Timken Q3 2023 Earnings Call Transcript

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November 3, 2023

There are 7 speakers on the call.

Operator

Hello, everyone, and welcome to the ACCO Brands Third Quarter 2023 Earnings Conference Call. My name is Emily, and I'll be coordinating your call today. After the presentation, there will be the opportunity for any questions, which you can ask by pressing star followed by the number one on your telephone keypad. I'll now turn the call over to our host, Chris McGinnis. Please go ahead.

Speaker 1

Good morning, and welcome to the ACCO Brands' Q3 2023 conference call. This is Chris McGinnis, Senior Director of Investor Relations. Speaking on the call today is Tom Tedford, President and Chief Executive Officer of ACCO Brands Corporation. Tom was named CEO on October 1. Tom will provide an overview of our Q3 results and 2023 priorities.

Speaker 1

Also speaking today is Deb O'Connor, Executive Vice President and Chief Financial Officer, who will provide greater detail on our Q3 results And provide an update to the full year outlook. We will then open the lines for questions. Slides that accompany this call have been posted to the Investor Relations section of aquabrands.com. When speaking about our results, we may refer to adjusted results. Adjusted results exclude transaction, integration, amortization and restructuring costs, a non cash goodwill impairment charge, The change in fair value of the contingent consideration related to the PowerAIT earn out and other non recurring items and reflect an adjusted tax rate.

Speaker 1

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 risk factors and assumptions.

Speaker 1

Our forward looking statements are made as of today and we assume no obligation to update them going forward. Now, I will turn the call over to Tom Tedford.

Speaker 2

Thank you, Chris, and good morning, everyone. Thank you for joining us. Before I discuss our Q3 results, I want to thank Boris for his mentorship throughout the years. We have partnered closely to ensure a smooth leadership transition, And we will continue to work together until he officially retires in early 2024. I would also like to thank our dedicated team at ACCO Brands For their good work in the quarter, we made significant progress against our key priorities, while facing a challenging demand environment.

Speaker 2

Since I became CEO on October 1, we have been reviewing our strategies to ensure we have the right focus on driving Long term value for our stakeholders as we navigate the current global demand environment. We have a strong team, category leading brands and a passion in our business to win. Now, let's transition to the 3rd quarter commentary. The Q3 was highlighted by the improvement in our gross margin, strong free cash flow generation And our solid management of expenses, which led to growth in operating income and adjusted EPS at the high end of outlook. At the start of 2023, we laid out 4 key priorities, which were The restoration of our gross margin, profitable management of our top line, continued investment in our brands and new products And tight management of expenses and inventory.

Speaker 2

Our top priority entering 2023 was recovering loss margin From the high rate of inflation experienced in 2022. Year to date, we have delivered 380 basis points of gross margin improvement, Driven by the combination of our cost savings actions and the cumulative effect of price increases. With the improvement in gross margin, we are back to our 2019 gross margin rate. Additionally, we have focused on more profitable revenue streams, while remaining committed to supporting our broad assortment of consumer desired products And delivering superior service to our customers. Globally, we grew or maintained our market share in key categories And have introduced exciting award winning new product solutions.

Speaker 2

We reacted quickly to a more challenging demand environment And prudently managed our spending within the quarter. We reduced inventory by 15% or almost $63,000,000 Versus the prior year, while improving our service levels to our customers. We also announced the next of our footprint rationalization program and continue to optimize our supply chain. Our execution on these initiatives led to significantly improved cash flow, debt repayment and a lower leverage ratio. While we executed well against our key priorities within the quarter, comparable sales were down 10% versus last year.

Speaker 2

The global macroeconomic backdrop continues to challenge our categories. Weaker than expected global business IT spending Has muted demand for our Kensington branded computer accessories. Additionally, sales trends did not improve as expected in our gaming accessories categories. While near term challenges persist, we believe technology accessories remain an important source of long term Profitable growth for the company. Global sales for Kensington branded computer accessories are down year to date After 5 years of double digit growth in the category, we protected investments in the business with exciting new products being Introduced.

Speaker 2

We believe as business IT spending recovers, so will the demand for our computer accessories categories. We made progress on our international expansion of gaming accessories and remain confident in the long term growth opportunities In both our EMEA and International segments, as we expand our channel reach, introduce new products And leverage our local commercial teams. Transitioning to the segments, I will focus my commentary this morning on North America. In the North America business, category trends worsened during the quarter and we continue to see retailers tightly manage their inventories Causing sales to be weaker than anticipated. Back to school is an important season for ACCO Brands in North America And despite a soft market, our brands performed well and delivered value for our customers.

Speaker 2

We understand the importance of execution during the back to school season and I am proud of our performance. From setting planograms on time To effective demand generation campaigns, the strong consumer value propositions we delivered for our customers And consumers. Previous industry forecast for the season called for sales to be flat to modestly lower in 2023. However, based on the most recent external data we track, The back to school season was weaker than forecasted. Despite the weaker season, the strength of our brands Allowed us to gain market share in both dollars and units.

Speaker 2

The weaker than expected season was an additional headwind in North America And lastly, I want to share a few comments and observations from my 1st month as CEO. I am humbled by the support of our dedicated and talented team at ACCO Brands. While near term challenges persist, We have a long history of delivering value for our customers and our shareowners. As we analyze our current performance, We are identifying ways to strengthen the company, including opportunities to accelerate growth and further optimize our cost structure. In my first day as CEO, we held a summit with our business leaders focused on innovation And new product development.

Speaker 2

Improving the outcomes of the company's innovation efforts is one of my top priorities. ACCO Brands has a strong history of leading our categories with innovative solutions. I am committed To reimagining how we invest in new product innovation and accelerating the progress of this important work. We are reviewing our near term strategic plans for each category and segment and are in the process of finalizing their requirements To deliver new product introductions to achieve our revenue and profit objectives. Our restructuring and productivity initiatives are achieving our targets.

Speaker 2

We are evaluating more opportunities to further simplify our business and reduce our costs. While the Q3 was challenging from a demand perspective, we remain confident that our collection of leading brands along with our geographic diversity We'll allow ACCO Brands to deliver sustainable organic revenue growth as global economies improve. We have the right team in place with a proven ability to respond to and operate well In challenging economic environment, I am proud of our execution to date in 2023. We have a solid balance sheet with no debt maturities until 2026 and low fixed interest rates for over half of our outstanding debt. We expect to generate consistent strong cash flow and we'll continue to prioritize dividend payments and debt reduction.

Speaker 2

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

Speaker 3

Thank you, Tom and good morning everyone. When we last spoke in August, we highlighted a slow demand environment due to the current macroeconomic backdrop. While we were expecting demand trends to improve, that did not happen as the global economies continued to challenge demand As both consumers and businesses curbed discretionary spending in response to the higher cost of living and higher interest rate environment. In addition, as the U. S.

Speaker 3

Dollar strengthened during the period, we realized only a 2% benefit from FX versus our outlook of 4%. The combination of these factors led to our sales shortfall versus our outlook in

Speaker 2

the 3rd quarter.

Speaker 3

Despite this, we made great progress in recovering our lost margin from the extreme inflation that challenged the company's margin profile In 2022. Our margin profile significantly improved in the Q3 and we managed cost well, Which allowed us to deliver adjusted EPS at the high end of our outlook. In the Q3 of 2023, Reported sales decreased 8% versus the prior year. Comparable sales excluding foreign exchange were down 10% Versus the prior year. The sales decline was due to lower volumes across all three of our operating segments, more than offsetting global price increases And volume growth in Latin America.

Speaker 3

Kensington, our computer accessories category saw significant decline Following the industry wide trends that Tom discussed. Gross profit for the Q3 was $145,000,000 An increase of 5% despite lower sales as gross margins improved 400 basis points from the cumulative effect of our pricing and cost reduction actions. Adjusted SG and A expense of $99,000,000 It was up from $95,000,000 in 2022. Adjusted SG and A as a percent of sales increased to 22.1% As strong cost controls were more than offset by increases in incentive compensation expense and the deleveraging from the lower level of sales. Adjusted operating income was $46,000,000 up 8% Compared to the $43,000,000 last year, adjusted EPS was $0.24 per share versus $0.25 in 2022, As our growth in adjusted operating income was offset by increases in interest and non operating pension expenses.

Speaker 3

Now let's turn to our segment results. North America reported and comparable sales both declined 15% As volume declines more than offset our cumulative pricing actions. Sales in the 3rd quarter were impacted by lower business and consumer demand Due to the weak economic environment, high single digit declines were due to weaker than expected industry wide back to school performance And lower office occupancy trends, with the remaining decrease driven by lower sales of computer accessories. Retailers have continued to tightly manage inventory levels, which meaningfully impacted replenishment for back to school. Sales of office products are down due to softer demand and declines from the favorable return to office trends realized last year.

Speaker 3

Office occupancy rates have stabilized at about 50% globally almost all year. North America adjusted operating income margin increased 160 basis points to 11.6% from the prior year Q3, Driven by pricing and cost saving actions. Now let's turn to EMEA. Reported sales were down 3%, While comparable sales were down 8% due to volume declines, lower sales of technology accessories were the main driver of the decline, Largely due to weaker IC and gaming spend. Although demand for our office products remain challenged due to the economic environment in the region And we have seen some trade down to our lower priced offerings, our market shares were stable.

Speaker 3

In the Q3, EMEA's adjusted operating income margin increased 500 basis points to 10.7 percent With adjusted operating income growing 80 percent to $14,000,000 The improvement in adjusted operating income Due to our pricing and cost reduction actions as we successfully recovered margins from last year's extreme inflation in Europe. Moving to the International segment, reported sales increased 5% and comparable sales were up modestly in the 3rd quarter. Sales growth on a year to date basis is stronger, reflecting timing shifts amongst the quarters. The growth was driven by price increases And good volume growth in Latin America as back to school continues its recovery. These were largely by reduced demand for technology accessories and lower overall demand due to a weaker macroeconomic environment.

Speaker 3

The International segment posted adjusted operating income of $18,000,000 down slightly due to an increase in spending to support go to market strategies And the benefit of bad debt reserve releases last year that did not repeat. Switching to cash flow and balance sheet items. Due to seasonality, we generally use cash in the first half of the year and generate significant cash flow in the second half of the year. Year to date adjusted free cash flow was $63,000,000 versus a use of $12,000,000 a year ago. The $75,000,000 improvement was driven by improved working capital management and lower prior year incentive payout.

Speaker 3

We ended the quarter with a consolidated leverage ratio of 3.8 times, well below our 4.75 times covenant ratio. And we expect to end the year at approximately 3.5 times. Longer term, we are still targeting 2 times to 2.5 times. At quarter end, we had $523,000,000 of remaining availability on our $600,000,000 revolving credit facility. As shown on our earnings slide, more than half of our debt is at a fixed interest rate of 4.25% and does not mature until 2029.

Speaker 3

We ended the quarter with total gross debt of $970,000,000 over $110,000,000 lower From the same time last year and our cash balance was $74,000,000 Turning to our outlook, we are updating our full year guidance for 2023. For the full year, we expect reported and comparable sales To be within a range of down 6% to down 7%. With the recent strength of the U. S. Dollar, we now do not Any benefit from FX on the revenue front for the year.

Speaker 3

The lower comparable sales growth It's due to the expectation of continued soft demand due to economic uncertainty and lower consumer and business discretionary spending. We will continue to focus on managing our costs tightly until we see an improvement in the demand environment. We expect full year gross margins of approximately 32% to 33%. In the near term, we are focused on maintaining this gross margin rate. As Tom discussed in his earlier remarks, longer term, we are reviewing actions for improvement.

Speaker 3

SG and A costs will be higher than last year due to increases in incentive compensation from the low levels reported last year. For the full year, we expect adjusted EPS of $1.03 to $1.07 per share. Adjusted operating income is expected to grow at low double digit levels, partially offset by higher net interest costs of about $14,000,000 And higher non cash non operating pension expenses of $5,000,000 The adjusted tax rate is expected to be approximately 30%. Intangibles amortization for the full year is estimated to be $44,000,000 which equates to approximately $0.32 Per share of adjusted EPS. We continue to expect our free cash flow to be at least $110,000,000 After CapEx of $15,000,000 and looking at cash uses in 2023, we expect to continue to prioritize dividends And debt reduction.

Speaker 3

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

Operator

Thank you. We will now begin the question and answer session. Our first question comes from the line of Greg Burns with Sidoti and company. Greg, please go ahead. Your line is open.

Speaker 4

Good morning. When you think about Managing your expenses in this environment and then balancing that with kind of the new focus on New product development, how do you reconcile those 2? Are you willing to sacrifice some margin in the near term to achieve some of your New product growth goals?

Speaker 2

Yes. Greg, good morning. This is Tom. Thank you for the question. We have worked very hard to really recover our gross margin rates from the unprecedented inflation that we faced in The plan is not to give back gross margin rates that we've earned back over this period of time From our cost actions and price increases.

Speaker 2

As we think about innovation, it's a clear focus of our company. And we think that Our innovative products, the new products that we're introducing need to be accretive to our current margin profile. So It is unlikely that any new innovation would be dilutive to margins on a move forward basis.

Speaker 4

Okay. Thank you. And in terms of the softness in gaming, I guess the expectation Was that maybe supply chain issues would get better and there was kind of a strong slate of games coming out that Might stimulate demand there. It doesn't look like that happened, but can you just give us maybe a little bit more color What you're seeing in the gaming market?

Speaker 2

Yes. It is a bit of a dynamic environment that we're Let me first talk about what our near term focus has been, which is really the international expansion Of the category, we've made great progress, particularly in our international segment, setting the foundation for what I believe There's a strong future growth in international. So really pleased with the work that we've done And preparing ourselves to expand the category globally. But the category is under some pressure and there's a number of reasons we believe The pressure continues to persist. At the beginning of the year, we had anticipated that it would start to see some improving trends.

Speaker 2

And frankly, those trends have not improved. They've really maintained their early year performance throughout the back half of the year. And that's largely in is due to a number of factors. So first, first party Continues to discount as they work through their inventory. Much like all of us, they struggled with Chip availability and worked very hard to get chips and built inventory and now they're working through that excess of inventory As the demand environment has slowed, so we're seeing some first party discounting that has continued into the Q3 that we did not anticipate.

Speaker 2

Next, in EMEA, in particular, we suffered through a number of store closures, right? The number of retail outlets that have Represented our product lines is down significantly and certainly that wasn't anticipated at the beginning of the year and is impacting sales. And then we just continue to see very cautious spending by the consumer and very cautious replenishment by our retailers. We've seen and experienced with our early orders that the holiday season is weaker than we had anticipated at the beginning of the year. And all of those factors combined have really proven to be headwinds that are too difficult to overcome this year In the gaming accessories market.

Speaker 2

As I said in my prepared remarks, we do believe that long term it is a fantastic platform. There's 3,000,000,000 plus gamers Worldwide, it's a category that's growing. It has more entrance into the category. So long term, we're very bullish on the opportunities I'll just have to continue to navigate the challenges that we face in the near term.

Speaker 4

Okay. Thank you.

Speaker 2

Thank you.

Operator

The next question comes from Kevin Steinke with Barrington Research. Please go ahead. Your line is open.

Speaker 5

Good morning. I just wanted to dig a little bit more into Back to school season, which you noted was softer than expected, is You mentioned that the lower inventory replenishment by customers, just what did you see for consumers when it was Just lower volumes purchased, trade down to lower priced products or I guess a combination of all the above?

Speaker 2

Yes. First, Kevin, good morning and thank you for the question. Yes, so back School was a bit weaker than we had anticipated when we spoke last. With that said, I am very pleased with our performance. We predominantly participate in student note taking, and we took share during the season with our collection of brands.

Speaker 2

And we grew our POS, right, our through the register sales grew modestly in a season that was down. So our performance It was really strong and you alluded to it, right? The season overall was lower than expected and that caused retailers to be cautious As they thought about their ending inventory positions in the categories that we compete in, which did not Materialize with replenishment orders that we had hoped for, right? The good thing is that most of our retail partners Came out of the season very clean, right? They didn't have to do deep discounting, and we are well positioned as we think about 2024 BTS Because of our brand performance in this season.

Speaker 2

So again, overall pleased with performance. Market was down. However, we grew modestly and took But we did not see replenishment orders as we anticipated as retailers just became more cautious through the quarter With their purchases and replenishment.

Speaker 5

Okay, great. That's good color. Thanks for taking the Question, and I'll turn it over.

Speaker 2

Thank you, Kevin.

Operator

Our next question comes from Joe Gomez with Noble Please go ahead, Joe. Your line is open.

Speaker 6

Good morning. Thanks for taking my question.

Speaker 2

Good morning, Joe.

Speaker 6

I wanted to just Circle back here with the weakness on the top line. You guys On the Q2 call that was 5 weeks into the quarter. When you held that call, a lot of the things that you have mentioned, The retailers and inventory, the economic weakness, strength of the dollar, all of that It was already prevalent when you made that forecast of in the 3rd quarter being flat to down 3% and actually came down 7.7%. And I understand the foreign exchange, but I'm guessing the kind of question is what happened that you were not anticipating in mid August Early August, I guess, I should say. That would have resulted in the top line being as weak as it was in the quarter?

Speaker 3

Yes. No, good question, Joe. Thanks. I think the 3rd quarter sales performance Also, I want to inform how we look at the Q4. And we thought there would be some lessening of The environment and that now there's really greater uncertainty and kind of recession points.

Speaker 3

The consumer It's definitely reducing their discretionary purchases more than we would have anticipated in the Q4. And I think the weaker demand that Tom has talked about in our tech services, really hit us harder in the Q4 than we would have imagined. The PC trends We talked about in the Q3 continued into the Q4, and our Kensington business suffered from that More than we would have anticipated. I think office also was down a little bit lower than what we had expected, Given the office stabilization that we had thought, we'd have more return to office in the Q4 than what happened. And then lastly, I would just say the retailers really show their conservatism in the Q3, that carries We believe we'll carry into the 4th and so far has and that also was an impact as we looked out.

Speaker 3

We are hearing some messaging too From our retail partners of a softer holiday than we would have anticipated a couple of months ago. And so all of those factors together, I think, has Caused us to reevaluate the 4th quarter and come in with our reduced guidance.

Speaker 6

Okay. And then kind of a follow-up to that. We're talking about weaker than Our originally expected environment here. And I know you guys said that one of the things you want to try and do is maintain that gross margin. You don't want to give any of that back.

Speaker 6

But in the weaker environment, the competitive environment oftentimes ticks up and how quickly do you think your Customers will be coming looking for price reductions to make themselves more competitive and And impact your margin level there?

Speaker 2

Yes, Joe. Same question and certainly one that we talk about internally. First, we try to position our business Holistically with our customers, right? We want to drive value for them and value can be Defined in a number of different ways. Certainly, price and program are constant negotiations with our customers and rightfully so, that they have a responsibility to do that and we have a So that they have a responsibility to do that, and we have a responsibility to make sure that we are competitive in the marketplace, and we believe that Our current pricing is competitive.

Speaker 2

I think we can support that. I gave an example In our prepared remarks and as a response to a question earlier, with our back to school offering, right, we took share, We grew our branded business in a very competitive season in which retailers led with private label. So we know we have an offering that creates value for our customers and it is desired from our consumers. And so we have to protect that value and that value comes at a cost and at a price. And so we work hard to be competitively priced in the marketplace And we believe we are.

Speaker 2

But where we do need to lean in with price, we're prepared to do that, but we have to offset that with more competitive input costs, Which we're prepared to do as well. So, this is a mix of work that we manage. It's not just simply a negotiation with the customer, and I think we've got a strong history of doing that. And as I mentioned, right, we believe our gross margins are fully recovered, and we want to protect that and maintain that. That's important So our company is important to you.

Speaker 3

Yes. And I would just add, inflation is still there, Joe. And so we're still seeing the input side. Labor is up. Things are up.

Speaker 3

And so as far as

Operator

to

Speaker 3

Tom's point, input costs are going up, Albeit not like what we had seen by any means, but up. And I don't think the demand environment this year is Matters on price as much as it does on just the discretionary purchasing.

Speaker 6

Okay, great. Thanks for that insight. Appreciate it. I'll get back in queue.

Speaker 2

Thank you, Joe.

Operator

At this time, we have no further questions. So I'll turn the call back to the management team for any closing remarks.

Speaker 2

Thank you for your interest in ACCO Brands. While the operating environment remains uncertain, We are focused on executing against our key priorities and keeping margin improvement at the forefront. We have managed well in difficult environments And are confident in our ability to navigate the current economic challenges. With a reimagined approach to product Innovation, prioritization of key growth categories supported by leading brands and a highly effective global commercial team, We will be well positioned to deliver organic growth as global economies recover. As previously mentioned, We are analyzing our cost structure and we'll be implementing actions to lower our costs.

Speaker 2

With improving revenue trends In a lower cost structure, we believe compelling market performance will follow. We look forward to talking to you in a couple of months to report on our 4th quarter results.

Operator

Thank you, everyone, for joining us today. This concludes our call, and you may now disconnect your lines.

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Timken Q3 2023
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