PowerA (ACCO) Earnings Call Transcript

Ladies and gentlemen, thank you for standing by. And welcome to the ACCO Brands' acquisition of PowerA conference call. [Operator Instructions] I would now like to hand the conference to your speaker today, Boris Elisman, Chairman and CEO of ACCO Brands. Please go ahead, sir.

Good morning, everyone. Thank you for joining us. I am Boris Elisman, Chairman and CEO of ACCO Brands. I'm joined by Neal Fenwick, our CFO; and Christine Hanneman, our Senior Director of Investor Relations. We're very excited to spend some time with you this morning reviewing our pending acquisition of PowerA, a leading provider of third-party console controllers and power solutions for video gaming platforms. Neal will follow me with the financial details of the transaction. Then, we'll take your questions. The slides that accompany this call have been posted to the Investor Relations section of accobrands.com. Statements made during this call, other than statements of historical fact, are forward-looking statements, which are subject to certain risks and uncertainties. Our forward-looking statements are made as of today, and we assume no obligation to update them going forward. Please refer to the slides accompanying this call and our SEC filings for an explanation of these risk factors and assumptions. Our actual results could differ materially from our forward-looking statements. We used some non-GAAP numbers in our presentation, and this slide describes those numbers and how we use them. Let me take a minute to set the stage. The legacy of ACCO Brands is office product sold through office channels in North America. Over the past several years, we have been strategically transforming our business to be more consumer and brand-centric, product-differentiated and geographically diverse. The intent is to increase growth and profitability and to reduce reliance on declining customers and commoditized product categories. As a result of this strategy, our business has evolved from 70% office products, 30% consumer, school and technology products to 55% office products, 45% consumer, school and technology products in 2019. Our top 5 customers represented 33% of our sales in 2019, down from 43% in 2016. And our international businesses contributed over half of our sales in 2019. We're achieving this transformation through both organic initiatives and acquisitions. Organically, we have been growing in our Kensington computer accessories offerings and by entering the wellness category with TruSens branded air purifiers. We have also upgraded our Five Star line of school notebooks and are selling much more through e-commerce channels. Acquisitions are an integral part of our overall strategic imperatives. Over the past 4 years, we have made 4 acquisitions, all of which brought us strong brands, leading market share positions, diverse channels and faster growth. Our acquisition approach has been to focus on consolidation, geographic expansion and adjacency opportunities that meet our strategic and financial criteria. Strategically, we are focusing on categories and geographies that provide opportunities for growth, leading brands and channel diversity that will give us increased access to the consumer. Financially, we are looking for returns above our weighted average cost of capital, cash flow and EPS accretion within a reasonable time frame and potential synergies. Our recent acquisitions were of consolidating or geographic expansion in nature. Yesterday, we announced the acquisition of PowerA, which is about growth into an attractive consumer product adjacency. PowerA fits many of our criteria. The company has had strong double-digit organic growth for many years and is well positioned for this growth to continue organically and by leveraging our footprint in Europe and other international markets. In addition, this acquisition gives us a platform for further inorganic expansion in a very attractive space. PowerA has recognizable brands that are both owned and licensed, with strong placement at retail and leading market share positions. This acquisition will increase our presence in faster-growing mass and e-tail channels and expand our U.S. channels by adding presence in electronics and gaming-focused retailers. PowerA has similar characteristics to our Kensington business. And we believe we will be able to leverage opportunities such as product development, supply chain providers and shared services between the 2 businesses. Neal will discuss the fit against our financial criteria in a few minutes. But we believe we've got a good value with very attractive returns for our shareholders. Now I'd like to spend a few minutes telling you about PowerA's products, markets and growth opportunities. The parent company was founded in 1984 and is based near Seattle. It has a long history -- it has had a strong history of double-digit sales growth with 2019 sales of $166 million and adjusted EBITDA of $34 million. Sales in 2020 are expected to grow approximately 20%. Most of its sales are in the U.S., with the remainder largely in Europe. PowerA is a leading accessories provider for Microsoft Xbox, Nintendo Switch and Sony PlayStation gaming consoles. It provides enabling technology for the world's fastest-growing entertainment medium. Console gaming has a historical growth CAGR of 13%, and by 2022, there are expected to be 2.9 billion gamers worldwide. The company makes gaming controllers, headsets, power charging stations and carrying cases. The addressable market for PowerA is around $2 billion in the U.S. and even larger internationally. The company has the leading market share positions for third-party gaming controllers and power stations in the U.S. and is considered a partner of choice with its licensing partners due to its merchandising expertise. PowerA has a proven track record of increasing market share across all core product categories due to its best-in-class products, speed to market, aligned incentives with partners and utilization of data-driven consumer and market insights. Sales growth usually accelerates with the introduction of new gaming consoles. Both Microsoft and Sony recently announced the next generation of Xbox and PlayStation consoles will be available starting this week, and we expect this will spur additional demand for accessories. PowerA currently does not have much international presence, which presents a great opportunity for them to leverage our infrastructure and relationships throughout EMEA and other international areas. For example, when we acquired Kensington, its sales were heavily skewed towards the U.S. Currently, its sales are 40% U.S., 40% EMEA and 20% international. We look toward a similar growth pattern with PowerA over time. PowerA is well positioned to take advantage of the expansion into cloud gaming, which will require controllers and power solutions that enable a consistent experience across all gaming modalities, PCs, consoles and mobiles. Cloud gaming services will expand the market for premium games beyond the current console and PC audience. PowerA has a first-mover advantage in mobile controllers and power solutions with the launch of its mobile gaming product line in late 2019. PowerA's success is a result of its strong, long-lasting relationships with Microsoft, Nintendo and Sony. The company has been recognized by its partners for superior product design and innovation and a highly reliable supply chain. These long-lasting relationships provide a significant barrier to entry. Likewise, PowerA has strong relationships with many retailers, including approximately 75% of sales that overlap with customers of ACCO Brands, which we view as an opportunity to deepen and leverage the strength of those businesses. PowerA is the category expert for controllers and power solutions because of its market leadership position and its ability to provide tailored products designed for each retailer's unique customer base. Now I will turn the call over to Neal to discuss the financial terms of the acquisition. Neal?

Thank you, Boris. I'm going to take a few minutes to review the details of the pending acquisition. The total upfront consideration is $340 million plus an additional earn-out of $55 million to be paid over 2 years based on achieving 1- and 2-year sales and profit growth objectives. The deal will be accretive to earnings and free cash flow for the full year of 2021. The acquisition is subject to customary closing conditions, including contract assignment, consents and regulatory filings. We expect to close before year-end. We will finance the acquisition through cash on hand and borrowings from our $600 million revolving credit facility. We amended our bank credit agreement to increase its maximum net leverage covenant by 0.5 turns from current levels, for a period of 6 quarters, beginning with the first quarter of 2021 and ending with the second quarter of 2022, to allow for similar headroom as we had before the acquisition. Slide 17. Even with the added debt for the acquisition, we remain in a good financial position. This slide is a pro forma look at our debt expectations at year-end assuming $100 million in free cash flow for this year, over $120 million in cash from operations and less than $20 million in CapEx. As many of you know, we typically use cash in the first half of the year and generate cash in the second half. We will have an adequate amount remaining on our revolver to handle the seasonal borrowings that we will need in the first half of 2021. We also have no debt maturities until 2024. Our pro forma net leverage ratio is estimated to be approximately 4.2x at close, but we expect the ratio to return to its current level of approximately 3.5x by year-end 2021. We are comfortable with the leverage ratio increase in the short term based on our confidence in our cash generation and the low interest rate environment. In the first quarter, we repurchased 2.9 million shares for $19 million. We do not intend to repurchase any additional shares for the remainder of 2020. In 2020, we will spend approximately $25 million in dividends. Near term, we will prioritize using our cash to fund our dividend and repay debt. Our long-term strategy remains to deploy free cash flow to fund dividends, reduce debt, repurchase shares and make acquisitions. We plan to achieve our long-term net leverage target of 2x to 2.5x through a combination of increasing EBITDA and decreasing debt. Move to Slide 19. With 1 month of the fourth quarter behind us, we are reiterating our outlook. We expect a 15% to 20% sales decline and adjusted EPS in the range of $0.26 to $0.32. We anticipate a 2% drag on sales and a $0.02 hit on adjusted EPS from adverse foreign exchange. We may receive some benefit from PowerA, but this is not included in our outlook due to the uncertainty over the timing of close. From 2016 through 2019, PowerA had a sales CAGR of approximately 40%. Sales are expected to further grow approximately 20% in 2020 to approximately $200 million. PowerA's adjusted EBITDA CAGR from 2016 through 2019 was approximately 70%. Its 2020 adjusted EBITDA is expected to be approximately $50 million, 5-0 million. In 2021, we expect the acquisition would be accretive to adjusted earnings per share by approximately $0.10, and in 2022, should add $0.15. Due to the timing of the working capital cycle and certain adjustments, we expect PowerA to add approximately $10 million to cash flow in 2021 and over $30 million in 2022 and beyond. With that, we will open the call to questions.

[Operator Instructions] Our first question comes from Joe Gomes with NOBLE Capital Markets.

Congratulations. So just real quick on the deal itself. Kind of, if you go a little more detail as to whom approached whom? Was this an auction? Or was just negotiated? Any more color on that is appreciated.

This was a negotiated transaction. It was not an auction. And we initially met with PowerA at the very beginning of 2020, very early February time frame and then got to know them a little bit better, and then it just moved from there. There was a good match with -- good cultural match and then good match in kind of their objectives, what they wanted to do with the business and the legacy they wanted to leave behind and our strategic desire to continue to move our business towards consumer categories, those faster-growing areas. So we're very happy that we were able to reach an agreement.

Okay. And on the EBITDA margins, obviously, we're looking at them here, they've pretty much doubled over the past 5 years. Can you give a little more color as to what was driving the growth in EBITDA margins? And how high do we think they could get for this business?

Obviously, there is economies of scale in the model. They have gross margins that are a little bit north of ours, so the gross margins will be accretive to ours as well. And it's a very asset-light, expense-light structure so that you can see the profitability of the business. I do not expect that we're going to be expanding the EBITDA percentages. I think that we're going to stay roughly in the same range. But obviously, with sales growth, more EBITDA dollars will drop to the bottom.

Right. Okay. And you talked about some of the e-commerce. How much of the business is e-commerce direct-to-consumer versus retail, or excuse me, versus brick-and-mortar type sales?

Most of their business today is retail, brick-and-mortar type sales. E-commerce customers are their -- overall, globally, their second biggest customer is e-commerce. And obviously, that's the fastest-growing part of their business. But they have great presence in all of the major retailers that broadly sell to consumers. So that's very attractive to us.

Okay. And one last one for me, and I'll get back in queue. Outside of the console manufacturers themselves, who are the biggest competitors in this space for PowerA?

They have competitors at the high-end. There are some companies that compete in the kind of high-end enthusiast professional range, companies like Razer that make controllers and accessories in that space. And then more in their mainstream price points, there are other private companies such as PDP that make controllers and they compete with them.

Our next question comes from Chris McGinnis with Sidoti & Company.

And also congrats on the acquisition. If you can just maybe start, you obviously highlighted the 75% of sales in the U.S., you have a strong global presence. Just how big is that opportunity do you think? Is the competitive landscape different? Can you just talk a little bit about bringing this to other markets? And what are the biggest hurdles to increase that share? Maybe if you can use Kensington as maybe an example of how you brought that so successfully outside of the U.S.?

Thanks, Chris. Yes, we think there's a huge opportunity to grow the business outside of the U.S. As we mentioned, 75% of their sales are currently in the U.S. And the reasons their sales are not high internationally is they don't have the infrastructure, the salespeople, the local presence to drive that expansion. And we do. And we can leverage our on-the-ground people to drive increased sales in Continental Europe, which I -- which we think is really a near-term opportunity, as well as other parts of the world, in Latin America and in Australia and New Zealand, specifically. So we think that's a very big opportunity for us to take the award-winning products that the PowerA team has developed and leverage our infrastructure and our sales resources to increase sales outside of the U.S.

Great. And just thinking about the supply chain, you said it's a low-cost model. They source most of their products. Can you just maybe talk a little bit about that? I think you're 50-50 now roughly with your legacy products, if you call it back?

Yes. It's a very similar model to Kensington. They design their own products. So all of the products are designed by them, but they don't have manufacturing facilities. They use partners to produce the products for them. So this is what we do with Kensington as well, and that's what makes it asset-light.

Great. And then just last question. Just around the new product introductions from -- or the new console launches that are happening now. How quickly do you come out with the newer offerings? Does it take time? Can you just talk a little bit about the impact of the 2 new consoles coming out, both for Sony and Microsoft? And how quickly you can kind of partake in that new opportunity?

Yes. PowerA is in the market as of yesterday when Xbox Series X was announced. So they're hitting the ground running. They have a great line of controllers supporting new Xboxes. They're working with Sony on PlayStation 5 accessories. So we expect there won't be any lag at all. We believe it's going to be a catalyst for incremental sales for PowerA.

Our next question comes from Kevin Steinke with Barrington Research.

I wanted to ask about -- it sounds like a really great -- nicely growing product category, but maybe how you came about the idea of this particular product category, maybe it makes a lot of sense from a strategic perspective, as you said, but maybe just how your thought process came to this particular product category that maybe wasn't on everyone's radar?

Sure. We've been looking for the last, I would say, 3 years or so, we've been looking at adjacencies in the technology space. We're very pleased with how our computer accessories business is doing and how it's growing. And we wanted to shore that up. So we've been casting a fairly broad net around that area, but we did not -- we were not able to find anything that met both our strategic criteria and financial criteria. And then PowerA and their advisers came to us very early 2020 and talked to us about their business and the opportunity for combining with our business and leveraging the -- our capabilities and their product line. And that's how it started. We thought it was a great fit. It fit into our strategic agenda. And we think it's a great growth platform for us, not just with PowerA but also for potential other acquisitions in this space.

Okay. Great. And can you just talk about, maybe for -- I'm not as familiar with this industry. But just the -- from a consumer's perspective, the rationale for using a third-party gaming console or gaming accessories relative to just what maybe Microsoft or Sony or what have you offers?