ACCO Brands Corporation — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019; unaudited. ACCO Brands designs, markets and manufactures branded consumer and business products for schools, homes and workplaces, and reports North America, EMEA and International segments.
Financial performance and position
| Metric | Q3 2019 | Q3 2018 | First nine months 2019 | First nine months 2018 |
|---|---|---|---|---|
| Net sales | $505.7 million | $507.3 million | $1,418.3 million | $1,411.9 million |
| Gross profit / margin | $155.9 million / 30.8% | $160.8 million / 31.7% | $447.5 million / 31.6% | $450.7 million / 31.9% |
| Operating income / margin | $48.8 million / 9.6% | $57.5 million / 11.3% | $128.1 million / 9.0% | $121.0 million / 8.6% |
| Net income | $28.0 million | $35.6 million | $63.3 million | $71.7 million |
| Diluted EPS | $0.28 | $0.34 | $0.62 | $0.66 |
| Operating cash flow | $190.8 million | $91.2 million | $75.1 million | $84.7 million |
Margins and earnings: Q3 gross margin contracted 0.9 percentage point and operating margin 1.7 points year over year. Management attributed pressure to product mix, lower cost absorption as inventory was reduced, inflation and tariffs, and higher SG&A. For the nine-month period, operating income increased 5.9%, but net income fell 11.7%, reflecting higher tax expense and interest expense, among other items.
Cash flow: Nine-month operating cash flow declined $9.6 million, with higher tax payments and working-capital requirements partly offset by lower incentive payments. Q3 operating cash flow was unusually strong, mainly because inventory payments were lower after purchases had been brought forward into late 2018 and early 2019. The company reported using the strong Q3 cash generation to repay $174 million of seasonal borrowings.
Balance sheet and liquidity at September 30, 2019: Cash was $37.7 million, total debt was $923.5 million, and stockholders’ equity was $766.9 million. The $600 million revolving facility had $132.4 million drawn and $454.8 million available, net of letters of credit. The company reported compliance with applicable loan covenants and said liquidity sources should be adequate for foreseeable requirements. Cash was down from $67.0 million at December 31, 2018.
Debt changes: A May 2019 credit-agreement amendment extended facility maturity to May 2024, expanded revolving commitments from $500 million to $600 million, established a $100 million U.S. dollar term loan, reduced certain borrowing costs and term-loan amortization, and eliminated annual excess-cash-flow prepayments. Total debt rose from $888.0 million at year-end 2018.
Changes versus comparable periods
- Q3: Reported sales slipped 0.3%. Excluding foreign exchange and Foroni, comparable sales increased 0.5%; North America growth was offset by weakness in EMEA and International. Operating income declined 15.1% and net income declined 21.3%.
- Nine months: Reported sales grew 0.5%, while comparable sales, excluding acquisitions and currency effects, rose 1.6%. Operating income grew 5.9%; diluted EPS declined 6.1% to $0.62.
- Regional performance: Q3 North America sales rose 3.4%, with operating income flat. EMEA sales fell 7.0% and International sales fell 0.6%; International operating income declined 32.9%. For the nine months, North America operating income increased 14.8%, EMEA was flat, and International declined 18.7%.
- Foreign exchange reduced sales by $9.7 million in Q3 and $45.4 million year to date. Q3 Foroni sales contributed $5.7 million; year-to-date acquisitions contributed $29.4 million, including $23.7 million from GOBA and $5.7 million from Foroni.
Outlook, management commentary and significant items
- Guidance: The filing does not provide a specific numerical earnings or sales forecast. Management expects ongoing growth opportunities from consumer brands, faster-growing geographies, channel expansion, product innovation, acquisitions, productivity and cost savings. It says cash, operating cash flow and available revolver capacity are expected to support foreseeable needs.
- Tariffs and pricing: Tariffs on Chinese imports increased in May and September 2019; another rate increase was expected in December. ACCO raised prices in August and intended further increases to recover costs, while warning that higher prices may reduce volume and that tariff costs may affect cash flow before price increases take effect.
- Acquisitions: ACCO acquired Brazilian paper-products company Foroni effective August 1, 2019, for a preliminary $42.1 million, funded with cash on hand. The purchase-price allocation remains preliminary; final valuations and adjustments could affect reported amounts. The acquisition added $5.7 million of Q3 sales. ACCO also acquired Cumberland brand assets in Australia for $6.0 million.
- Tax and contingencies: The nine-month effective tax rate was 37.6%, versus 27.6% a year earlier. The 2019 period included a $5.6 million increase in reserves for Brazil tax assessments, $0.8 million of deferred state tax, and $1.6 million of Brazilian tax accrued on a contingent tax-credit gain. The company described the $5.6 million reserve increase as an immaterial out-of-period adjustment that should have been recorded in 2018; it said payment is not expected in the foreseeable future unless it loses the case.
- The accrued Brazil tax-assessment amount, including tax, penalties and interest, was $33.4 million at September 30, 2019. ACCO intends to contest the assessments; an adverse outcome could materially affect cash flow when settled, and the process may take years.
- Tilibra had $4.3 million of Brazilian tax credits it reasonably expected to offset against taxes in Q4 2019, subject to legal and tax uncertainties. ACCO recognizes such benefits when realized; $1.6 million of Brazilian income tax was accrued on the contingent gain.
- Q3 included $2.1 million of restructuring charges; nine-month charges were $4.8 million. Restructuring liabilities were $5.4 million at period end, mostly expected to be paid within 12 months. The company also recorded $1.9 million of acquisition-related integration costs year to date.
- ACCO repurchased $56.8 million of shares during the first nine months and paid $18.1 million in dividends. On October 29, 2019, the board declared a quarterly dividend of 6.5 cents per share, up 8.3% from 6.0 cents.
- Management reported no material change in disclosed risk factors. Other litigation and environmental matters were not expected by management to have a material adverse effect, but the filing notes that adverse outcomes cannot be ruled out. Disclosure controls were assessed as effective.
Important facts for investors to verify
- Whether tariff-related price increases recover input costs without materially weakening demand or sales volume.
- Whether International segment sales and margins stabilize, and whether North America growth continues after the back-to-school season.
- How much of the year-to-date earnings decline reflects recurring operations versus tax items, foreign exchange, acquisition costs and restructuring.
- The final Foroni purchase price allocation, including any resulting changes to goodwill, intangibles, depreciation or amortization.
- The outcome, timing and potential cash impact of the Brazil tax assessments, and the timing and amount of tax credits ultimately realized.
- Seasonal cash generation, working-capital needs, debt levels, borrowing costs, covenant compliance and the company’s planned balance among acquisitions, debt reduction, dividends and buybacks.
- The Q3 operating cash flow figure of $190.8 million is presented in MD&A; investors should reconcile it to the cash flow statement, which reports $75.1 million for the first nine months.