggered a review of our good growth. The charge is reflected in our North America segment, which carries a significant portion of our total goodwill. Inflation was more of a headwind than we had previously anticipated, which is why our gross margin and operating income declines were more significant than our sales decline.

Given the lower sales overall, we are experiencing fixed cost deleveraging in our facilities. While inflationary costs are beginning to come down, their lagging effect on our P&L will continue to impact our gross profit through the end of the year but should improve as you progress through 2023. Third quarter adjusted SG&A expenses were $95 million, compared with $101 million in 2021, primarily as a result of cost savings and lower incentive compensation accruals and the positive benefit of FX partially offset by continued investment in our go-to-market program. Adjusted SG&A expense as a percent of sales was 19.5%, above last year's 19.1% due to lower sales. However, year-to-date adjusted SG&A as a percentage of sales was down 40 basis points. Our near-term SG&A target remains at 19.5% of sales.

Now let's turn to our segment results for the quarter. Comparable net sales in North America decreased 10% to $259 million. The decrease was due to lower inventory replenishment by retailers and volume declines in gaming accessories. As previously discussed, retailers purchased earlier in the year than typical to ensure product availability. Beginning in the third quarter, retailers' inventory replenishment was significantly less than anticipated. We performed well in the U.S. back-to-school season with approximately 10% comparable sales growth. Back-to-school sell-through was up 4%, outpacing market growth of 1%.

North America adjusted operating income margin decreased due to higher cost of finished goods and specific commodity materials and higher inbound freight and outbound transportation costs that were not adequately offset by price increases. Just like EMEA, North America will be implementing another round of price increases on January 1, 2023.

Now let's turn to EMEA. Net sales were down 19% to $130 million, primarily reflecting the adverse FX. Comparable sales were down 4% to $154 million, mainly due to volume declines offsetting our price increases. In Europe, the current energy crisis and significant inflation have created a more challenging demand environment. The energy crisis is expected to worsen this winter, and we expect consumer sentiment to remain low through the end of this year and into 2023. EMEA posted lower operating income and margin from the lower sales volume, which led to underutilization of our manufacturing facilities and therefore, deleveraging of fixed costs.

Boris referred to a review of our manufacturing footprint, which we are undertaking now. Price increases have not been large enough to offset accelerated inflation generally especially for locally sourced raw materials. However, we are making sequential progress on the price cost differential, and we expect our January price increase to meaningfully mitigate the overall impact of these inflationary cost increases. In addition to allow for more frequent price changes, we are renegotiating several customer contracts.

Moving to the International segment. Net sales increased 26% and comparable sales rose 31%. We were encouraged to see volume contributing more than price to the increase. This growth was driving by improved demand in Latin America, especially a note taking products as schools and businesses continue to return to in-person education and work. The International segment posted higher adjusted operating income and adjusted operating margin as a result of higher sales and improved expense leverage. These improvements were driven by the rebound in Mexico and Brazil.

Switching to cash flow and balance sheet items. In the quarter, we generated $84 million in adjusted free cash flow. Year-to-date, we had a $12 million use of adjusted free cash flow, which reflects our seasonality. Sequentially, inventory was down $40 million from the second quarter, but remains high due to inflation and lower-than-expected third quarter sales volume. Our accounts payable balances are relatively low as much of our inventory was purchased earlier in the year and payments for those goods were made by quarter end. As we bring inventory down, we should shift into a more normal payables balance.

We announced an amendment to our bank credit agreement, which increases the maximum consolidated leverage ratio beginning with the fourth quarter of 2022 and favorably amend several other items. The increase in the consolidated leverage covenant up to 5x, allows for greater financial flexibility and headroom for the company during these challenging amount of time. The amendment does not change our interest rate pricing grid. We ended the quarter with a consolidated leverage ratio of 3.9x. We expect that ratio to be approximately 3.8x to 3.9x at year-end. Longer term, we are still targeting 2 to 2.5x. CapEx year-to-date was $12 million. We also paid dividends of $22 million year-to-date and repurchased 2.7 million shares of stock in the second quarter for $19 million. At quarter end, we had $417 million of remaining availability on our $600 million revolving credit facility. As shown on our earnings slide, more than half of our debt is fixed and not impacted by interest rate increases, and we have no maturities until 2026.

Turning to our Outlook. We are reaffirming our guidance presented in October for sales, adjusted earnings per share and adjusted free cash flow. For the full year, our Outlook is for comparable sales to be flat to up 2%. I think this demonstrates the progress of the transformation and portfolio shift and resilience of the company in a really tough economic period. We also expect foreign currency impact to remain a headwind with a 4% to 5% negative impact on sales and a $0.05 negative impact on adjusted EPS. Full year adjusted EPS is expected to be in the range of $1.05 to $1.10. The adjusted tax rate is expected to be approximately 29%. Intangible amortization for the full year is estimated to be $42 million, which equates to approximately $0.31 of adjusted EPS. We expect our adjusted free cash flow to be within a range of $90 million to $100 million after CapEx of $15 million. Looking at cash uses for the remainder of 2022, we expect to continue to prioritize dividends and debt reduction.

We have been chasing inflation for the last 18 months. We expect sequential adjusted gross margin improvement in the fourth quarter, but gross margins will be down versus the prior year. The additional price increases in January, along with our cost savings initiatives, will give us further to our long-term adjusted gross margin of 33%. This is an ongoing challenge due to the magnitude and persistence of inflation.

Sales in October continued to reflect significant inventory destocking by retailers with their cautious approach to replenishment. Given this trend and the likelihood that it continues, we would be tracking to the midpoint of our 2022 sales and adjusted EPS outlook. Even though we expect certain areas of our business to achieve growth in 2023 and many of our brands to maintain or increase market share. If the macro environment continues in the current state, we expect our overall volumes will decline. However, this decline is expected to be fully or partially offset by price. 2023 should look differently than 2022 from a cadence perspective and more similar to 2021 when resellers were conservative with their inventory. In fact, we expect first half 2023 comparable sales to be approximately at 2021 levels, less the negative impact of adverse FX of around $30 million a quarter.

We expect full year gross margins to expand and for SG&A to remain at our 19.5% rate in 2023. We expect full year free cash flow to grow compared to 2022, driven by the improved profitability and a more normal working capital cycle. We will provide additional details in February when we report our annual results.

Now let's move on to Q&A, where Boris and I will be happy to take your questions. Operator?

Thank you. (Operator Instructions) Our first question comes from Joe Gomes from Noble Capital.

So I just wanted to get maybe a little deeper dive into the outperformance of the international segment. Is this all just related to the rebound in Mexico and Brazil are -- how are the other parts of the international segment performing?

It's being led by very strong performance in Brazil and Mexico, both of those countries have rebounded from a couple of years of COVID, Schools are open, offices are open, and we're seeing very strong business. So back-to-school in Mexico and in preparation for back-to-school and just office business in Brazil. If we look at outside of those 2 countries, Chile has done well and has grown mid to high single digits in the quarter. And then Australia is recovering. They had a very tough first half of the year with a lot of COVID cases in Australia, but saw a small growth in Q3. And in Asia it's still difficult. It's a small part of our business. But we are seeing some sales declines in Asia just driven by weaknesses due to 0 COVID policies in many of those countries and just the weak macro in Japan.

And that segment has done very well and passing price to offset the inflation is seen as well.

And on the inventories, you guys talked a little bit about how you built it in anticipation. They came down somewhat in the third quarter. How much more do you think you've got to come down there to be where you'd like to be in terms of the inventory levels?

We still have ways to go. We are pleased with the progress that we made through the year. I mean we built a lot of inventory last year in the second half, primarily driven by supply chain difficulties. And then we started taking it down earlier this year. We wish we could have done more, but due to lower sales, lower volumes in Q3 were still a little bit high. So my anticipation is we'll still make significant progress in the fourth quarter and really come end of this year, early next year will be in the normal working capital cycle. The supply chain issues are pretty much behind us. So there's not a reason to hold more inventory than we need to come end of this year. And once we're normalized, we'll be able to go with a normal working capital cycle in 2023.

Yes, that's right. And just, Joe, don't forget high inflation, 10%, 11% is also on those inventory balances as you just think about the level.

And one more, if I may. A lot of companies have talked about the difficulty in the hiring and retention environment. Just wondering how you guys are finding your ability to hire people in or retain people that you want to retain?

We haven't had any issues. We saw a little bit of a pickup in attrition last year in '21 in the summer. But this year, it's been running pretty flat. I mean it's still a very competitive market, but we're not having difficulties either with attrition or with hiring people.

Our next question comes from Greg Burns from Sidoti.

With the added covenant flexibility with the new amendment going to 5x. What do you foresee? Like where do you foresee leverage kind of peaking here given the current outlook? Do you feel like you're going to rise to that level and work down from there? Or how should we think about leverage going forward?

Yes. I know. So Greg, as I talked about fourth quarter this year, we're going to be in that $383.9 and the new ratio is at kind of 4.5, is that 4.5%. So that kind of 50, 60 basis point differential would be as we look out kind of the lowest -- or the highest point, lowest point differential. And we really got it to get more headroom for next year as we go into this uncertainty, but not worse than kind of a 50 basis point spread. If that's what you're looking to.

Yes. So we don't expect to get to 5. We don't expect to get to 5, but it was added for flexibility of headroom given the uncertainty in the environment. Typically, our leverage peaks in Q2 as we build inventory for back-to-school. So as Deb said, we expect to be at least 50 points below that 5x.

And Greg, the one nice thing, too, is the banks are really supportive on that seasonality. And so going forward, we'll have that higher ratio in the first and second quarters for that seasonality that, Boris, for spoke to.

And then in North America with the retail side of the business, what -- where do inventory -- channel inventories currently stand? Can you just talk about how that impacts you gave a little color on how that's going to impact the first half of next year, but do you see -- then see a stronger sell-in in the early part of the year next year to replenish those inventories? How does that historically play out?

Yes. The inventories right now are pretty low in the channel. It doesn't mean that they won't be able to go lower. It all depends on sell-through is and retailers will carry a certain number of weeks on hand depending on what the sell-through is. But we expect retailers to be conservative with inventory all the way through the first half of next year. So this year, as Deb mentioned in the prepared remarks, they brought in inventory early because of the supply chain issues to prepare for back-to-school. We think that's not going to happen next year. We think that given both the economic challenges and easing of supply chain they will be more chasing inventory. We'll bring in what only what's necessary and then try to chase sales with additional purchases in Q3. So we think that -- and that's what happened in 2021. So we think it's -- what's likely is retailers will be conservative with inventory in the first half. And then as they sell through in Q3, they will bring more inventory in.

And then on the commercial side in North America, how far below pre-pandemic levels is that business still? And do you think you can get back to pre-pandemic levels there?

Yes. We're about -- so if you look at during the pandemic, we lost, let's call it, 15% or so on the commercial side. We made up about 2/3 of that. So we're down about 5%. And yes, we are clawing our way back and people are going back to offices and that's driving POS. So we think that we will be able to make it up in 2023.

And then just lastly on PowerA. Do you think that business is fully kind of reset from the pandemic bubble? Or is there additional kind of normalization that needs to happen in North America? And what's the status on your strategy to kind of expand that business globally? Do you have the footprint fully in place to do that? Or is there more investments that need to be made?

Sure. So globally is going very well. The business has been growing globally in 2022, and that's both in EMEA and internationally, and we will continue to invest and expand that footprint and the sales growth. So we feel very, very comfortable in our ability to do that.

In North America, it's still normalizing and my expectation is we will continue to do that through Q4. It's just driven by -- partially by steel supply chain issues, there's still semiconductor chip shortages that affect people's ability to buy both Xbox Series X as well as the PlayStation P.S.I.s and then also the lack of chips or some of the wireless accessories. So that's impacting availability as well. As well as just normalization of demand, people were staying home and playing games. Now they're traveling and going out and playing these games. And I think that's going to be still the case in Q4. But we do expect that to recover and rebound in 2023, and we expect growth in the (inaudible) business in 2023.

Well, just to kind of drill in on that growth outlook. Is that mostly going to be coming from the rest of the world or North America, do you think North America can grow to? Or is that mostly going to be coming from Europe and Asia?

We do expect North America to grow, but the growth rates will be much higher in Europe and international, that it would be North America. But we do expect growth in North America.

The next question comes from Kevin Steinke from Barrington Research.

I wanted to just -- I just wanted to start off by asking about gross margin, and you noted that you expect some improvement in 2023 in light of the price increases you're implementing on January 1 and maybe some cost reductions. But I would assume we should think of gross margin progression is, I don't know, fairly gradual and still maybe meaningfully below that 33% target. Just trying to get a sense of how much you think can be accomplished. And I know inflation is kind of still of a wild curve, but any thoughts on gross margin progression.

I mean I'll just started out (inaudible) add on, but I think you're exactly right. It's going to be a gradual improvement and expansion and growth margin. And we are still fighting and we still haven't gotten to the price cost differential as we sit here in the third quarter, right? So we've got 10%, 11% inflation, 8%, 9% price. So we're still lagging. And we've got to do the catch-up on that, and that's going to take that January price increase to do it. So you're right, it's going to be gradual. It's going to be throughout the year. And I think the 33% is a little bit away.

Yes, I agree with that, Kevin. We're going to be making progress. I'm expecting progress in Q4 and certainly throughout 2023. But I don't think we're going to get fully to that 33% number until after 2023. We're still going to be catching up in 2023.

You mentioned in your prepared comments, modifying some contracts to allow for more price increases, maybe sounded like that was fairly isolated to a few customers. I'm just trying to get a sense as to how broad of an initiative that is and how meaningful that could be in terms of your ability to catch up to inflation maybe a little more quickly.

That's specific to EMEA. We really couldn't do price increases more than twice a year in a normal environment that's okay. But when you have inflation, 14% a year, that's not frequent enough. So our teams are working with customers to modify the contracts to allow us to do more frequent price increases so we can keep up with inflation. And by the way, it works both ways. It's both increases and decreases. I'm sure nobody will complain about more frequent price decreases, but nevertheless, contraction allows us to develop.

(Operator Instructions) Our next question comes from Hamed Khorsand from BWS Financial.

So the first question was, is the lower stocking levels resulting in shorter order intervals from retailers?

Meaning, more frequent and smaller orders, Hamed, is that what you mean?

Yes.

Yes, it is resulting that. That is correct.

Are you able to be efficient in that kind of operating structure?

Well, we do have minimum order quantities. So we charge above a certain amount, the outbound freight is included in the price and it's free below a certain amount they have to pay for outbound freight. So there is a built-in financial incentive to keep orders at a certain level. And what happens in reality is retailers go to wholesalers for really small orders because we won't -- it's not economical for them to get it from us. So even though there is some shifting to more frequent lower dollar orders, there is economic incentive built in not to make it inefficient for us.

And has the product mix changed greatly for you as to what retailers are willing to stock? And how does that relate to the inventory you have on your -- in your warehouses?

It really hasn't changed. I mean, retail is typically stock A and B items and then the CMD items they offer on an as-needed basis. And that has continued. I mean over time, if I look at over the last 5, 10 years, certainly, the mix has changed as was computer accessories and cool and burning product is away from storage and organization. But if I look at within this year kind of individual SKUs, it's still (inaudible) A&B SKUs being stocked and CMD SKUs being brought in just in time.

What's really driving this break on replenishment is just the economic outlook and retailers becoming very, very conservative with how much inventory they want to stock given that they're forecasting an economic recession.

This concludes our Q&A session for today. So I'll hand the call back to Boris Elisman for closing remarks.

Thanks, Maxine, and thank you, everybody, for your interest in ACCO Brands. Previously, we have managed well in difficult environments and are confident in our ability to navigate current economic challenges. We're also confident that we have the right strategy and believe we're well-positioned to continue to deliver organic sales growth, compelling market performance, and improved financial results as global economies recover. We look forward to talking to you in a couple of months to report on our fourth quarter results. Thank you.

Thank you, ladies and gentlemen. This concludes today's call. Thank you for joining. You may now disconnect your lines.