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Executives

Bob Keller - Executive Chairman, Chief Executive Officer and Chairman of Executive Committee

Neal Fenwick - Chief Financial Officer and Executive Vice President

Jennifer Rice - IR

Analysts

Karru Martinson - Deutsche Bank AG

William Chappell - SunTrust Robinson Humphrey, Inc.

Arnold Ursaner - CJS Securities, Inc.

Reza Vahabzadeh - Lehman Brothers

ACCO Brands (ABD) Q1 2011 Earnings Call April 27, 2011 8:30 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the First Quarter 2011 ACCO Brands Corporation Earnings Conference Call. My name is Lacey, and I will be your coordinator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Ms. Jennifer Rice, Vice President of Investor Relations. Please proceed.

Jennifer Rice

Good morning, and welcome to our first 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. These slides provide detailed information to supplement the call.

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's my pleasure to turn the call over to Mr. Keller.

Bob Keller

Thank you, Jennifer, and good morning, everyone. Our first quarter net sales were essentially flat on a year-to-year basis on a volume decline of 4%. Including cost related to the rationalization of our European business, earnings from continuing operations were negative $0.04 per share. Excluding those costs, earnings were positive, $0.01 per share. We remain on track to meet our financial objectives for the year.

During the first quarter, several of our customers bought less than their point of sale. Most take advantage of our improved supply chain performance and the sell-through of their year-end purchases. The combined impact in the first quarter was a little over $14 million in sales. By the end of the quarter, those customers were largely back to normal replenishment.

The underlying demand for our products has not changed, and we remain confident in our ability to grow our business this year. In fact, we committed an incremental $1 million in the first quarter to support resets of our durable products: staplers, boards, trimmers, binding and laminating machines and shredders to help better position our customers to sell more of our products. We remain pleased with the health of our customer relationships and continue to work hard to be a better partner to them.

On our last call, we highlighted 2 areas of the business where we needed to improve our performance: Europe and our Print Finishing Solutions business. We took the actions we had planned for the first quarter in both businesses and continue to expect them to deliver substantially improved results this year.

On the pricing side, we implemented increases in January in the U.S. and Europe to recover some of the increased commodity cost, which we've incurred since mid-2010. We've already committed additional price increases for July in those locations, as a result of continued commodity cost inflation, specifically, in fuel, plastics and steel.

On balance, we exited the first quarter where we needed to be in order to deliver the year. Our customer relationships are strong, and the underlying demand for our products is in line with our expectations. Our inventories and accounts receivable are a bit higher than they should be, and we'll address that. Our recovery plan in Europe and our Print Finishing Solutions business are on track, and we continue to like how we're positioned competitively.

At this point, I'll turn the call over to Neal for a more detailed look at our results. Neal?

Neal Fenwick

Thank you, Bob. Our first quarter performance is recapped on Slide 4. Reported sales were roughly even with the prior quarter. Foreign exchange translation added 3%. Pricing was favorable 1%. Underlying volumes declined 4%, primarily, due to customer inventory reductions and the impact of the fourth quarter buy forward.

EBITDA was $25.5 million, including the impact of $3.9 million of costs in the quarter from the rationalization of our European business. EBITDA also included $1.7 million of benefits from foreign exchange translation. EPS from continuing operations was a $0.04 loss, using a 30% tax rate and including the one-time costs. Excluding the cost in Europe, earnings per share would've been positive $0.01 versus the comparable $0.03 in the prior year quarter.

Our gross profit margin declined 30 basis points to 30.3% as shown on Slide 5. The decline was due to sales mix and FX translation, which had a 50 basis points impact. In addition, the continued flow-through of higher costs above the current realized value of price increases had a 20 basis point impact. Cost reduction, such as improvements in freight and distribution costs helped mitigate the impact of these factors.

SG&A expenses increased 200 basis points, primarily due to $3.9 million or 120 basis points of costs in Europe. Excluding these costs, SG&A was up 3%. The primary drivers behind the underlying increase were incentive compensation accruals and deleveraging due to lower sales volume. In all, operating income decreased 32%, including the cost in Europe, and operating margin declined to 4.7% from 6.9%. Excluding the severance costs in Europe, operating margin would have been 6%.

Turning to an overview of our segments. During the quarter, reported sales for the Americas declined 4%, driven by a 7% decline in sales volumes. The impact of the inventory reductions that Bob discussed was most significant in the U.S., where certain customers ordered significantly below POS levels in order to improve their inventory turns, as well as run down inventory bought ahead of the Q1 price increase.

Largely, as a result of the volume decline, operating margins in the Americas decreased 160 basis points to 3.6%. Keep in mind that Q1 is our seasonally low-margin quarter. We also invested in several new planograms and accelerated go-to-market spending that we believe will drive demand and improve market share for durable products.

International segment sales increased 4%, driven by foreign exchange translation and pricing. Underlying volumes declined 2% due to adjustments by certain customers to their inventory level's impacted volume.

In terms of International profit, excluding the $3.9 million of charges, International segment profit margin contracted about 100 basis points to 8.1%, primarily, the result of adverse sales mix and the flow-through of high commodity cost.

Computer Products sales increased 4%, and volume increased 1%, driven by another quarter of strong sales of new products for iPads and iPhones, primarily, in the U.S. Computer Products operating profit increased 15% in the quarter, and margin expanded 210 points to 22.5%. Improvement was driven by lower SG&A costs compared to the prior year. The prior year included a $700,000 greater bad debt expense related to a true-up of Circuit City exposure.

Turning to cash flow, which is detailed on Slide 6. We ended the quarter with $20 million of cash on the balance sheet and no borrowings on our ABL facility. We used $63 million of cash in the quarter to fund the normal seasonal investments in inventory and accounts receivable. However, our inventory and accounts receivable levels are a little high right now, due in part to foreign exchange, which added $9 million to expected inventory levels of prior quarter and $14 million to accounts receivable levels.

Inventory levels also reflect a slight prebuild ahead of cost increases and slightly lower than forecast volumes in the quarter. We also paid out an incremental $8 million of incentive compensation compared to the prior year. We continue to expect to generate $50 million to $60 million of free cash flow this year.

Our outlook in total for 2011, as shown on Page 7 of the slide, is unchanged. We continue to expect growth of 2% to 4% and EBITDA growth in the mid-single digits. All in, we expect to grow earnings per share 20% to 30%. This assumes a 30% tax rate and 58 million shares.

Our performance is always weighted to the second half of the year for a number of seasonal factors. But in 2011, the second half will also benefit from the initiatives underway in Europe to improve our profitability in that region. We expect to incur another $2 million of charges as we complete final stages of that plan. And we expect to realize approximately $5 million of savings from these actions in the remainder of 2011, increasing to $6.5 million on an annualized basis. Our guidance includes these costs and associated savings.

That concludes our prepared remarks. At this point, Bob and I will be happy to take your questions. Operator?

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And our first question will come from the line of Reza Vahabzadeh with Barclays Capital.

Reza Vahabzadeh - Lehman Brothers

You talked about the customer purchases being below POS levels for the quarter. Is there any potential that customer purchases were ahead of POS in the preceding quarter and ahead of your price increases, and so this what a bit of a 2-quarter rebalancing, so to speak?

Bob Keller

Reza, I think about a little less than half of this was based on kind of buy-forwards, so $6 million to $7 million of the $14 million, we think, were buy-forwards in December. And we think the rest of it is, is our customers are getting comfortable with the fact that our supply chain is operating better and are ratcheting up their turns on our products. But we think it's largely normalized, as we exited the quarter. We were kind of back to close to a 1:1 sell-through and buy-in.

Reza Vahabzadeh - Lehman Brothers

Got it. And then, as far as the price increases you took last quarter, are your prices and price caps across different tiers and product lines -- are they in line with competitors?

Bob Keller

Yes. We're very sensitive to what's going on in the marketplace. And those discussions are always tough, but they are, clearly, more rational because our customers are building some of the same products that we're building, so they have a very good sense of what the real costs are. And we look at what competition is doing. And they're never fun discussions, but they are much more rational discussions than they've been historically.

Reza Vahabzadeh - Lehman Brothers

Got it. And then you talked about the sales mix impact on gross margin. I'm sorry if I missed it, but what was the significant contributing factor to that?

Neal Fenwick

It's, fundamentally, just the mix of the curves in terms of which customers and which product categories.

Reza Vahabzadeh - Lehman Brothers

Got it. And would you anticipate your product cost impact that was 20 basis points this quarter to stay the same in the second quarter, or would it rise in the coming quarters?

Neal Fenwick

So the product cost impact will continue to get worse in subsequent quarters, but we will get more favorable benefit from price increase in the subsequent quarters as well.

Reza Vahabzadeh - Lehman Brothers

Got it. Thank you.

Operator

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

Arnold Ursaner - CJS Securities, Inc.

Can you comment if you noticed any attempt to quantify the weather impact that you may have had in the quarter?

Bob Keller

It had a bigger impact in January, and specifically, customers that had high concentrations in Mid-Atlantic and the Northeast. And we probably had something in the neighborhood of $500,000 to $1 million impact in Japan based on the earthquake and tsunami and subsequent events there from a sales perspective. But across the quarter and across the year, meaningless.

Arnold Ursaner - CJS Securities, Inc.

Got it. And are you putting in fuel surcharges for freight?

Bob Keller

We have done that.

Arnold Ursaner - CJS Securities, Inc.

Okay. And can you update us on your strategy and for the success you've had with key retail accounts that you've been targeting? Can you freshen that up a little bit for us?

Bob Keller

I think across the board, our customer relationships are as good as they have ever been. We have a very strong relationships with Staples and Depot and Max. Our relationship at Wal-Mart is very good. We're excited about the opportunities there. We've gotten into the e-commerce marketplace with Amazon. And while that's a small number, it's been growing. And the number of our products available on Amazon have been growing. And we feel good about the relationships with our customers, frankly, on a global basis.

Arnold Ursaner - CJS Securities, Inc.

Okay. My final question, if I can. You mentioned you had a 6% operating margin on an adjusted basis in the quarter, and I fully appreciate it is not a key quarter by any means. But you also have a 12% or 13% operating margin goal out in the future on a more normalized basis. How close do we get to double-digit operating margins this year?

Neal Fenwick

So the first thing to remember is we're, of course, very seasonal, and we have much stronger margins in Q3 and Q4. And so our expectations are unchanged in terms of our earnings performance for this year. And you'll see a steady improvement on a full year basis, and that will continue this year and into next year.

Arnold Ursaner - CJS Securities, Inc.

Thank you very much, Neal.

Operator

And our next question will come from the line of Bill Chappell with SunTrust Robinson Humphrey.

William Chappell - SunTrust Robinson Humphrey, Inc.

Just want to kind of go back to the volume issue in the quarter. And just trying to make sure I understand kind of the near-term trends -- I mean, were you surprised that you were able to kind of lap up the incremental volume so quickly in the quarter? Because it seems like for that kind of overhang coming in from the last quarter to be back to 1:1 replenishment by the end of the quarter, it seems pretty quick and with the seasonally small quarter.

Bob Keller

Well, I think, we were accused at the end of the last quarter of being conservative about our sales number. We feel good about how our customers our positioned and how our products are positioned and about the underlying demand for our products. So the demand is kind of what we have expected. We think the market, as a whole, for the year is going to still be around flat. We think it'll be slightly down in the first half and slightly up in the second half. We think the biggest opportunity for us to grow the business in the near term is to take share. We feel good about our success in the first quarter. And frankly, we have more on the table right now than we've had at any point in the 2-plus years that I've been here. So we like how we're positioned competitively.

William Chappell - SunTrust Robinson Humphrey, Inc.

So would I imply this in the categories that were affected that you're seeing actual consumer takeaway or POS closer to up mid-single digits?

Bob Keller

I think, if you build the price increase into that, that's probably fair. On just a pure volume basis, we're a little north of 1%. We're between 1% and 1.5% on a volume basis.

William Chappell - SunTrust Robinson Humphrey, Inc.

Okay. And in terms of the mix of the business, have you seen consumables pick back up, in terms of the durables versus the consumables and the trend to last year versus this year?

Bob Keller

.

It's actually the opposite. We've been linking the -- our perspective the last couple of years has been the durables would recover faster, and it's tied to business financial health. 2 years ago, the mix in our business was probably 50-50, durables versus consumables. And as we exited the first quarter, it's probably 55 durables, 45 consumables. So we continue to see strength on the durable side and softness on the consumable side.

William Chappell - SunTrust Robinson Humphrey, Inc.

Okay. And as I look to the mid-year price increases, are you comfortable -- I'd assume by now that they've been signed off. Are you comfortable that they can offset most of the current commodity pressures, or are you still going to be kind of chasing it going into early next year?

Bob Keller

I think they are fair and reasonable in the space that we're in. I think we're going to have to be more efficient in order to protect our financial outlook because I think it's going to be -- our expectation is it's going to be a more competitive environment in the back half of the year.

William Chappell - SunTrust Robinson Humphrey, Inc.

And then my final question. I mean, I think you have a pretty conservative outlook for Europe as you consolidate and restructure. Any early read on that, and kind of how that's progressing of whether you really have the customer losses or, I guess, decline in sales that you had expected?

Bob Keller

.

We'll get a much better feel for that this quarter. We notified customers in the first quarter. We started moving customers the last week or so of the first quarter. And we'll do it through the next 6 weeks -- the first 6 weeks of Q2. And so as we come out of Q2, we'll have a better impact on sales. But we have been actively communicating with our customers. We set up a My ACCO website for those customers. The participation in that so far has been strong. Our communication with the wholesalers that are going to be picking up that volume has been consistent with our expectations. And the people moves that we had to make in the first quarter went as planned.

William Chappell - SunTrust Robinson Humphrey, Inc.

Great. Thanks so much.

Operator

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

Karru Martinson - Deutsche Bank AG

In terms of the price increases, was that fully implemented here in the quarter, or was there going to be a lag into the second quarter?

Bob Keller

It was fully implemented in the quarter. It doesn't take full effect in January. We see it kind of bleed into the quarter. But the total number that you see is mitigated somewhat. In our core businesses, the U.S. and our European business, we raised prices. And our trading companies, because of FX volatility, we lowered prices. And what your seeing is a net number. The other thing that we do is we net marketing programs against some of the price increase. And we were more aggressive in the first quarter, repositioning our durables products. We spent more than we had originally budgeted in the first quarter to help our customers position our products better for sale throughout the year. And so the price increases that we had expected to implement in the U.S. and Europe, we got.

Karru Martinson - Deutsche Bank AG

Okay. So second quarter here, we'll see a full impact and possibly, less aggressive marketing programs to kind of restore that margin, correct?

Bob Keller

You'll see a lift on pricing in Q2.

Karru Martinson - Deutsche Bank AG

Okay. And you mentioned your second half getting more competitive. I was kind of wondering, on the lower end of the business, the private label, what are you seeing there? Are they following the industry's lead on pricing?

Bob Keller

.

The private label tends to be a 1-on-1 discussion with our customers. We haven't seen, relative to our product mix, any significant change over the last 12 to 15 months, frankly, in that space for us.

Karru Martinson - Deutsche Bank AG

Just on Japan, I mean, what's the total scale of your business with that market?

Neal Fenwick

It's a small business for us. In total sales, it's about $40 million.

Karru Martinson - Deutsche Bank AG

And just lastly here, as you guys start to build cash in the second quarter and through the rest of the year, that $50 million to $60 million, what is the use of cash for this year kind of targeted at?

Bob Keller

.

We're going to probably accumulate cash. Buying back our debt at this point is still expensive. And the only caveat to that is if we truly saw some opportunistic acquisition opportunity, we'd take a look at it, but the primary intent is to build cash throughout the year.

Karru Martinson - Deutsche Bank AG

Thank you very much, guys.

Operator

And at this time, we have no questions in queue. I would like to turn the call back over to Bob Keller, Chairman and CEO, for closing remarks.

Bob Keller

I appreciate everyone joining us this morning, and we look forward to talking to you after the second quarter. Take care.

Operator

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

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