ACCO Brands Corporation (ACCO) Earnings Call Transcript & Summary

Good afternoon, everyone. My name is Bill Reuter. I'm the high-yield consumer products analyst here at Bank of America. Very pleased to have the long-term -- long-time, high-yelled issuer ACCO Brands with us today. We have Neal Fenwick, who is the Chief Financial Officer, a business that had been steady and operated in the core office products and categories and then went through some transition, last year, with a relatively good-sized acquisition. So I think, Neal is going to make maybe, a couple of comments and then we're going to go into Q&A. Anyone who is in the -- sorry, the technology that will allow you to ask questions, please just feel free to filter those through me. With that, Neal.

Thank you, Bill, and thank you for the invite. It's always a nice opportunity to talk to our investors. We, as you know, refinanced all of our debt, back in March. And we were pleased with the investment support that we got. And part of the important thing, then, is to make sure that we make ourselves accessible to investors so that they can understand what's going on in our business. And we try to make sure we have good disclosure and part of that is being open. So feel free to fire away with your questions.

Great. Well, I will start off with a handful, and anyone else, as I said, please feel free to send those to me. But the first is, talking about the U.S. back-to-school season, obviously, it was much different than 2020. A lot more schools were open. However, I think, some students continue to work or learn from home. Can you talk about what the tailwind is that you expect next year, in terms of what I would expect to be a full transition to in-person learning in the U.S.?

Certainly, we're hoping for the same. So schools are in the mid-90% attendance level, and that's pretty much the level of at which we saw point-of-sale demand for products this year versus 2019, significantly up on the year before, but going to [ Creek ] over this as the baseline. We ourselves saw less sales than our customers thought, of our product, and that was because our channels started the year with an inventory overhang. The good news is, they ended the year without one. And so for next year, we really should have 2 tailwinds. We should have a year, where there's more normal level of return with all students hopefully, being back at school and also, no inventory overhang. So for back-to-school in North America and in that context, I'm going to say U.S. and Canada, we have a good tailwind. In Mexico, we have an exceedingly good tailwind. We have an exceedingly poor back-to-school in 2021. It basically, didn't happen. And so we're anticipating a much better back-to-school. Unfortunately, still in Mexico, vaccination rates are low. So we hope, they will continue to pick up, and kids will go back -- much like we're hoping to see in Brazil, where vaccination rates are much higher.

Transition to the other major driver in the U.S., which is office workers. Can you talk about what you've seen there? There's obviously, a lot more seasonality in the back-to-school business. But if you could talk about it, on an annual basis, how demand is between the 2 different demand drivers? And then, what types of tailwinds, do you think, we could continue to see in 2022?

Sure. And you're correct, there's less people in offices than there are in schools, by a long way. And so I'm going to, kind of, answer this question a little bit by hopping over to our EMEA segment first. So in Europe, we've seen hybrid use of offices, which has been much, much higher than we've seen in North America. And in EMEA, we saw our business recover much -- it had very little complete lockdown. It had partial lockdowns, and schools didn't really end up. So for the last 5 quarters, we've been trading in EMEA at above 2019 levels. That's partly because we took share, but a lot of it is because hybrid use of offices has basically, become the norm in the EMEA setting. We anticipate hybrid use becoming the norm in the U.S. So what we're seeing at the moment is approximately 40% office accommodation in the U.S., in use. And we anticipate that continuing to increase. Hopefully, you'll see a lot of people go back at the beginning of the year, and you'll see more drift back through the year. But for us, hybrid use is good enough. We don't need people to be back in the office 5 days a week. What our experience has been, is that as more hybrid workers return, they start populating 2 desks, the one in their office and the one at home. And so for us, it actually opens up opportunities. And if you look back at our 10-Q reports for [ 2 ] -- Q2 and Q3 we actually published what the level of commercial improvement was. And the commercial business in Q2, was the real driver of recovery. It was up more than 70%. And in Q3, it was up another 20%. And so we are seeing a good rebound from the real depths of COVID, and we anticipate seeing continued recovery each quarter as more markets start going back to using their offices and hopefully, populating that second desk that they'll continue to have at home.

I guess, this would require some sort of study, but have you been able to figure out whether there may have been any changes in behavior with around the use of paper. There's obviously, a lot of products that you guys have, whether it's notebooks, whether it's staplers, whether it's binding equipment, all of these are related to paper, when people are working at home, they may have used a little bit less. Have you been able to try and figure out whether any of those behaviors remained?

The behavior change we've seen, is really one that it's gone long before COVID, but got accelerated with COVID. And that's really, the shift to electronic-storage documents, away from paper storage. And so categories like large-capacity ring binders, have really become very much more miniscule, whereas paper usage for things like school notebooks, is really unaffected. It was affected during the nonschool period, but notebook. So our leading Five Star brand, at a POS level, grew share this year, back-to-school. So we do not believe that there's any change in school use of notebooks. And also, paper use is, kind of, shifting, in the way it gets used. And so paper has been in a long-term decline for many years. That hasn't changed. We think, it took a leg down, on top of that long-term decline, because of COVID. And fundamentally, we don't believe those markets will return. Whereas other markets, such as the presentation products, security products like shredding for cleanable, shareable products like dry-erase boards, which are used in conference areas and even staplers, which you [ won ] in each of your desktops. We see growth for all of those categories as a result of the shift in behavior. So overall, a mix shift in our business, and it's a mix shift to the positive. It's actually, a decline in one of our weaker margin categories.

Your gross margins have remained solid, despite a whole lot of commodity inflation. Can you talk about the impact of those cost savings that you've done, as well as what those discussions with your retail customers or any of your customers have been, in terms of pushing through those price increases? Has there been pockets, where you've had difficulty with that, et cetera?

Yes. I mean, we've been facing a rising tide of inflational year. It started the year with big inflation that was really driven by international freight. And it's, kind of, morphed through commodities that, one by one, all went up. And it's been a game of catch-up for us and still is a game of catch-up, with a rising cost base. And so we've had to push through multiple price increases. We've had to have major arguments with every one of our customers to achieve that. And we have no choice. And so we've been pushing them. We had to do it. We had to achieve it, and we've been able to achieve it. There are more lags and more price rises that are higher in other countries, and that's really driven by a combination of -- they're seeing exactly the same commodity increase and freight increases of the U.S.. But in a bunch of other countries, they've got currency devaluation at the same time, which means that imported products are even more expensive. So EMEA, South America, for example, had have to have price increases that are even bigger than the U.S. And so the challenge there is even bigger, and to a certain extent, it will take longer as a result.

In terms of your inputs, I know a lot of them are difficult, if not impossible, to hedge, but there may be some that you enter into forward-purchase contract. And I guess, you talked about it, in a big-picture context, what you're trying to do, in order to insulate yourself, somewhat, from some of these movements?

The biggest hedging activity we have, is actually for currency purchases. And so we take forward-currency contracts. And that, fundamentally, we need to do, in order to -- because the time line in many of our overseas markets were raising prices, is longer. And so from a commodities perspective, other than currency, it's very hard to get a perfect matching and not have to mark to market because we are buying derivatives of those exposures. And so the main installation we get is, through our holding our own inventory and holding our vendors to notice periods on their contracts. And those are the two tools we use, to try and slow down the rate of increase that hits our books so that we can get it timed closer to our ability to raise prices. Unfortunately, we've never managed to get perfection in that department. And so it always costs us a little bit of margin, when we get into rising inflation, and we gained a bit on the downside.

I know that a lot of companies have experienced manufacturing disruption. I guess, are there any areas that you have had facilities that recently are continuing to be impacted by substantial amounts of downtime? Or is that a risk that you believe, is something for investors to think about over the next couple of quarters? Or is it we largely past that?

No. I mean, we haven't had supply shortages of, of course, downtime. We've had outbreaks of COVID in some of the plants. And we've had good policies in place to make sure that we protected our employees, but we've had odd shifts that have had to all go home and quarantine, for example, which has become the norm. And so you learn to work around it. And so we've done a very good job of protecting our employees. But you can't protect people from meeting their friends. And.

Yes. I guess, we wouldn't want to. The shortage of chips, this has been something which everyone is hearing about, everyone's talking about it. Is this something that's been impacting your volumes? Or is it more related to the shortage of chips in the consoles that obviously, there are high attachment rates with your products.

Good questions. You answered the PowerA exposure correctly. It's the console demand, which is impacting us. We have to prebuy chips that are encoded for the gaming controllers. And so we always carry an inventory of them. And so that's not been our constraint. But on the Kensington side, getting enough chips for all of the products that we need, has been a constraint and very long lead times. And so some of the more speculative part of the Kensington business, where we would go out after contracts, have not been easy for us to pursue because we can't get the chips.

I guess, the outlook for demand, console availability, last Christmas, was a little bit disappointing. I'm sure, a lot of the investors here aren't technology analysts, so they don't really know exactly, what's going on with the consoles. What are you hearing, in terms of availability for the holiday season? And then, if you could talk a little bit about what those attachment rates are like, how tied do you think your sales are, relative to consoles and put that in contrast to relative to software sales?

Sure. So consoles do drive a certain level of sales for controllers. And so availability of consoles is important. It's not the only thing that drives the market. We also sell replacement ones, and we sell power adapters, and we sell cases and a bunch of other things. But it certainly, is driving the extra demand that we're seeing at the moment. The good news is, we still anticipate the PowerA business growing 20% this year over last year, based on our previous guidance. And that's actually more than we came into the year, thinking it would grow 15%. So it's not quite as toppy as we thought it was going to be, in the middle of the year, and that's because of console availability. We have plenty of product. So if there is console availability, we will be able to satisfy it. We're still seeing shortages of consoles. And so they are still in short supply. What that will really do is, elongate the period of console renewal. It will take much longer than normal. Historically, it's been like a 2-year cycle. It's probably, going to be a 3-year cycle, where that demand will get satisfied over a much longer period. And that's actually -- not actually a bad thing, as far as we're concerned.

Yes, I can understand that, that could be good in some ways. In terms of input-cost inflation, is this -- and once again, still on the PowerA side, is this a meaningful increase in your cost of goods sold? Or is it more the ocean freight for these products that has been a bigger impact, in terms of any sort of margin pressure you've seen?

That's, kind of, shifted as the year has gone on. It started off being ocean freight being the big driver, and it's now become input costs driving up. And I suspect, those 2 will flip around in 2021, and commodities will come the biggest cost, partly because I think ocean freight costs will start to come down in the second half of the year. And so the -- but overall, there'll still be an increase in cost in '21 -- in '22 versus '21. So for PowerA, it's been the same as it has pre-COVID. It started with freight, and it moved into supply chain costs.

Yes. Yes. I think, we've heard that pretty consistently. I guess, in terms of -- have there been any changes -- there's been some indications that the backlog of ports is improving. When you're talking about ocean-freight costs, it sounded like the first half of the year, is still going to be up. Do you expect that the second half of the year will be down, on a year-over-year basis?

It will, hopefully, be down. But at this stage, we'll just -- we'll react as it happens. And it's really a function of -- My personal belief is that you will see it start coming down in the second half, based on what I've been able to read about various analyst reports on the shipping industry. And we're starting to see some shippers offer fixed-price contracts out at cheaper prices than current spot rates, and that is a fair indication that they think the prices are going to fall.

Yes. Yes. In terms of net leverage, we're sitting here at 3.8x or so. The leverage target to 2.5x will, I guess -- Is it fair to say you are on the sidelines until we either get into that range or closer to that range? Or would you be opportunistic, if you saw something that you felt was at the right price?

By the end of this year, we anticipate being at 3.5x or lower, based on our previous estimate for the year. And that's the same level we were at, when we bought PowerA. So in the event that something opportunistic comes along, we would consider going after another acquisition. I think that we have equally got no problem just letting leverage drift down. And so a little bit of what you will probably see, is a more balanced use of how we apply cash in 2022. We'll be able to do more than just pay debt down and pay a dividend. And so we may consider other uses of cash during that period of time. But at the end of the day, we view deleveraging as reloading the gun so that we can make more acquisitions. We do believe, acquisitions are important. We also, though, have achieved a major milestone, we believe, with the acquisition of PowerA, which is that we now think we have enough fuel mix to actually also achieve organic growth. And so proving that to the markets, we think, is really important. And so that is going to be a major piece of our focus as well as just, kind of, paying debt down. And it just shows that we can get the top line to grow.

What the PowerA acquisition from -- in terms of what the business was, while I can see how it's very attractive, it was surprising to me, from a segment standpoint. What are the current attributes you're looking for and targets to add to the portfolio, at this point, or those criteria?

Yes. A lot of people found PowerA to be more surprising than we did. The customer overlap with ACCO was more than 70%. The supply chain that we have for PowerA, is very similar to the supply chain that we have for Kensington and a bunch of our other electrical products. And for us, there were two real advantages for a business like PowerA. Number one, we could leverage our infrastructure well, and we bought a business that didn't have any because it came out of -- it's half of the business fundamentally, we left the other half behind. So we were able to pick it up, without having to have any restructuring costs, leave them with the parent [ Co. ] and just pick it up and put it straight through to leverage our business. And then secondly, we think we offer it a real opportunity for growth, and that's to expand internationally -- I'm going to say internationally, I mean, outside of its current business base, which is predominantly in the U.S. and U.K., to leverage our infrastructure more globally. And again, we already deal with the key customers in a lot of other countries, and we have distribution, customer service and all those things that you need to be a viable player for a seasonal-product category in those other countries. And so to us, it had two great fits. We could give it something it can have on its own, and it was able to leverage what we had.

Just as a reminder to any of the investors, please feel free to use your interface to highlight some questions that you'd like asked. I guess, the other side for that is divestitures, is there anything you would consider, whether it's a regional -- a region of a business that you would want to sell or alternatively, certain subsegments of the traditional Office Products segment that don't have as much either synergy or they're not as integrated as the rest of the businesses?

Historically, we found the -- people aren't really interested in buying the things that we don't want. They want to offer very low multiples of cash flow, and often, it's more valuable for us, just to wind them up. And that's, kind of, what we've tended to do with most of what we've pulled out of, over time. It's just into liquidate our investment in it to get that cash back. So it's not to say you never would. It's just we have a lot of declining businesses that are good cash cows, and most people assume that they can buy them from you for a small multiple of cash flow. And you look at it and you go, "oh, no. I can do a lot more, just by closing it."

Yes, that makes sense. In terms of Kensington, that is an area where you experienced some growth, is there ability to expand these products geographically? And I guess, with regard to even the broader portfolio, are there regions of the world, where, you think, there's substantial opportunity for just geographic expansion?

Yes. We've been, actually, broadening Kensington's geographic expansion for quite some time. And so we've been starting to expand, where that sells in South America, is a good example of an area, where we've been seeing good strong organic growth start to develop. Again, it's kind of the pathfinder for moving PowerA into many of those markets. And so today, 60% of Kensington sales are outside the U.S. It's already, quite significantly, non-U.S., but the market opportunity in other countries, still, is quite large. And so we're getting good growth for Kensington, internationally. It's actually because of not being able to play in the contract market this year, not going to grow in the U.S., it's going to shrink, but that's really due to the chip availability issues.

Yes. I guess, given the company's mixture of both self-manufacturing and third parties, what are you experiencing, in terms of labor inflation, across the business? And then, you've traditionally been able to find $30 million or so of cost savings, every single year. Do you continue to think you're going to be able to find something like that to offset some of these pressures, next year?

We're good at driving for cost reductions, and we will continue to do so. We also need to spend more money on product development and marketing. And so as we pivot our business, it's important for us that we pass on inflation, and we take those cost reductions and invest them in driving growth in the business. And so that's a lot of what we're trying to do as opposed to just take our cost reductions to offset margin pressures. Fundamentally, we believe that the cost pressures on the main things that compete against our products, which tend to be private labeled, are bigger than the cost pressures that are on our products. And so if we need a price increase, the private label needs an even bigger one.

And then on labor inflation ...

Yes, labor -- is regional. And so there are pockets of areas where there's a lot of labor competition, and you have to meet the market in those areas. And so the -- that has been something, but it's relatively small in the scheme of our internal cost structure.

In terms of -- you mentioned R&D and investing in new product development, is this mostly in Kensington, I'm sure that PowerA has some innovation that will be coming along there. And you've also been expanding into some new products entirely, such as some of the air purifiers. What should we be expecting from you guys? And how important is our new products, in terms of annual sales?

I'd like new products to be even more important, in terms of annual sales, than they are today. They're really important in the technology space. Life expectancy of a product, in that area, is really very short. And quite often, they're just modifications on a theme, but you have to have a rolling pathway of constant renewal in either Kensington or PowerA. That's also true in, kind of, a lot of the areas like wellness, it's true in areas where you're trying to get more into markets. I mean, one of the big investments we made, was in home shredders. We happened to hit a home run in that by having that investment come through to market, just as COVID hit. And so it's allowed us to take a big market share in Germany, in particular, with acquire. But beefy home shredder as opposed to one that, kind of, plugs, every time you try and use it.

I guess, in terms of big picture, strategic outlook, how would you define the mandate or the strategy that the company is going to have, going forward, in terms of there's a lot of things that are going on. Where do you think the business may be in 5 years, if it looks substantially different than it does today? Any key parts to that?

I think, scale helps. And so the more we can increase our scale over time, the better our business becomes. We're able to leverage that scale nicely. And so it's fundamentally, why acquisitions continue to be an important piece of the long-term nature of our business. So we need to drive internal efficiency, we need to feed that into a higher product-development marketing cycle, and we need to add more scale and the fundamental drivers that should propel our business to be larger and more profitable and growing.

Great. Well, if there's nothing from the audience, I have exhausted all of my questions, and we're almost at the end of our time here, anyway. Neal, thank you so much for joining us, to all of you for tuning in. Happy holidays to all.

Thank you.