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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

Dan Mazer - Harvest Capital

William Chappell - SunTrust Robinson Humphrey, Inc.

Arnold Ursaner - CJS Securities, Inc.

Unknown Analyst -

Reza Vahabzadeh - Lehman Brothers

ACCO Brands (ABD) Q2 2011 Earnings Call July 27, 2011 8:30 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter 2011 ACCO Brands Corporation Earnings Conference Call. My name is Stacy, and I'll be your conference moderator 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 to Ms. Jennifer Rice, Vice President, Investor Relations. Please proceed.

Jennifer Rice

Good morning, and welcome to our Second 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. E-slides provide detailed information to supplement this call. When speaking to earnings per share, we are using a normalized effective tax rate of 30%.

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 is my pleasure to turn the call over to Mr. Keller.

Bob Keller

Thank you, Jennifer, and good morning, everyone. Earlier today, we released our second quarter financial results, and I continue to be pleased with our progress. In what remains a difficult operating environment, we grew our top line by 8% and expanded our operating income margin 110 basis points.

We returned our European operations to profitability, and we ended the quarter with $93 million in cash. Including the costs related to the rationalization of our European business, earnings from continuing operations were $0.15 per share.

Virtually all of our businesses and geographies performed at or above our expectations. Our teams in Australia, Asia-Pacific, Canada and Latin America all delivered strong results. Our Kensington Computer Products business was substantially ahead of plan, in large measure because of robust sales of iPad and iPhone accessories and the continued success of the new ClickSafe computer security line.

In the United States, we held our own in a difficult business environment. Our Print Finishing Solutions business, a focus area we targeted for improvement, achieved breakeven status in the quarter, and we're expecting it to both grow the top line and become profitable in the second half of the year.

In Europe, our account transition plan and our SKU rationalization are both tracking to our internal expectations. On the product side, the Swingline Stack and Shred Auto Feed Shredder, which we introduced at the beginning of the year, continues to perform particularly well for us globally.

During the quarter, we announced that we had sold the GBC Australia operations to our longtime distribution partner, Neopost. While we weren't seeking a purchaser, Neopost made an attractive offer, and they will become the exclusive distributor of print finishing products for the direct channel in Australia and New Zealand. The sale added significantly to our cash reserves and it had no effect on our 2 larger operations in the region, ACCO Australia and our joint venture interest in Pelikan Artline.

In closing, while we're pleased with our second quarter results, we remain cautious about the external operating environment. We continue to believe that we'll grow our business in line with our previous outlook, sales up 2% to 4% excluding currency. But based on our year-to-date performance, we now believe that we'll be at the high end of our earnings range, growing EPS around 30% and generating $100 million to $110 million in free cash flow by year end.

Overall, I believe we are well positioned to deliver on our commitments for the year. With that, I'll turn the call over to Neil for a more detailed review of the numbers. Neil?

Neal Fenwick

Thank you, Paul. Our second quarter performance is recapped on Slide 4. Reported sales increased 8% with a 6% benefit from foreign exchange. Pricing was favorable 2%, underlying volume was flat. EBITDA was $42.2 million and included $3.7 million of benefit from foreign exchange translation. EPS from continuing operations was $0.15, using a 30% tax rate versus a comparable $0.08 in the prior year.

Our gross profit margin increased 100 basis points to 32%. The increase was mainly due to the reductions in freight and distribution costs. SG&A expense was down 20 basis points, primarily due to reductions in Europe. In all, operating income increased 22% and margin expanded 110 basis points to 9.3%.

For the 6 months, sales increased 4% driven by foreign exchange. Volume was down 2% for the 6 months due to the Q1 impact from the year-end buy forward and inventory reductions by certain customers. Pricing for the 6 months period was favorable 2%.

As shown on Slide 5, gross margin increased 40 basis points for the 6-month period to 31%. Cost savings accounted for 50 basis points of the improvement, but were partially offset by material cost increases, which were not fully offset by our price increases.

SG&A was up 8% for the 6 months, including $4.7 million impact from foreign exchange. As a percentage to sales, SG&A increased 80 basis points to 23.5% of sales, primarily due to $4.3 million or 70 basis points of reorganization costs in Europe and $3.7 million of higher incentive compensation costs. These were partially offset by savings, mainly in Europe.

EBITDA for the 6 month period declined 3% to $66.3 million. Excluding the $4.3 million of reorganization costs in Europe, EBITDA was up 3%. EBITDA included $5.3 million benefit from foreign exchange during the 6-month period. EPS from continuing operations was $0.09 using a normalized tax rate of 30% and even with the comparable period.

Now I will provide an overview of our segment performance for the quarter. During the second quarter, reported sales for the Americas increased 3%, with foreign exchange pricing and volume all positive factors.

Customer purchases were back in line with point of sale after certain customers had ordered below POS in Q1 in order to prove their own inventory turns. Operating margins in the Americas were down slightly, 20 basis points to 8.3% due to product material cost increases and continued investment in new planograms and accelerated go-to-market spending to drive demand and improve market share for durable products.

In our International segment, sales from continuing operations increased 14% driven by foreign exchange translation and pricing. Underlying volumes declined 4%, largely due to reduced demand in the U.K. We are also experiencing a small volume decline associated with the transition of certain of our smaller and non-profitable accounts to wholesalers. In the International segment, profit increased 84% and operating margin expanded a strong 320 basis points to 8.5% as our European region returned to profitability.

We incurred approximately $400,000 of additional charges associated with the rationalization of our European business, which was less than the $2 million we guided to, as many employees agreed to continue to work during their notice period. We have realized $600,000 of savings and expect a further $3 million of savings in the second half, hoping to offset the $4.3 million expenses incurred, making the initiative near breakeven for the year. By next year, savings should grow to $6.5 million annually.

Finally, Computer Products had a very strong quarter with sales up 16% and volume up 8%. We saw strong demand for our new products that accessorize iPads and iPhones. Computer Products' operating profit increased 22% in the quarter, and margin expanded 150 points to 26.9%. The improvement was driven by volume leverage and lower promotional activities.

Turning to cash flow, which is detailed on Slide 6. We ended the quarter with a very healthy cash balance of $93 million and continue to have no borrowings on our ABL facility. We received $54 million of cash proceeds in the quarter from the sale of our Australian GBC - Fordigraph business and generated $32 million of cash from operations. We used $11 million of cash to repurchase our senior subordinated notes when the price fell to par, and therefore improved our leverage profile.

Our working capital balances remain a little high, in part due to foreign exchange and in part due to higher accounts receivable and inventory balances, mainly in Europe. Versus a year ago, foreign exchange added $23 million to receivable balances and $14 million to inventory. We continue to expect to generate $100 million to $110 million in free cash flow this year, including announced sale proceeds and should end the year with over $3 per share in cash.

In terms of our 2011 outlook, adjusting for the sale of GBC - Fordigraph business, we are reiterating our expectation for sales to grow 2% to 4% before foreign exchange. As Bob mentioned, due to the benefits of foreign exchange realized in the first half, we are now guiding to the high end of our EPS growth range of 20% to 30%. The second half should benefit from the initiatives underway to improve our profitability in Europe.

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

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Bill Chappell with SunTrust.

William Chappell - SunTrust Robinson Humphrey, Inc.

I guess a couple questions just kind of on the outlook for the back half. I think by now you would have a pretty good outlook on how the European restructuring's gone and also kind of some of the competition in the shredder business and reactions there. Can you maybe give us some updates in terms of, I know for Europe you had expected to lose some revenue during the transition, but would have a better idea and also see some more pricing pressure on the shredder business; maybe you can give us an update there?

Bob Keller

Yes. I think we're pleased with the progress that we've made in Europe. We've returned that business to profitability, both sales volume on the transition accounts to date is consistent with our expectations. We're making progress again consistent with our expectations on the SKU rationalization. We're cautious about sales in the back half. We think consumer confidence kind of goes up and down, and the economic environment both here in the States and in Europe is still pretty volatile. And we think our customers have a focus on inventory management as a response to the concerns that they have. We've got a lot of customers that are focused on their working capital. And so, we're pleased with the things that we can control, and we're on track in Europe in terms of our expectations. So I don't think anything has changed relative to our perspective about the second half other than that we remain cautious about top line. On the shredder situation, our competitor, who had a delivery problem is now delivering product. We expect that to continue to be a very competitive marketplace. We've got business, and they have business that is up for grabs in the second half and we will compete fiercely on that. But kind of net-net, we're pleased with where we are from a pricing perspective.

William Chappell - SunTrust Robinson Humphrey, Inc.

And I guess kind of following up on that in terms of looking at market share gains, can you maybe give us an update on how the bake-offs have gone year-to-date? And what you see kind of going into 2012 in terms of new business?

Bob Keller

Yes, we're again pleased with the progress that we've made in terms of market share. We have a couple of opportunities in the back half of the year that are very large opportunities that we're focused on that would be -- have a meaningful impact in 2012. And we think we're positioned where we need to be positioned in order to compete effectively for those. So when we look at the industry as a whole, we think volumes are probably down slightly in our traditional channels. And the fact that we're flat to marginally up would say that we've been successful in taking share.

William Chappell - SunTrust Robinson Humphrey, Inc.

And then I guess...

Bob Keller

Don’t think the market's growing.

William Chappell - SunTrust Robinson Humphrey, Inc.

Just trying to that into perspective for kind of the 0.4% volume growth in North America this quarter. Does that mean some of the stuff you won last year is more back-end weighted?

Neal Fenwick

I think it is a combination of the fact that it's partially back-end loaded and partially that volumes as a whole in some of the traditional channels are down.

William Chappell - SunTrust Robinson Humphrey, Inc.

Okay. And then just finally, kind of your initial read on back-to-school. I know it's early, and I know it's not as big of a focus. But kind of what you see in both the U.S. and internationally?

Neal Fenwick

It looks an awful lot like last year so far. I think it's going to be a very competitive marketplace. I think the traditional office products superstores are going to compete aggressively. I think they had a pretty good year last year, and the load-ins have been consistent with last year.

Operator

Your next question comes from the line of Arnie Ursaner with CJS Securities.

Arnold Ursaner - CJS Securities, Inc.

Quick question first. The math, if you had a deferral, if you will, or a timing issue on about $1.6 million of expenses for Europe, am I correct that's about a $0.02 benefit in the quarter, about $0.015 to $0.02 benefit in the quarter?

Neal Fenwick

The way to understand that, Arnie, is that we incurred exactly what we expected in Europe. For Europe, what you have is a situation where when you going into a big severance, you're unsure how people will respond. And so we have to assume the worst case, which is that we will pay maximum severance for people's notice period. We were successful this year in getting people to work. So effectively, if we had gone through our original plan, we would have incurred more severance costs and we would have a lot more savings in this quarter in terms of how we would have displayed it. By having people work, we effectively incurred less severance cost and incurred -- and received less savings.

Arnold Ursaner - CJS Securities, Inc.

Okay. And Bob, all during the course of the quarter, your stock was, at various times, under a lot of pressure. Based on comments some of your customers made, the big box retailers, can you just remind us again of the sales mix for ACCO Brands between the big box retailers and what people seem to not include in thinking about your company, the wholesalers and the independents where trends appear to be pretty different than the big box retailers. Can you freshen that up for us a little, please?

Bob Keller

Sure. The big box retailers represent 30% of our business. And so the majority of our business is to the wholesale and the independent dealer channel, and we had a couple of the wholesalers, the U.S. wholesalers announced this week and their office product sales were up 4%, and they service both the independent dealer channel and the superstore channel. And so just looking at the numbers, it's pretty obvious that the independents are growing at high single digits or even potentially a little bit higher than that.

Arnold Ursaner - CJS Securities, Inc.

And another issue that comes up frequently is the other channels of distribution, Internet and others. Just remind us the exposure you have there, if you can?

Bob Keller

I think that's just, it's a growing channel. It's small and getting bigger. A year ago, we had 750 SKUs at Amazon, we've got 3,500 SKUs listed at Amazon today. That business is growing exponentially. The mass channel, as a whole, we're pleased with, specifically with Wal-Mart where we continue to grow that business aggressively. And so the superstore channel is clearly facing some challenges. And I think there probably has been some share shift in the small and mid-sized customer. I think one of the things that we've done pretty effectively over the last 2.5 years is broaden our coverage of alternate channels, the mass channel, the e-commerce channel. And we've done a better job of supporting our wholesalers and independent dealers than we had been doing previously. And so I think that's reflected in our numbers.

Arnold Ursaner - CJS Securities, Inc.

And my final question is, are you putting in place or are you attempting to put in place sufficient price relief to offset your higher costs? And what are you seeing as customer response in trying to make your margins whole or getting the costs recovered?

Bob Keller

We're pleased with the progress that we've made on pricing. I think one of the things that's not obvious, we report that 2% of our growth is specific to pricing is that, that's a net number on a global basis. And it reflects the offset of the price decreases that we had in Australia, which is a very large market for us, which the currency has gone, not crazy, but it's been pretty volatile there. I think they're trading at over $1.09 as of the end of business yesterday. So we think that the price increases that we put out were fair and equitable and consistent with the data. And we're comfortable with the response that we've gotten.

Operator

Your next question comes from the line of Reza Vahabzadeh with Barclays Capital.

Reza Vahabzadeh - Lehman Brothers

On the cost side of the equation, do you see input cost pressures accelerating into second half? Or are they peaking, stabilizing or are they decelerating?

Neal Fenwick

It's an interesting question, and it's a very mixed bag that we've seen as a response. I mean clearly in our second quarter, we incurred more raw material cost increases than we had in the first quarter. And you saw that be a negative drag on our margins. We did raise our own prices starting in July to try and offset some of that continued erosion that is obviously going to get worse as we go into the third quarter. From a headline point of view, we've seen some of the extreme commodity cost increases come back down, but they're still significantly above where they were last year. And we never actually paid and never passed on to our customers those extreme cost increases. We are seeing more cost increases generally come through, particularly on things like paper and packaging now.

Reza Vahabzadeh - Lehman Brothers

Got it. And would you say that the price increases that were implemented in the first half and to the extent you can tell here in the third quarter, are they generally matched with the competitors?

Bob Keller

I think you have to or you lose share. And so we think the combination of our service levels, our product innovation and pricing, we think we're pretty competitive at this point.

Reza Vahabzadeh - Lehman Brothers

Got it. And then as far as sales by channel, I think you just alluded to better sales in the wholesale channel than maybe your traditional big box channel. Has that different sales trend, has that been really consistent in the first half? And would you expect more of the same in second half or is it too hard to tell?

Bob Keller

It's a very, very competitive industry. I think the traditional office products superstores are adding focus to the small business and mid-sized marketplace. I think they’ve commented on that in their earnings call, and so I think that will become a more competitive market than it's been maybe in the last 12 months. But I just, I think it's a competitive space, and we've got a lot of people going after the same customers.

Reza Vahabzadeh - Lehman Brothers

Right. You had commented that your -- some of your customers are very focused on inventory management. Does that mean that inventories are in decent shape or are they being brought down? Any comments on where you think inventories are at customers?

Bob Keller

Yes, the -- I think inventories are lower than they have traditionally been. And I think our customers are going to push to take them even lower in the back half. So in the first quarter, we saw that our sell in was significantly below their point-of-sale numbers. We thought about $14 million less in Q1. In Q2, we think our sell in and their point-of-sale was roughly the same, pretty close to a one-to-one relationship. Our expectation in Q3 is that our customers will buy below their point-of-sale, and that's just from the meetings that we've had with customers about what their inventory plans are. I mean, they're going to try to push the edge of the envelope. And I think in Q4, it's not clear what people are going to do relative to buy forwards. Based on the trajectory of raw material increases, our expectation is that we will have a January price increase. And traditionally, people have bought forward in advance of that. It's not obvious to us that, that will necessarily happen this year. So we're cautious about the top line. We think we have expenses under control. We think we've got an ability to manage SG&A in reaction to gross margin. And so we're comfortable about our ability to deliver on our profitability in the back half of the year. But we'll have to be responsive to what the top line demand is. Underneath all of that though, the demand for our products has been pretty consistent when you look at point-of-sale on a 6-month basis. We feel good about the demand for our products across all of our channels.

Operator

[Operator Instructions] Your next question comes from the line of Arun Seshadri with Credit Suisse.

Unknown Analyst -

This is Felix Way [ph] in for Arun. I just wanted to get a sense of how FX is factored into your guidance?

Neal Fenwick

In terms of our guidance from a sales point of view, we've always given sales guidance that excluded the impact of FX. Obviously, we do assume it in terms of our EPS guidance. And so from our point of view, I think some of the more extremely favorable FX numbers that exist today, we're not assuming continue through the end of the year. And it's a very volatile issue that if I could predict currencies, I probably wouldn't be doing this job.

Unknown Analyst -

Great. And then I also wanted to focus on cash tax guidance for a second. I noticed that it looks like $5 million from the 1Q slide. Can you talk about what's driving that?

Bob Keller

Yes, that's really driven by FX. If last time I put the real number down, I would have put more like $22 million, and I just rounded it down. And this time, it's about $24 million, and I've just rounded it up.

Operator

Your next question comes from the line of Dan Mazer with Harvest Capital.

Dan Mazer - Harvest Capital

Can you remind me on just what the restatement, what the base EPS of 2010 that you're basing your 20% to 30% guidance, EPS growth guidance?

Jennifer Rice

$0.47.

Dan Mazer - Harvest Capital

Okay, $0.47. Okay, great. So the -- so I think that implies $0.60, probably, or $0.61 is at the high end. And I think you came in better than a lot of analysts this quarter. Is there – in just going through the models in the back half, is there anything that kind of stands out on just -- is this just being kind of conservative on sales and there's going to be lots of the big FX translation? Or just -- maybe just kind of in the context of the back half coming down in your models?

Bob Keller

Sure. Yes, I think what you should read into it was we had a very strong Q2, and that puts less pressure on the back half of this year. I think most of the models had kind of a hockey stick, and there's less pressure on the back half. And we don't think it helps anybody for us to get ahead of our SKUs. We just think it's a challenging environment out there and a volatile environment. And our expectation is we're going to deliver regardless of what the external environment is so.

Operator

And at this time, I'd like to turn the call back over to Robert Keller, Chairman and CEO for closing remarks.

Bob Keller

Thanks, everybody, for joining us this morning. We're obviously very pleased with the quarter. We think we continue to manage the business effectively in a very challenging operating environment and expect to continue to do that in the second half of the year and look forward to talking to you at the end of next quarter. Thanks.

Operator

We thank you for your participation in today's conference. This does conclude your presentation. You may now disconnect, and have a great day.

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