ACCO Brands Corporation (ACCO) Q3 2011 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Third Quarter 2011 ACCO Brands Corporation Earnings Conference Call. My name is Lacy, and I'll be your coordinator for today. [Operator Instructions] I would now like to turn the presentation over to your host for today's conference, Ms. Jennifer Rice, Vice President of Investor Relations. Please proceed.

Good morning, and welcome to our third quarter 2011 conference call. Speaking on the call today are Bob Keller, Chairman 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. E-slides provide detailed information to supplement this call. When speaking to earnings per share, we are using a normalized effective tax rate of 30% and we exclude the cost associated with the repurchase of our bonds. 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. Now it is my pleasure to turn the call over to Mr. Keller.

Thank you, Jennifer, and good morning, everyone. Earlier this morning we released our third quarter financial results and I'm pleased to report that despite continued global macroeconomic headwinds, ACCO Brands continue to execute well and deliver on our commitments. Sales grew 6% year-over-year, and our operating income margin expanded 100 basis points on sale volume that was essentially flat. EBITDA improved 16% and earnings per share increased 60% to $0.24. We've reduced our debt by almost $50 million through the repurchase of bonds which Neal will discuss shortly, and still ended the quarter with $41 million in cash and no borrowings on our ABL. Consistent with last quarter's performance, all of our business units contributed to our success. Sales in the Americas and in Computer Products were in line with our expectations and the ongoing turnaround of our European business contributed significantly to our bottom line results. Australia and our Asia-Pacific businesses continue to exceed our expectations. We're proud of what we've accomplished to date, but we're particularly pleased with our turnaround in Europe. We lost money there last year and after absorbing the cost of the changes we needed to make in Q1, we've been profitable in both Q2 and Q3. Our margins expanded there by 770 basis points in the third quarter and in spite of the volatility of that market, we expect further improvement in both margins and profitability in Q4. At a company level, we believe that we're well positioned to deliver on our full year 2011 commitments. Our customer relationships are strong, our people are energized, we've added talent to the sales part development and marketing leadership teams. Our new product pipeline is robust and we continue to compete aggressively for profitable growth opportunities. In closing, while we're cautious about the external operating environment, we do feel good about our own performance. We are reiterating our guidance for the year, with sales expected to be up 2% to 4%, excluding currency, and earnings at the high end of our projected range, growing EPS about 30%, and ending the year with $100 million to $110 million in free cash flow. Now I'll turn the call over to Neal, for a more detailed look at our results. Neal?

Thank you, Bob. Our third quarter performance is recapped on Slide 4. Reported sales increased 6% with a 4.5% benefit from foreign exchange. Pricing was favorable 2%, underlying volume was down modestly. Gross profit margin increased 100 basis points to 31.6%. Increases mainly due to improvements in Europe, resulting from price increases which have begun to offset the increases we've seen in our cost of goods as well as operational improvements in areas such as freight and distribution. SG&A expense as a percent of sales increased 10 basis points to 20.8%. Operating income increased 18%, with operating margin expanding 100 basis points to 10.4%, our highest operating margin since 2007 before the recession began. EPS from continuing operations, excluding the $0.05 cost associated with repurchasing our senior secured notes was $0.24 versus a comparable $0.15 in the prior quarter. For the nine months, sales increased nearly 5%, largely driven by foreign exchange and pricing. Volume was down 1.5% for the 9 months due to lower end market demand and customer inventory reductions in the first quarter. As shown on Slide 5, gross margin increased 60 basis points for the 9 months period to 31.2%. Cost savings, particularly in freight and distribution, were the largest driver of improvement. SG&A was up 7% for the 9 months including a $6.9 million impact from foreign exchange. As a percent of sales, SG&A increased 60 basis points to 22.6% of sales, primarily due to the $4.5 million of reorganization cost in Europe and $3.7 million of higher incentive compensation costs. These were partially offset by operational improvements mainly in Europe. Operating income for the 9 months increased 5% to $79 million. And EBITDA increased 4% to $114 million. Both included the $4.5 million of reorganization cost in Europe. Foreign exchange added $8.7 million to EBITDA, and finally, EPS from continuing operations was $0.33, excluding the $0.05 of cost associated with bond repurchases. This compared to $0.24 in the prior-year nine-month period and with an increase of 38%. Now I'll provide an overview of our segment performance for the quarter. During the third quarter, sales for the Americas increased 2.5%, driven by favorable pricing and foreign exchange. Volume was slightly lower as market share gains in key categories continue to mostly offset underlying declines and marketplace demand. Back-to-school performance were in line with our expectations. Segment operating margins were down 30 basis points from the prior year due primarily to higher fuel costs. In our International segment, sales from continuing operations increased 14%, driven by foreign exchange translation and pricing. Underlying volumes declined 2%, largely due to reduced demand in Europe. International segment profit grew nearly three-fold and operating margin expansion is strong, 770 basis points to 13.2% as our European region return to profitability. We continue to expect to realize $3 million of savings in the second half associated with the improvements to our customer model in Europe, making the initiative near breakeven for the year. By next year, savings should grow to $6.5 million annually. Computer Products sales increased 4% in the quarter, with volume up 1%. Strong demand for our new products that accessorize iPads and iPhones, help offset the decline in other areas, mainly security. Computer Products operating profit decreased in the quarter to 24% from a record setting 28.4% last year, due to lower security royalties and product mix. Turning to cash flow which is detailed on Slide 6. Third quarter operating cash flow essentially was supplied to our final interest payment for the year. And we used cash on hand to reduce our debt by $48.9 million. We still ended the quarter with a healthy cash balance of $41.3 million and will further add to this balance in Q4, which is our seasonally strongest cash flow quarter for the year. In terms of our debt reduction, we have now reduced debt by $60 million year-to-date. In the quarter, we repurchased $35 million face value of our senior secured notes for $38 million, and $14 million of our senior subordinated notes. On an annualized basis, the reduction in debt will lower our interest expense by $5 million or $0.06 per share. We are also now nearing a point where our senior secured leverage to EBITDA ratio could be at or below 2.5x. Once it is at or below 2.5x, we have more flexibility in how we manage our balance sheet. For instance, we could buy back an unlimited amount of our subordinated notes should the price warrant it. Even more importantly, however, we are within a year of being able to call our senior secured notes and potentially refinancing this debt in a matter that could significantly lower our interest expense. We feel good about the fact that our balance sheet has become very manageable. In closing, we reiterate our outlook for the year. Adjusting for the sale of GBC – Fordigraph business, we continue to expect sales growth of 2% to 4% before FX. We continue to expect to be at the high end of our EPS growth range of 20% to 30%, and we continue to expect free cash flow including proceeds from the GBC – Fordigraph sale of $100 million to $110 million which implies strong free cash flow in Q4 of $80 million to $90 million. That concludes our prepared remarks. At this point, Bob and I will be happy to take your questions. Operator?

[Operator Instructions] Our first question will come from the line of Bill Chappell with SunTrust.

Can I get a better understanding just want to get a better understanding on just kind of the volume trend especially in North America and understanding that you'd want a fair amount of business coming into this year in excess of $50 million. That should've helped the organic growth. But are you seeing an incremental decline in some of these end markets or is this similar to the trends you've seen at the start of the year or how should we look at even on the progression through the quarter?

I think it depends on geography and channel, frankly. We think Europe has gotten progressively softer as the year has gone on. We wouldn't consider the U.S. market to be anywhere close to being robust, but it's been more stable. And for us specifically, I think we've seen the retail channel be softer than probably we would've expected or hoped at the beginning of the year. The commercial channel is relatively stable. It's down a little bit. Retail is probably exclusive of Wal-Mart. It's probably down double digits in the quarter. Commercial office products superstore commercials, kind of flat to down a point. The wholesalers and the independents continue to take share from our perspective and that's up double digits for us. And so, it's kind of a mixed bag. But at the end of the day, I think -- we think it's soft and will remain soft and our ability to continue to deliver results is going to be based on our ability to execute.

Well, switching that same question to Computer Products. I mean, I have to remember what the currency benefit was last quarter, but it seems like it's a pretty big deceleration sequentially. I didn't know if that's just timing of shipments or if or maybe you could give a little more color on what's happening with the security side of the market?

Yes. I think we had a very good second quarter on the security side and a softer third quarter. We think a piece of that is tied to the shift from laptops to tablets. And we had very strong sales on the non-security side in the quarter, which more than offset the softness that we saw on the security side. And so we're interested in the fourth quarter. We'd expect a little bit of a bounce back on the laptop market in Q4 and the security market in Q4.

Okay. And then just 1 or 2 last ones. On terms of use of cash flow, I mean, will you continue to use that from now to year-end to do things, or are you just now on a more wait-mode to see where things kind of play out going into next year and what you can do in terms of refinancing?

Obviously the big thing is the ability to refinance next year, but we look opportunistically at what happens in terms of where are debt's pricing et cetera and we'll see if we generate a lot of cash in the fourth quarter and it's a question, if it's a good use of it or not and how much we need for the refinancing which we look to do next year.

Okay. I have one more for Bob. I think we're now in the bake off season for winning new business for next year. Can you kind of give us any update of how that's going and what you expect in terms of new market share wins?

Yes. We feel good about how we're positioned. We actually have more stuff that we are competing for from a take-away perspective than we've had in the 3 years that I've been here. We like our chances. Generally over the last couple of years. We won 2/3 of the that ones we had an opportunity to compete for, and we'd take that percentage right now.

And our next question will come from the line of Arnie Ursaner, with CJS Securities.

My first question, when we had you on the road recently, you spent a great deal of time talking about consolidation within the industry and the role ACCO could play as a potential buyer of assets that were available in the market. Can you perhaps freshen that up a little bit, and...

Sure. It starts with the perspective and I think we're pleased that we're in a position to actually start to think about our business and our industry from a strategic perspective as opposed to just an operational perspective. And I think we're in a position where both from a financial point of view and an operational point of view, we can consider opportunities. We think there are some that are out there, and our expectation is there will be more over time. But we have a pretty high bar. Our expectation if we were thinking about an acquisition would be that it would be accretive on an immediate basis, that it would be hopefully deleveraging, but no worse than neutral relative to leverage. And something that we believe that would expand our scope into adjacent markets or give us a very strong position in markets that we already serve. We would like to expand geographically, that would be something that would be of interest to us into emerging markets that would give us a stronger play there. We're obviously very pleased with our trading companies have performed over the last several years and believe that, that's an opportunity for us and one that we did execute well. So while this isn't something that the kind of comment on an ongoing basis, I think it's important that people appreciate. And we've managed the business conservatively. We would look at acquisitions rationally and not let it get away from us.

My second question. This is normally the time you're negotiating with your clients about price increases for their catalogs for next year. Given all the commodity volatility that we've seen. Are you at least hopeful or expecting to get sufficient price increases to recover your commodity cost and maintain, if not slightly improve margin?

That's exactly how we think of it, as a cost recovery, and we're already in discussions with our customers, both in the Americas and internationally. And our expectation is that we will raise prices in line with commodity cost increases in both geographies.

Are you seeing any customer reaction to the point where, as you have in the past, if you can't earn an appropriate return, you'll walk away from the business. Is it that difficult, the negotiation process now?

No. I think we feel very good about the strength of our relationships with our customers, and we appreciate that they're in difficult, competitive circumstances as well. But the conversations are rational. And the -- I think they appreciate that we're not trying to take advantage of any situation that we are in fact just trying to recover our retrospective cost increases. If they don't believe they're in a competitive position to enable us to do all that we want to do, we try to take the conversation to something that creates a win-win, where we get additional placements or end caps or something that allows us to improve our profit position within their organization.

Can I ask one more real quick, I'm not expecting you to answer, but I'll give it a try. You mentioned you had $3.7 million higher incentive comp in the quarter. Related to the cliff earn-outs, have we essentially fully accrued those? And if we do get it done at year-end, is there another one that begins next year?

We don't comment specifically. We have more accrued this year than we did last year. Our expectation is we would further accrue in Q4, based on our expectation for the quarter. And the way we have our compensation plans set up. There's always going to be some measure of this in those plans that says, if we don't return value to our share owners, we're not going to pay out full bonuses. That's just kind of a core belief that we have. So regardless of what we do this year, that as a philosophy is going to be embedded in our compensation programs.

And our next question will come from the line of Reza Vahabzadeh with Barclays Capital.

Just a housekeeping item, I guess, on the FX benefit. Is that a translation gain or is that a transaction gain?

It's translation.

It's what we refer to all the time. In terms of transaction, it's going in multiple different directions depending on which country, and it's always an issue in all of our foreign jurisdictions where pricing really follows the FX curve, and so it tends to be a timing issue in non-U.S. jurisdictions as opposed to the long-term P&L issues.

And then so your market share gains that you anticipated for this year, that is taking place as you anticipate it?

Yes. We feel good about our share gains during the course of the year. I think they've been consistent with the prior 2 years that I've been here and we like our position going forward.

And then as far as the category from your answer to the prior question, it sounds like U.S. is, give or take, in line with your expectations. Europe, progressively softer and Computer Products is in line with your expectations, is that right?

Yes. That's pretty fair.

And then you talked about the -- your guidance for 2011. The use of working capital that you're referring to for 2011, is that going to be something comparable to 2010?

No. The biggest issue with working capital to use is if we grow or not. And so obviously, from a relative point of view, if you grow to about 18% of the sales growth accounts, what we have seen is big swings due to timing as to how working capital has been in the various months and quarters of this year. But from an overall point of view, our working capital needs a generally modest, but they can have dramatic swings one quarter to another.

I see. So it's a little difficult to forecast?

Yes. I don't see it as a big number. But by the end of the year, it can be a big number within quarters and at particular points if you get a big swing. A good example is our accounts receivable at the end of September. They are -- in terms of outstanding receivable days, they've been the best all year, but in terms of dollars, they look high because we had very high sales in the last 2 months of the quarter.

And then as far as cost inflation as we go into fourth quarter, would you anticipate just a cost inflation to accelerate a bit, just given what's happening in China sourcing cost or would you anticipate that to be about the same as you saw in the third quarter?

On average, about the same. We've seen a lot of volatility in certain commodities. In some of the ones that went up very, very significantly in the beginning of the year have now come down to more moderate levels. And some of those that haven't increased at the beginning of the year have risen very slightly. We're not seeing the dramatic volatility in raw materials that we were seeing in the beginning of the year anymore.

Got it. My last question is how do you feel about inventory in the channel at retail and wholesale?

We think our customers are managing inventory pretty tightly. So we don't believe that there is excess inventory in the channel at this point in time, and we'd expect buys to look like point of sale until we approach the end of the quarter and then people are going to have to make decisions based on the price increase and where they are relative to their full year program commitments for December buys.

And our next question will come from the line of Karru Martinson with Deutsche Bank.

I guess on that same line of questioning, normally you guys do see pull-forward ahead of pricing. I mean, is that going to be an expectations this year?

I think it differs from customer to customer. Our expectation is there probably be some this year, but we haven't built a ton of it into our forecast.

Okay. And when you look at the pricing actions that you've taken and that you're looking at for the upcoming year. What have you been seeing in terms of the competitive response both on the private label side and on the branded?

I think, the pricing on both is pretty reasonable. We're all working off the same cost structure. We think we've been competitive and continue to be competitive inclusive of what we're doing from a pricing point of view and we'd point to the market share gains we've had over the last 2.5 years as an indication that we're priced appropriately.

Okay. When we look at CapEx here at $15 million for the year, we've been having kind of very reasonable moderate CapEx expenditures for the last couple of years. Is there any expectation that we need to increase that going forward? Or is this kind of the longer-term run rate?

Fundamentally, having transitioned all of our models that were much more significant sourcing organization. Our use for capital now is really around both new product development and IT. And in both cases, we're reasonably well served. We do have some IT projects which are still ongoing and we have a lot of new product development projects which are ongoing. And as we've guided to in the past, $20 million initially is a comfortable run rate for us in terms of capital.

Okay. And then when you guys look at the new product to rollout for next year as you're competing for business. Masses kind have been the target for you guys. Do you see yourselves growing share there, are the products more targeted towards that type of consumer or kind of where the categories we should be looking at?

Yes. We introduced a shredder last year, kind of about this time, started shipping it in the fourth quarter which is Stack-and-Shred, put 100 sheets of paper in and close the top and then shreds them all and its jam-free, and doesn't make a mess on the floor when you pull them in. And it was a huge success. We've loved that product. We're bringing out a 60-sheet version and an 80-sheet version with the 60-sheet and the 80 both targeted for retail. We thought the 100 would be kind of the low-end of the commercial range. We're also bringing out a 250 and a 500 for the higher-end commercial range. And so we're excited about that. We've made great strides in terms of share in the shredder category based on the success of that product. And we think that product kind of redefines the category. And so we're excited about that. When you look at the shift in the technology side from the laptops which were largely driven by commercial purchases to tablets and smartphone accessories which are driven by consumer spending. We're really excited about that. We've just introduced a product called Bungee, which you put a keyfile on and it links to your iPad and iPhone and allows you to basically ensure that they don't walk away from you or that you don't leave them behind. And so it's kind of a security thing and a finder thing. And also, it's a recharger for your phone, doubles the battery time on your iPhone. We brought out a Secure Back, which is a security product for the iPad so that you can put a cable lock on an iPad if you're going to leave it in a hotel room or something like that if it doesn't fit in the safe in some of the hotel rooms that some of us stay in. We think that's a great product and so -- and we just brought out some new power products, product we called Enigma, internally, that's going to be a universal power play, which we think is going to get great play in the retail and e-commerce channels. So we have -- the majority of our business historically has been targeted at the commercial marketplace. We're starting to spread a little bit into the consumer channel. We think that opens up a marketplace for us.

Just lastly, in terms of the rating agencies you've vastly improved here over the last couple of years. What's their mindset and outlook on your ratings?

I think S&P has always had a good read on our business, and rates us significantly higher than Moody's. So I would hope that we would see some positive movement from Moody's given our results.

And our next question will come from the line of Arun Seshadri with Credit Suisse.

Just have a couple of quick questions. Most of mine have been answered. First, could you remind us of what flexibility you have from a restricted payments perspective in terms of share buybacks? Obviously, your stock has been pretty volatile this year and you could argue. I'll give you some scope for a potential buybacks in the future as well.

I reckoned this in earlier call, but the critical test for us is falling 5x and until we get our skewed leverage below that point, we're restricted from repurchasing our shares. Once we achieve that level, we're no longer restricted.

And then as far as your growth -- your sort of perspective on industry growth going forward, any updated color on sort of what you expect for the next few quarters in terms of industry growth?

And how -- we're just focused on delivering 2011. We feel pretty good about that.

And then finally, could you just remind us a little bit about your break out of revenue and EBITDA in Europe? I think if I remember right, 1/3 of your international is -- 1/3 of Europe is U.K., and so developing Europe is still pretty small within overall Europe, correct?

So within our international segment, Europe is the largest of the units. It represents about 24% of our total sales. And the U.K. is the most significant individual geography we have there and represents about 1/3 of these sales, but it is significantly more of the profit.

And can you remind us about countries like merging Europe, Southern Europe countries, how big they are?

We have very small presence in Southern Europe. So the majority of our business is in U.K., France, Germany and Benelux countries

The points, I think, Neal was making there was that we have very little exposure to the European countries that have the highest risk of default.

Thank you. Ladies and gentlemen, this concludes the question-and-answer portion of today's call. I would like to turn the call back over to Bob Keller, Chairman and CEO for closing remarks.

Thanks, everybody, for joining us this morning. We're excited about the quarter. We thought we did a terrific job in a reasonably tough environment. We look forward to talking to you after Q4 and we'll see you then.

Thank you for your participation in today's conference. This concludes your presentation. You may now disconnect. Good day, everyone.