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Office Depot (NYSE:ODP)

Q1 2012 Earnings Call

May 01, 2012 9:00 am ET

Executives

Brian Turcotte -

Neil R. Austrian - Chairman, Chief Executive Officer, Member of Corporate Governance & Nominating Committee, Member of Corporate Governance & Nominating Committee and Member of Finance Committee

Kevin Peters - President of North America

Stephen M. Schmidt - President of International Operations

Michael D. Newman - Chief Financial Officer and Executive Vice President

Analysts

Colin McGranahan - Sanford C. Bernstein & Co., LLC., Research Division

Rupesh Parikh - Oppenheimer & Co. Inc., Research Division

Michael Lasser - UBS Investment Bank, Research Division

Carla Casella - JP Morgan Chase & Co, Research Division

Daniel T. Binder - Jefferies & Company, Inc., Research Division

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

Christopher Horvers - JP Morgan Chase & Co, Research Division

Michael Baker - Deutsche Bank AG, Research Division

David Gober - Morgan Stanley, Research Division

Anthony C. Chukumba - BB&T Capital Markets, Research Division

Alisa Guyer Galperin - Nomura Securities Co. Ltd., Research Division

Alan M. Rifkin - Barclays Capital, Research Division

Joseph I. Feldman - Telsey Advisory Group LLC

Operator

Good morning, and welcome to the First Quarter 2012 Earnings Conference Call. [Operator Instructions] At the request of Office Depot, today's conference is being recorded. I would like to introduce Mr. Brian Turcotte, Vice President of Investor Relations, who will make a few opening comments.

Mr. Turcotte, you may now begin.

Brian Turcotte

Thank you, and good morning. With me today are Neil Austrian, Chairman and Chief Executive Officer; Mike Newman, Chief Financial Officer; Kevin Peters, President of North America; and Steve Schmidt, President of International.

Before we begin, I'd like to remind you that our discussion this morning includes forward-looking statements, which are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements reflect the company's current expectations concerning future events and are subject to a number of factors and uncertainties that could cause actual results to differ materially. A detailed discussion of these factors and uncertainties are contained in the company's filings with the SEC.

In addition, during the conference call, we refer to certain non-GAAP or adjusted financial measures. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP financial measures, as well as our press release and accompanying webcast slides for today's call, are available on our website at www.officedepot.com. Click on Investor Relations under Company Information.

Neil will now summarize Office Depot's first quarter 2012 results. Neil?

Neil R. Austrian

Thank you, Brian, and good morning. Office Depot reported first quarter 2012 sales of $2.9 billion, down 3% compared to the prior year. Constant currency sales in the first quarter of 2012 were also down about 3% versus prior year. Our first quarter 2012 results showed continued year-over-year earnings improvement despite lower sales. The company reported net earnings after preferred stock dividends of $41 million or $0.14 per diluted share in the first quarter of 2012 versus a loss of $15 million or $0.05 a share in the same period one year ago.

First quarter 2012 results included approximately $28 million of net benefits related to a number of discrete items. Charges primarily related to restructuring activities and actions to improve future operating performance and the loss on the extinguishment of debt were more than offset by a pension settlement related to a 2003 European acquisition. Excluding this net benefit, net earnings after preferred stock dividends would have been approximately $14 million or $0.05 a share. I should note that our first quarter 2011 reported earnings also included $8 million in charges. The net after-tax impact of the charges negatively impacted first quarter 2011 earnings by about $0.05 a share.

Total company gross profit margin increased about 120 basis points in the first quarter of 2012 compared to the prior year. This was the eighth quarter out of the past 9 that we increased total company gross margins year-over-year. The gross margin improvement this quarter was driven by increases of 170 basis points in North American Business Solutions, 140 basis points in North America Retail and 20 basis points for the International division.

EBIT, adjusted for charges and credits, was $47 million in the first quarter of 2012 compared to $34 million in the prior period. The $13 million year-over-year improvement was attributable to a strong performance again this quarter in North American Business Solutions. I should note that first quarter 2012 EBIT, adjusted for charges and credits of $47 million, included a non-cash store impairment charge of approximately $18 million in North American Retail.

I'll now ask Kevin to review our first quarter 2012 performance in the North American Retail and Business Solutions division.

Kevin Peters

Thanks, Neil, and good morning. The North America Retail division reported first quarter 2012 sales of $1.2 billion, a decrease of 8% versus the prior year. Because fiscal year 2011 was a 53-week year ending on December 31, first quarter 2012 sales benefited from having fewer selling days impacted by the holidays compared to the first quarter of 2011. However, store closures completed during 2011, including our 10 remaining stores in Canada, negatively impacted total sales in the first quarter of 2012. The net effect of the holiday shift and store closures is estimated to be neutral on the first quarter of 2012 sales.

Same-store sales in the 1,096 stores that have been open for more than a year decreased 6% for the first quarter 2012. As we described last quarter, this comp sales deceleration is largely reflective of our deliberate and continued focus on improving the profitability of the business, which is enabled by taking a more strategic and economically defensible approach to our product assortment, pricing and promotion. For example, over the trailing 12 months, unit sales of tablets and readers have mostly offset the unit decline in laptops as we've rationalized our laptop assortment and been less promotional in general. However, the average sales price of tablets and readers are about 40% lower than their laptop counterpart, contributing to a decline in overall comp sales.

More recently as the laptop market has softened, this has accelerated the comp sales pressure. Now despite the comp sales pressure, the gross margin contribution from tablets before attaching related accessories is higher than our historical gross margin from laptops with attachments. Therefore, as we grow our assortment of tablets and their related accessories in the coming quarters, fine-tuning the laptop assortment and complete the renovation of our peripheral assortment through the introduction of exciting new product categories to stimulate demand, we're optimistic we can grow the business profitably.

We take a closer look at our performance by product category. Copy & Print Depot continued to perform well again this quarter, achieving high single digit increases in sales. We also saw increasing sales in the aforementioned tablets and e-readers, while sales of computers and their related products were down. It's important to note that if we excluded sales of computers and their related products, same-store sales would have been flat in the quarter in the first quarter of 2012.

Sales in paper, ink and toner decreased in the low single digits versus prior year. Sales of furniture were also down year-over-year as promotional activity in the first quarter of 2011, which drove a significant increase in sales in this category, was not repeated this year.

North America Retail's average order value was slightly negative in the first quarter, and customer transaction counts declined approximately 5% compared to the same period last year. Our goal to increase direct import of products continues to go well. For example, direct import penetration in North American Retail increased in the first quarter versus prior year to 11%. The North America Retail store count at the end of the first quarter was 1,123 stores. During the quarter, we opened one new store and closed 9. In 2012, we plan to close 25 to 30 stores in total. We also remodeled 7 stores and relocated 5 in the first quarter, successfully reducing the square footage of those locations by almost 40% on average.

North America Retail reported operating profit of $44 million in the first quarter of 2012 compared to $58 million in the same period last year. This decline was driven primarily by a store asset impairment charge of approximately $18 million and a negative flow-through impact of lower sales, partially offset by the year-over-year gross margin improvement of about 140 basis points and lower payroll and advertising expenses. To the extent that forward-looking sales and operating assumptions are adjusted or we commit to a more aggressive store downsizing or store closure strategy, additional non-cash store impairment charges may result in the future.

We continue to make progress on our key initiatives, and I'll now provide you with an update on a few of them, which drive profitable sales and reduce cost for North America Retail.

First initiative is the in-store customer experience, which was rolled out to an additional 370 stores since the end of 2011 for a total of approximately 700 stores to date. Our conversion continues to improve with sales growth and rolled out stores exceeding the balance of the chain. We are currently on track to complete the rollout of the remainder of the chain by July 2012.

The second initiative involves our continued effort to improve the sales productivity of our stores through both store closures where appropriate and the development of a plan for a more aggressive cadence of store downsizing. This includes remodeling about 30 to 35 locations in 2012 and reducing the average store size wherever possible. Given the remodels and relocations currently in the pipeline, we believe that we are on track to deliver occupancy savings of about $10 million in 2012.

Also in the first quarter, we opened our new 5K store in St. Petersburg, Florida. This opening, in addition to 2 store relocations into the 5K format during the quarter, raised our total to 11 locations at quarter end. We remain very excited about the potential for this new 5,000-square-foot store concept across our fleet.

Looking forward, the second quarter is typically our weakest sales volume of the year, and we anticipate our same-store sales rate to be down but better sequentially as we continue to execute our new technology and peripherals assortment strategy. Our second quarter operating profit is projected to be down versus prior year due to lower sales in some nonrecurring benefits from the second quarter of 2011.

Now let me shift our attention to the North American Business Solutions division. BSD reported first quarter 2012 sales of $828 million, a 3% increase versus the same period last year. The year-over-year sales comparison included the calendar shift that benefited the first quarter of 2012. On a normalized basis, we believe the sales would have been about flat. First quarter 2012 sales in the direct channel were up 2% versus last year, while sales in the contract channel increased 3%. Sales to large accounts increased high single digits versus prior year due to successful large customer acquisitions in the back half of 2011.

In addition, we continue to gain traction in this customer segment as evidenced by a number of large customer bids won during the quarter. We also achieved positive sales growth in our global account segment. However, we continue to see weakness in the public sector as these customers experienced budgetary pressures.

Sales to small- to medium-sized contract customers were relatively flat versus prior year. We are pleased to announce that we have finalized the transition of our telephone account management organization from legacy third parties to our new inside sales organization based in Austin, Texas. We are excited about bringing this critical sales function back in-house with the goal of driving high-margin small business customer sales growth in contract.

Looking at our first quarter sales by product category, we reported positive year-over-year sales growth in Copy and Print, seating, printers, cleaning supplies and break room supplies where, by the way, we continue to gain traction with sales improving at a double-digit rate again in the first quarter.

First quarter 2012 operating profit for BSD was $43 million, up $26 million from the same period one year ago. This increase reflects a 170 basis point gross margin increase, partially offset by higher supply chain expenses and temporarily higher payroll costs during the transition to the new inside sales organization. It's important to note that we're now lapping the bulk of the successful cost reduction efforts realized in 2011, and we are now seeing a shift towards gross profit rate expansion in 2012 driven by our sales and margin initiatives as they continue to gain traction.

In summary, it was a good quarter for the North America Business Solutions. We continue to win new business and retain existing customers in the contract channel, and our direct channel performed well once again. We improved margins in both channels as our cost containment initiatives and prudent investments to grow the business drove improved operational performance. As we move through 2012, we continue to look forward to improved performances for both channels.

In regard to BSD's second quarter 2012 outlook, we expect our sales to be flat to up slightly versus prior year and operating profit to be about flat on a year-over-year basis as we anniversary about $10 million of nonrecurring benefits one year ago.

I'd like to turn the call over to Steve now to review the first quarter 2012 performance in the International division. Steve?

Stephen M. Schmidt

Thank you, Kevin. The International division reported first quarter 2012 sales of $825 million, a decrease of 2% compared to the prior year period in U.S. dollars and an increase of 1% in constant currency. I should note that the International sales benefited by approximately $30 million in the first quarter 2012 from the calendar shift. Excluding this benefit, constant currency sales would have declined 3% versus prior year.

As I speak to sales results by channel this morning, I will do so in constant currency. Total European contract channel sales increased mid-single digits in the first quarter of 2012 versus the prior year with sales growth in the U.K. and Germany, partially offset by weaknesses in other countries. Our contract channel in Asia also reported a mid-single-digit increase in year-over-year sales in the first quarter of 2012.

First quarter 2012 sales in the European direct channel were lower than a year ago. We continue to focus management attention and resources on our direct channel business to reverse the unfavorable trends in this channel. Our objective is to improve the customer experience, both online and offline, in order to increase customer retention, acquisition and development.

First quarter 2012 sales in the European retail channel increased by low single digits compared to prior year. This was mainly driven by the acquisition in Sweden in the first quarter 2011. As a reminder, in Europe, we own and operate a total of 115 retail stores in France, Sweden and Hungary. In Asia, we continue to see sales growth in our South Korean retail business.

The International division reported first quarter 2012 operating profit of approximately $15 million compared to $27 million reported in the same period the prior year. Excluding approximately $18 million of charges related to business restructuring actions and process improvement activities, adjusted operating profit in the first quarter was $34 million compared to $33 million in the same period in 2011. These charges primarily included an adjustment to close facility accruals and severance costs for restructuring activities in several European locations. If we exclude the calendar impact benefit of $30 million on first quarter 2012 sales, our adjusted operating profit would have declined by about $9 million as a result of negative flow-through impact of lower sales.

In Latin America, Office Depot de Mexico reported first quarter 2012 sales of $285 million and net income of $17 million. We do not consolidate sales from this joint venture, but Office Depot's portion of the net income was approximately $8 million for the quarter and is reported in the miscellaneous net income line on the income statement. Slide 7 shows that Office Depot de Mexico ended the first quarter with 249 stores after opening a total of 9 new stores in Mexico, Panama and Guatemala. We remain very pleased with the performance of this business and are optimistic about our retail and business-to-business growth opportunities throughout Latin America.

In summary, the International contract channel performed well in the first quarter, and we're making progress in improving the performance of our direct channel. As we look forward, we'll continue to carry out our strategic initiatives to profitably increase sales and reduce our costs.

In regard to our second quarter 2012 outlook, we expect our sales in constant currency to be down 4% to 5% versus the prior year and operating profit, excluding charges, to also be down as the negative sales trends more than offset cost reduction efforts.

I'll now ask Mike to review the company's first quarter 2012 financial results in more detail. Mike?

Michael D. Newman

Thanks, Steve. As Neil mentioned earlier, first quarter 2012 total company EBIT, excluding charges, was $47 million, a $13 million increase versus one year ago. First quarter 2012 EBIT of $47 million includes the $18 million North American Retail asset impairment previously mentioned. Before the asset impairment, EBIT increased about $31 million year-over-year.

The waterfall chart on Slide 8 provides a snapshot of the factors driving the $13 million year-over-year improvement in EBIT. On the plus side, we had approximately $44 million in benefits realized from our business initiatives and $16 million related to productivity improvements and cost reduction efforts. These benefits were partially offset by about $22 million from the negative impact of lower sales volume, $18 million from the store asset impairment charge and $7 million from business reinvestment.

I'll now update you on our restructuring charges. In the first quarter, we reported $23 million of restructuring-related charges and other costs intended to improve efficiency and benefit operations in future periods. These charges included about $18 million for European business restructuring and process improvements and approximately $5 million for business process improvements at the corporate level. I should note that the European charges included an $11 million adjustment of a lease reserve for a closed distribution center in the U.K.

I'd next like to expand on the $28 million of net benefits related to discrete items that Neil mentioned at the outset of the call. These benefits included $68 million of pension benefit related to a 2003 European acquisition that more than offset $23 million in restructuring charges and about $12 million related to the extinguishment of debt. The $68 million of pension benefit was recognized as a credit to income on the income statement, and a $5 million expense related to this arrangement is presented in G&A expense for a net increase to operating profit of $63 million.

Turning to Slide 9. Free cash flow for the first quarter of 2011 was a use of $128 million, up slightly versus one year ago. However, this total includes $58 million of usage related to the pension funding. The inflow of $58 million of cash related to the pension settlement was treated as a source of cash in investing activities and from an accounting perspective, this is treated as a purchase price adjustment. The payment of $58 million made by Office Depot into the pension fund was treated as a use of cash in operating activities and negatively impacts free cash flow by $58 million. However, the total cash impact to Office Depot is 0.

The free cash flow usage in the first quarter, excluding the pension settlement, was primarily driven by a decrease in accrued expenses such as payroll and bonus. I should note that our original full year 2000 free cash flow projection of $80 million to $100 million, although unchanged from an operational perspective, will also be impacted by the accounting treatment of the pension settlement and is now estimated to be in the $20 million to $40 million range. Again, the total cash impact to Office Depot from this pension settlement will be 0.

Turning to liquidity. We ended the first quarter with $489 million of cash and cash equivalents and $704 million available from our Amended Credit Agreement for total liquidity of $1.2 billion. No amounts were drawn under the Amended Credit Agreement at quarter end.

Further to our liquidity, on March 15, we've purchased $250 million of our outstanding 6 1/4% senior notes due in 2013. The total consideration for each $1,000 note surrendered was $1,050, resulting in loss on extinguishment of debt of about $12 million. On March 14, 2012, we issued $250 million of 9 3/4 senior secured notes due in March 15, 2019.

We are pleased that we've been able to increase our operating flexibility by successfully staggering our debt maturity dates with the remaining $150 million of our outstanding 6 1/4% senior notes due August 2013, the $1 billion asset base lending facility due May 2016 and 9 3/4 senior secured notes due March of 2019.

Shifting to operating expenses. Total company first quarter 2012 operating expenses adjusted for restructuring charges but including $18 million of asset impairment charges of $845 million, were down $6 million versus the prior year period. The year-over-year reduction in expenses was driven by productivity improvements and lower advertising in North America, partially offset by higher supply chain expenses and payroll in BSD.

The effective tax rate for the quarter on a reported basis was 18%. The effective tax rate on our earnings adjusted for discrete items was 34% for the first quarter, but our tax rate can be volatile because of our valuation allowances. As I mentioned last quarter, the U.S. Internal Revenue Service has proposed a royalty assessment from our foreign operations. We disagree with this assessment and based on the technical merits of the issue, believe that no accrual is available, excuse me, is required at this time. We continue to work with our outside tax advisors and the IRS to resolve this dispute in a timely manner.

During the first quarter, we recorded a dividend on our convertible preferred stock of approximately $8 million, which was paid in kind on April 1.

Looking at the second quarter of 2012, we expect total company sales to be down about 3% versus the prior period and adjusted EBIT to be down $20 million to $30 million compared to last year, reflecting a number of factors including nonrecurring 2011 items, lower International division operating income and the deleveraging impact of sales softness in North American Retail.

There are 2 important things to note in our first half 2011 results as compared to 2012. The first quarter in 2011 was relatively -- was a relatively weak quarter EBIT-wise as we were investing in our key initiatives and in advertising. So our first quarter 2012 EBIT comparison was a relatively easy one. Also, the second quarter of 2011 included significant nonrecurring benefits that we are now comping. However, we expect full year 2012 EBIT to be in the $120 million to $130 million range, including the first quarter impairment charge of $18 million. This tracks with the guidance we gave you on the fourth quarter earnings calls of $140 million to $150 million of full year 2012 EBIT.

With that, I'll now turn the call back over to Neil.

Neil R. Austrian

Thank you, Mike. As you heard this morning, our first quarter performance was much improved versus prior year despite the sales decline as we continued to execute our strategic plan. In fact, I should note that first quarter 2012 adjusted EBIT of $47 million is $13 million higher than last year. And that's because this year's adjusted EBIT includes the non-cash store impairment charge of $18 million, which we look at internally as being a $65 million EBIT, an increase of about $31 million versus prior year. Although the second quarter outlook is weaker than we'd like, we remain confident in our plan and in our ability to execute and believe we will drive significant full year 2012 EBIT improvement versus the prior year.

Brian Turcotte

Thanks, Neil. Operator, we are now ready to take questions.

Question-and-Answer Session

Operator

[Operator Instructions] The first question is from Colin McGranahan.

Colin McGranahan - Sanford C. Bernstein & Co., LLC., Research Division

So just looking at Q2 first, just, I guess to make sure we're working off the same numbers, was the nonrecurring benefit in 2Q '11, was that -- did that total $10 million?

Michael D. Newman

Yes. Colin, this is Mike. We called out 2 items last year. We called out items last year that were about -- in aggregate, about slightly over $10 million. Frankly, there was probably of other smaller items that were below a certain threshold that had a fairly significant impact year-over-year that we didn't call out. There were 6 or 7 items that were below $2 million or $3 million that we did not call out, so what we're comping from last year is well in excess of $10 million.

Colin McGranahan - Sanford C. Bernstein & Co., LLC., Research Division

Okay. But the down $20 million to $30 million x charges, EBIT looks like it was maybe about $11 million?

Michael D. Newman

Last year, yes.

Colin McGranahan - Sanford C. Bernstein & Co., LLC., Research Division

Last year, so add back the $10 million, are you saying you're going to be down $20 million to $30 million from kind of a baseline of $21 million?

Michael D. Newman

We're going to be down $20 million to $30 million from the baseline of the $11 million that was reported last year. Yes, the other thing I'll point out is that historically -- well in the last 4, 5 years, we typically have lost -- we had negative EBIT in Q2. If you look back in '09, '10, we lost anywhere from $16 million to $20 million. So the Q -- as I said in the script, Q1 last year was unreasonably -- unusually soft due to the reinvestments we were making in the business in advertising. We were also investing heavily in initiatives. And so it's really for me to look at the first half where we're seeing -- if you look at the guidance we gave, we're going to be flat to slightly up to first half 2011 if you exclude the impairment. That's where we think we are, which has us on track to do the guidance for the year that we talked about in the call.

Colin McGranahan - Sanford C. Bernstein & Co., LLC., Research Division

Okay. And then is there anything -- obviously, you're anniversary-ing these nonrecurring benefits from 2Q last year, and you still have a little bit weaker retail comp until some of the accessories and other tech stuff comes in. But is there anything unusual about 2Q that would cause such a big down -- downward pressure in profitability?

Michael D. Newman

Year-over-year, it's really the unusual. If you look, we're a little bit softer in retail than last year. We're a little bit softer in International, and we've got more of the initiatives kicking in, in Q3, especially with in-store customer experience. I'm not at all concerned about the 2Q number. It's really, for me, it's the profile of 2011 Q1 and Q2 that's giving us this plus very strong performance in Q1 and very soft performance in Q2. I feel like we're on track to get the guidance for the year. It's really the nature of last year's numbers that has -- makes it look different.

Colin McGranahan - Sanford C. Bernstein & Co., LLC., Research Division

Understood. And then I guess taking a step back though and just thinking about the profit profile, clearly another great gross margin performance here in 1Q, pretty long string 8 out of 9 quarters. Would you think the gross you're starting to get toward the end of that on gross margin and so there's just less benefit there? And how do you think about gross margin more broadly going forward?

Kevin Peters

Yes. I think -- Colin, it's Kevin. I think in the North America business, the way that we think about gross margin going forward is I think we'll still see some benefit from our mix shift, particularly as we rationalize out of the -- principally, the low-end laptop assortment and embrace the tablet and reader assortment along with the accessories. So I think that's one piece. I think the other piece that arguably probably we're in the earlier innings with is our direct import and owned brand penetration. I think we made some progress there, but I think there's probably much more progress to make in terms of penetration, both in BSD and retail, that should give us some continued tailwind in gross margin improvement.

Operator

Your next question is from Brian Nagel.

Rupesh Parikh - Oppenheimer & Co. Inc., Research Division

This is Rupesh Parikh for Brian Nagel at Oppenheimer. We saw laptop sales were again pressured this quarter. What are your expectations for the rest of the rest of the year and do you expect any meaningful improvement with the Windows 8 launch and the roll out of Ultrabooks player in the year?

Kevin Peters

This is Kevin. I think -- a couple questions. So I think laptop sales were, in fact, the market was soft in Q1 and maybe even some acceleration of the softness in late Q1. I think at this point, I'm not -- I'm personally not expecting a turnaround in Q2 or Q3. I think the wildcard, as you point out, is the Windows 8 launch and how the market responds to the Windows 8 launch. I think the Ultrabooks, with regard to your other question, is a wait-and-see. I think the price points on the Ultrabooks today relative to the Mac alternative probably aren't as appealing. If there's downward price pressure on those, there may be a pickup there but probably only in concert with the Windows 8 launch because that enables the functionality of the touchscreen.

Rupesh Parikh - Oppenheimer & Co. Inc., Research Division

Okay. And our second question has to do with the $80 million impairment charge. Is that -- is the majority of that charge related to leases? And also, why was this included within the adjusted EBITDA number?

Michael D. Newman

Yes, it's actually not related to leases. It's the impairments on about 50-some stores that really relates to leasehold cost, and it's everything but leases that's in the store. And your last question was why is it included in operating?

Rupesh Parikh - Oppenheimer & Co. Inc., Research Division

Yes.

Michael D. Newman

Yes, because the accountants make us.

Neil R. Austrian

Yes, this is Neil. What I'll point out of those 50-some stores, there's only 2 that are cash flow negative. This is an accounting charge that really doesn't affect anything. It goes against the leasehold assets that are in each store, and you have to do it on a store-by-store basis.

Operator

Your next question is from Michael Lasser.

Michael Lasser - UBS Investment Bank, Research Division

It's Michael Lasser from UBS. Just to be clear, on the full year guidance reduction, is that exclusively coming out of the -- the EBIT guidance reduction, is that exclusively coming from the second quarter? So you expect the back half to remain the same? I mean, that's what the math would imply, obviously.

Michael D. Newman

Yes, just to be clear, our guidance -- the last time we spoke to you guys on Q4 call, we guided $140 million to $150 million. The guidance we're giving today -- what I was trying to point out in the script is essentially the same if you exclude the impact to the impairment. So we guided $120 million to $130 million, including impairment. And so what we're looking at in Q1 was year-over-year improvement of about Q2 being down $20 million to $30 million and realizing we're up against some significant onetimers from last year. So the balance of our improvement year-over-year would be in the second half, which I think is what your point is.

Michael Lasser - UBS Investment Bank, Research Division

Yes. And is the business today trending where you thought it would be? So you're not anticipating some...

Neil R. Austrian

In fact operationally, if not for the onetimers in Q2 last year, I think we'd be up $10 million to $20 million operationally versus last year's numbers. Now having said that, we have a number of initiatives kicking in, in Q3, in-store customer experience. Some of our other initiatives are a little bit more back-end weighted. So I feel like we're on track where we need to be to hit that guidance.

Michael Lasser - UBS Investment Bank, Research Division

Okay. And then 2 real quick questions. On the stores that haven't been converted, how much of a lift are you seeing both on the sales side and the margin side to give us an indication of what we can expect moving forward?

Kevin Peters

Yes, Michael, we haven't called out specifically to the exact value of the lift. I think what we said in the script was that the stores that we rolled out on the in-store experience -- customer experience program are performing better on a comp sales basis than the balance of the fleet.

Michael Lasser - UBS Investment Bank, Research Division

Okay. And the returns associated with that, presumably they're going to require incremental costs as well?

Kevin Peters

The costs are typically more onetime, and that's related to the transition, and it's primarily related to training. But the easiest way to think about it is just simply converting more shoppers into buyers. So the new program through virtual merchandising and through better selling skills of our associates in the store allow us to convert more shoppers into buyers. We convert them. Even if you think we convert them at the average basket size, that flows through as incremental margin.

Michael Lasser - UBS Investment Bank, Research Division

Okay. My last question is on the reduction of the lower-end laptops. Is it your expectation that once you anniversary that, that will start putting pressure on the overall comp results? Because, I guess there's a case that can be made that there's always the segment of buyers that will be interested in that assortment, and so you could be perpetually missing out on those consumers.

Kevin Peters

Yes, I think one of the things that we've talked about, Michael, is we're not going to chase comp sales at the expense of profit. And when we looked at our technology assortment, while we had laptops in our assortment that drove traffic into the stores, in particular, the laptops that were the lower price point laptops tended to be purchased from consumers that were won and done. So they weren't sticky customers. They came in. They bought. They didn't attach. We lost money on the laptop, and we didn't see the customer again. And so our decision was to get out of that business, to go to more of that mid-tier and upper tier price point and then replace those low-end laptops now with tablets and readers. So I think there will be comp pressure. There will be comp pressure from simply transitioning out of the low-end laptops. There will also comp pressure in terms of the mix between laptops and tablets and readers. But more importantly, we should see an IDM benefit as a result of the mix shift.

Michael Lasser - UBS Investment Bank, Research Division

Okay, that's helpful. If I could seek one last one. I know I'm pushing it here. But Neil, we're 4 years into an economic recovery. We're still seeing mixed results from -- on the demand side. Admittedly, there's some onetime-ish type issues going on. But what sort of economic conditions do you think need to exist for the top line trends to improve?

Neil R. Austrian

Well first, I might take a little issue with the recovery because the recovery has been really spotty. I mean if you look at our business, Europe is in a recession. And you just have to look at the papers again today to see what's happening in Spain and how that's going to kick over to the rest of some of the Eurozone. And here, I think what we're seeing is that while some of the consumer sentiment has changed slightly, and I'll say slightly, what we haven't seen in all of our data is any enthusiasm yet from small- to middle-sized business in terms of hiring. And it's the hiring part of that, that dramatically affects our business as opposed to just seeing some sales go up. While the manufacturing sector has clearly improved in the United States, basically our business is almost non-related to that across the board. So what we're looking for is just more of the same, quite honestly, for the rest of the year.

Michael Lasser - UBS Investment Bank, Research Division

Okay, and good luck with that.

Neil R. Austrian

Only thing I'd like to add to that is we are seeing trends in our BSD business, where we're seeing large national accounts and segments of BSD. You saw the guidance for Q2. We're looking at flat to slightly up in sales. So that is encouraging for us and actually gives us hope that, that may be one of the early signs of some light at the end of the tunnel going forward.

Michael D. Newman

But more so private industry than public sector Tier 1.

Neil R. Austrian

The public sector is dead right now.

Operator

Your next question is from Carla Casella.

Carla Casella - JP Morgan Chase & Co, Research Division

My company is JPMorgan. And I just wanted -- the first quarter same-store sales, can you give us an idea of the sequence of it? Was it pretty even throughout the quarter? Do you see sequential improvement each month?

Neil R. Austrian

First quarter same-store.

Kevin Peters

Okay, I'm going to just repeat your question because I believe your question -- this is Kevin, I think your question was with regard to same-store sales in retail in the first quarter, was the comp sales relatively equally distributed across the months or did it accelerate or decelerate? What that your question?

Carla Casella - JP Morgan Chase & Co, Research Division

Exactly, yes.

Kevin Peters

Okay. Yes, I think, for all intent and purposes, that it was essentially flat across the quarter. And I think it's reflective of some of the decisions that we made beginning late last year to start to rationalize the tech assortment and begin to bring in the mix of tablets and readers. I will say, however, as we got closer to the end of the first quarter, specifically as it relates to laptops and desktops with the general market trends and softness, that we did see some acceleration in the comp sale pressure.

Carla Casella - JP Morgan Chase & Co, Research Division

Okay, great. And then you mentioned that you had some duplicative costs in the first quarter from payroll related to the transition to inside sales force. Is that complete now or should we similar in the second quarter and did you give a magnitude of what the -- how much the duplicate cost was?

Kevin Peters

Yes. Those were onetime costs, specifically associated with the transition from our multiple third parties into our in-house inside sales organization in Austin, Texas. And it was just payroll that we used to make sure that it was a seamless transition and our customers weren't impacted. It was onetime in nature and won't repeat.

Carla Casella - JP Morgan Chase & Co, Research Division

Okay. Did you say that dollar amount?

Kevin Peters

We did not call out the dollar amount.

Carla Casella - JP Morgan Chase & Co, Research Division

Okay. And just one follow-up -- one final question. How much of the North America Business Solution is now public sector or where could that be as a percentage of that sector by year end?

Kevin Peters

I don't think we specifically called out the percent of our business at the public sector. But I think it would be fair to say given the budgetary pressures on the public sector that as a percentage of our total sales is declining.

Neil R. Austrian

Declining, we typically called it out at 20% in the past this year given the performance where you're seeing significant differentiation versus the rest of BSD. It will be declined by year end.

Operator

Your next question is from Dan Binder.

Daniel T. Binder - Jefferies & Company, Inc., Research Division

Dan Binder, Jefferies. I had a couple of questions for you. First, on the Copy and Print business. Given the trends in paper and ink and increasing use of electronic presentations in corporate America, I'm just kind of curious, what you think is supporting the growth in Copy and Print? Is this simply you just have such a small share, and that's growing off a low base and what your outlook is for that business?

Kevin Peters

Yes, I think there's 2 things, Dan, that I would share about Copy and Print. Certainly, while there's pressure in the reduction of paper consumption, I think that's actually just a piece of the Copy and Print business. So for example, shipping is included in the Copy and Print business, and we're seeing nice double-digit gains in shipping. Office Depot is, I think, one of the only retailers that has UPS and USPS shipping. In addition to that, business cards would be another category that sits inside of Copy and Print Depot, as well as signs and banners. So all of those categories are growing. I think the other area of opportunity for us is in the space called managed print services, which is really allowing companies like Office Depot and our partners to help small and medium businesses, as well as large global accounts manage their print services business by going in and helping them understand how we can reduce the number of printer assets that they have on the floor and get better utility out of the print jobs that they have. So I think that those 2 things are certainly 2 drivers to continue growth opportunities and I think your first point, probably a good one as well, and that is just the opportunity from being under-penetrated to grow the business.

Daniel T. Binder - Jefferies & Company, Inc., Research Division

Great. I was wondering from a competitive standpoint what you're seeing across the different divisions from your main competitors from a pricing standpoint.

Neil R. Austrian

I think primarily, I assume you're asking on the BSD side. I don't know that I would say that there's any significant change. I think it seems like everybody is finding creative ways to win business. And so I don't know that there's been any material change. I guess the one callout I might spend a little time talking about is in the past, I think most contracts were all inclusive, so it was a broad range of a customer supply business. We are seeing some indications today where customers are beginning to break out smaller parts of the supplies business and doing separate contracts on those, so they might have a separate contract for paper, ink, toner, printers, technology, things like that.

Operator

Your next question is from Matthew Fassler.

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

It's Goldman Sachs. My first question relates to the $18 million charge for underperforming stores. Given that this is booked against EBITDA and you're including it in operating earnings, what are the layers of stores that are coming close to the thresholds that would trigger those kind of write-downs? And was it the apparent deceleration in sales at end of the quarter that triggered these chargers or was it a little longer on the comment?

Michael D. Newman

A little bit longer on the comment. If we look at those stores individually, Matt, the stores that generated the $18 million charge were about 50 in number. We probably -- we start the analysis out with a group of stores that's about double in that size and look at a number of different parameters. We look at sales going forward. We look at the impact of our initiatives. We look at store-specific initiatives. So it was really the change in sales that we saw immediately following Black Friday, and it's particularly driven by a lot of the tech and peripheral changes that we've seen. So frankly, it's a conservative forecast going forward that drove that impairment charge. But it's a group of about 50 stores, and the analysis starts again with a group that's about double in that size. And we eliminate about 50 of those stores through the process. Some of those stores are also partially impaired, meaning they have positive cash flows going forward, but they don't have enough to cover their book value. The other point to make is that we're in a capital-constrained environment. And if we had more capital, we would likely downsize a lot of the stores if we had the capital. And if we downsize those stores, great returns, we would make them profitable post downsize. So given the environment where in a kind of -- it's kind of an interesting thing that they're actually on a priority list for us to downsize if we had more capital to allocate to them.

Kevin Peters

Yes, I think Mike -- that's a great point for Mike. I think the stores that were hit with the impairment were typically our lower volume stores. And in fact, most of these stores would be candidates for a 5K downsize. When you run the pro forma on the 5K downsize, they're profitable.

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

And can you remind us what the capital commitment is for a 5K downsizing on average?

Michael D. Newman

Per store?

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

Yes.

Michael D. Newman

Yes, about $600,000.

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

Got it. And that's the cash cost or does that include the write-down of the lease, et cetera?

Michael D. Newman

Well, it's just cash cost.

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

Got it. And then secondly, I know you've gotten a couple questions on this, just to parse what you said about the nature of the comparison. I think you had isolated one item of that $10 million, and then you said 6 or 7 that were probably $2 million in aggregate. So that would add up to something along the lines of $20 million. But I think you also said in answer to a question that the down $20 million to down $30 million would be up $10 million or more on kind of a more normalized comparison for the second quarter. So I'm not trying to study the words too closely, but just really want to understand how big the one-offs were last year. And I understand the second quarter is a lower volume quarter, so things tend to get -- the leverage tends to come to out in a fairly extreme way. But just to be sure I understand exactly what the year-on-year trend would imply for the second half and whether you need to see sales get better in the second half in order to make your numbers.

Kevin Peters

Yes, if you take -- here's the easiest way a simpleton like me looks at it. If you look at Q1 and you look at Q2 guidance, excluding the impairment charge, we're up $30 million in Q1. You saw the guidance on Q2. That would say that you're about flat, excluding impairment. I think that if you look at what we called out last year and the individual items that we didn't call out, we had about $20 million of unusuals last year. So in some range, we'd be up EBIT year-over-year through the first half, which is the reason the earlier question I got gives me confidence that we're on track to deliver that $120 to $130 of EBIT for the year, again, including the impairment charge. So we called out about $10 million plus of charges last year. There was another $10 million that we didn't that were very small items, and that's the policy we use. We weren't trying to be cute last year. We had about 6 or 7 items that were $2 million-ish each in the order of magnitude.

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

And to the extent that at the outset of the year, you spoke directionally to low single digit sales declines in aggregate. Is that still the sales plan that underlines that EBIT expectation?

Michael D. Newman

Yes, we have a fairly conservative look at the year, and we've been focused on initiatives and we've been focused on cost. That was actually the forecast that went into the impairment discussion as well. Kevin is pushing his people much harder than that internally, and they have different goals. But from the standpoint of what we're looking at in terms of EBIT commitments, you're right.

Operator

Your next question is from Chris Horvers.

Christopher Horvers - JP Morgan Chase & Co, Research Division

JP Morgan. Piggybacking on a series of questions, including what Matt was just driving after. So it sounds like the cost containment initiatives, a lot of that's in the base now. Due to gross margin lift, there's some incrementally going forward but -- and perhaps that's getting baked into the EBIT. So is the -- your outlook going forward, more predicated on, not necessarily macro, but your ability to improve results in North American Retail with the accessory and PC resets and with the new store operating model and maybe just a little bit of BSD getting better?

Kevin Peters

Yes, I think -- Chris, its Kevin. I think -- let's do BSD first. SO certainly, we've lapped over the U.S. community. We've had some nice wins in picking up some large global account, so I think our expectation is that BSD will perform better, to your point. I think with regard to North America Retail, I think we're not planning on any change in the macroeconomic environment. What we are expecting is that with the changes to the technology and peripheral assortment, as well as our continued actions on pricing and promotion, and then finally, better conversion to the in-store customer experience that we'll improve the comp sales trend but more importantly, continue to drive incremental margin to the business.

Michael D. Newman

We think the initiatives -- again, we've guided $150 million to $170 million of gross benefits from initiatives this year. I think we still have got initiatives that if we look at '13 that we'll be working on. We're starting to translate some of the successes here into the International businesses as well. So to say that we're going to rely on the macro going forward would be a gross misstatement. I think we're still at, to Neil's earlier point, we have to operate this business assuming this environment is not going to improve dramatically. BSD is better, but we're still very focused on initiatives and process improvements and trying to look at parts of the business that aren't growing, to Kevin's point, like CPD and other areas of growth.

Neil R. Austrian

This is Neil, Matt. I think the other piece is that we haven't really -- we focused on but we have discussed is I'm very optimistic that over the next year or 2, we're going to significantly turn around the direct business on the International side, which is enormously profitable relative to the contract business. And I think Steve has done a terrific job from the time he jumped in there in November in terms of understanding what the issues are and taking some of the best practices we learned here over to Europe and infusing that in the business. So I think there's a real opportunity for that. The other piece I'd mention on the BSD side that Kevin talked about earlier, our small- to medium-sized business, as you guys know, it's significantly more profitable than the large. And I think that the business we've set up in Austin, Texas is going to significantly change the mix of our customers over time to a more profitable margin base in the BSD side in the U.S.

Christopher Horvers - JP Morgan Chase & Co, Research Division

Neil, as a follow-up to that. So maybe in that $150 million to $170 million of gross benefits from initiatives this year, how much is explicitly non-sales-related?

Neil R. Austrian

80% of it. You're getting some contribution from in-store experience, but also there is pricing promotions, indirect expenses. Quite a bit of it is non-sales-related.

Christopher Horvers - JP Morgan Chase & Co, Research Division

Okay. And then -- and final question on the store impairment charges. I'm assuming this analysis is done once a year. So you wouldn't expect any additional charges in the future quarters in '12?

Neil R. Austrian

It's actually done every quarter. We did it -- we started it in November for year end, and we did it again in Q1. So to say that we would not expect -- for us to see a significant change in this impairment charge, we would need to see a change in the trajectory of the sales assumption we use, which I'm not going to call out and/or a lack of performance in our business initiatives, which you guys have seen we've done a very nice job in the last 1.5 years on that, or a significant change in the specific store assumptions that are really out of the control of the macro, a store for whatever reason doesn't perform well either due to people or due to egress or whatever, because it's done on a store-by-store basis. So for me to sit here and say you won't see any noise on this going forward would be a difficult thing for me to say.

Operator

Your next question is from Mike Baker.

Michael Baker - Deutsche Bank AG, Research Division

It's Mike Baker from Deutsche Bank. I wanted to focus on store closings and downsizes and leases and those types of questions. Can you remind us when your leases come due, how many come due over the next couple of years? And more specifically, of those that come due, how many are bigger stores and/or candidates for the type of reduction that you guys have been talking about, either to a 5K store or just something smaller than the current existing footprint?

Kevin Peters

Sure, Mike. This is Kevin. So to maybe take a step back, we have about 100 stores a year that come up for lease renewals. So at a macro level, that's kind of the size of the prize each year that presents us with an opportunity to downsize the store. As it so happens, some of the largest stores in our fleet, which we refer to as the traditional store, it's the concrete floors with the high bay racking. A significant number of those stores come up for lease renewal over the next 4 years. So they are not only the oldest stores, but they're also some of the largest stores. So they're in line, a big opportunity for us to downsize and remodel, get a better customer experience and of course, improve our occupancy cost. What typically happens as stores come up for renewal is the very first thing we try to do is understand whether the store is in the right trade area. Assuming the store's in the right trade area, then we'll try to downsize the store in place. In some cases, we're able to get landlord funding for that. In other cases, we're not. If the store is not in the right trade area and we can't find a suitable alternative location, we'll close the store. We called out that we're planning on closing 25 or 30 stores this year. Our downsizes and remodels are, call it another 30 or so a year. And then the balance, absent any incremental capital, have largely just been renegotiated, in most cases actually at lower rent. So going forward, we have 2 footprints that we're going to use, the 5K and the 15K. I think it would be fair to say that we'd roughly need twice the capital that we have today to be able to downsize a greater percentage of those stores. Over the last 2 years, all of us have been focused on getting this business back to profitability and managing our free cash flow. I think we are in a position now to take a harder look at the opportunities that might allow us to accelerate downsizes and remodels in 2013 and beyond. We hope that we'll be able to get back to all of you in July at our next earnings update with more details around what that might look like.

Michael Baker - Deutsche Bank AG, Research Division

I think that's important. But it sounds like even this year, you're touching maybe 50% to 60% of those 100 that come up for renewal through closings and...

Kevin Peters

That is true, and we think we'll get about a $10 million benefit in occupancy costs this year.

Neil R. Austrian

This is Neil. I think when we put the plans together for '11 and '12, it was pretty clear that you had an economy that was not going to help. We had a turnaround here in terms of dramatically improving both our cost structure and the margin structure, and we laid out a number of initiatives. And what we also told the investment community, our shareholders and our board is we're going to absolutely be cash flow positive because we didn't know where the economy was. And maybe, just maybe, we played it too cautiously. And what we're looking at now is thinking about how we might dramatically accelerate rolling out 5K stores and downsizing our stores so that when we have 100 that come up, we can impact most if not all of those.

Michael Baker - Deutsche Bank AG, Research Division

Yes, I think that makes sense. If I could just do rapid fire a couple of housekeeping questions here. So real quick on the impairment charge, 50 stores, I think you said that those aren't necessarily closing. In fact, are any of those 50 within the closings?

Kevin Peters

We might close 2.

Michael Baker - Deutsche Bank AG, Research Division

Two, okay. Sorry, I missed that. Of the 700 stores that are now or have better customer experience, you said they're better than the chain. We can't say if those are positive in terms of comps. What we can only say that they're less negative. Is that true?

Neil R. Austrian

That's correct.

Kevin Peters

That is correct.

Michael Baker - Deutsche Bank AG, Research Division

Okay. One more, you call out the impact of the holiday shifts, specifically, in terms of dollars to international and delivery. I don't remember if you talked about it for retail. A lot of numbers lying around this morning. If you didn't, just to complete the model, could you give us that number?

Kevin Peters

We did not call it out.

Michael D. Newman

It was just -- it was a wash, Michael. Between the store closures throughout 2011 and the holiday shift benefit, it was a wash.

Michael Baker - Deutsche Bank AG, Research Division

Right, understood. But if we just want to isolate the holiday shift, again, you did tell us what it was for delivery.

Kevin Peters

We didn't.

Michael D. Newman

No.

Michael Baker - Deutsche Bank AG, Research Division

Right, I understand you didn't tell us. I'm just asking if you could tell us now.

Michael D. Newman

Don't have the number with us.

Operator

Your next question is from David Gober.

David Gober - Morgan Stanley, Research Division

It's Morgan Stanley. A couple of questions on the International business, if I could. And just wondering if we could kind of touch on the guidance for the second quarter and dig into some of the components there. So if I heard you correctly, you're expecting international to be down 4% to 5% in constant currency basis in 2Q. Just curious if that's -- if you adjusted 1Q for the counter shifts and all the changes there. Is that roughly similar or is it a deceleration? And if it is a deceleration, what are the components that are driving that?

Neil R. Austrian

Yes. The way that I'd characterize as a following is that we really continue to see economic headwinds across other European market. You saw with the U.K. end recession. Spain just announced some major economic issues, and we're seeing that across all of Europe. We talked about in our discussion the fact that the direct business continues to have some headwind against this. So it's really a combination of the economic headwind in addition to our direct business which, again, we're working on trying to improve. But that's really what's driving kind of our forecast at this point.

David Gober - Morgan Stanley, Research Division

And within that comment, and I know Neil mentioned some of the optimism around the direct business, you've noted for a while now that the direct business has been a driver of some of the weakness there. Can you kind of give us a little bit of the directionality around what the declines are looking like there? Are they improving? Are they getting worse? And it sounds like that's expected to dip a little bit in the second quarter, but just wanted to make sure I'm hearing that right.

Neil R. Austrian

Yes, what you see across Europe in the direct business is you really see a change in the marketplace similar to what happened here in the United States is you're really seeing a transition from what I'll call classic direct business which is catalog, direct mail and e-mail, obviously, too, e-commerce. And so you're seeing that decline occur across the European business. We have a very strong business in direct as a result of the Viking acquisition. And that core piece of the business as it's declined is obviously moving to the web, and so what we're managing is that transitional process between those 2 different elements. And that's really where you've seen the decline. What we talked about, though, is we are seeing improvement in the trends. We've got resources and plans put in place to manage that, and our expectations are that we will continue to see improvement in that business as we go forward quarter-by-quarter.

David Gober - Morgan Stanley, Research Division

Okay. And Kevin, just kind of following up on the some of the comments that you've made on the real estate strategy, understanding that you're going to come back to us in July with an update. Is there an ultimate kind of footprint in terms of the number of stores that you guys are thinking of? Just kind of looking at the store closings on an annual basis, it seems like you're pretty much on track for 2% to 3% a year. But just curious if there's an ultimate number that you have in mind there.

Kevin Peters

No, I don't think we have an ultimate number in mind. At the end of the day, brick-and-mortar and the Internet have to find a way to play in the same field. And I think for us, brick and mortar will be about convenience, the sensory experience and for customers who need help navigating to a solution. And so as we think about downsizing our store footprint, we're going to make sure that part of that process addresses those 3 attributes, but also allows our customers who shop in the store or on the Internet to have a seamless experience. And so we'll let that kind of drive what the store count looks like.

David Gober - Morgan Stanley, Research Division

Okay. And if I could squeeze one housekeeping item in there for Mike. On the preferred, you had mentioned on the last quarterly call that you were picking the preferred. And obviously, that's what happened. Just curious now that you've turned about a portion of the 2013 maturity, are you going to continue to pick that preferred?

Michael D. Newman

Yes. At the last call, we gave guidance that we do pick for all of 2012, and that's all we really guided towards. So it's really -- the really good decision to pick had a lot to do with our capital location discussion. Some of it had to do with the rest of the bonds that we have come due in 2013. But frankly, more of it had to do with the investments that we'd like to make in the business. We'd like to accelerate the downsizing. As Kevin said, we'll come back to you in another quarter or so, and there are other things in our business that we'd like to invest in. We'd like to invest more in e-commerce to drive that business. So it would be hard for me to say what the guidance is beyond '12, but that was really what was behind it.

Operator

[Operator Instructions] Anthony Chukumba, your line is open.

Anthony C. Chukumba - BB&T Capital Markets, Research Division

It's Anthony Chukumba with BB&T Capital Markets. Just had 2 quick questions for you. One was on the old U.S. Communities contract. Previously, you had given updates in terms of how much of that business you'd be able to retain, and I was just wondering what the update was there. And then the second thing, you talked a little bit about direct imports and what the penetration was there. I was just wondering about what your private label penetration was and what your long-term target is for that.

Kevin Peters

Anthony, it's Kevin. I think what we've talked about with regard to retention of customers on the U.S. Communities contract is that we retained north of 85%. And so that continues to be where we're at today. In terms of direct import penetration, it varies a bit by channel. But I would say it’s kind of that mid-teen range for direct import and in the low to mid-20s for private brand penetration. I don't know that we necessarily have a target other than we believe that there continues to be opportunities to grow penetration, both in direct import as well as private brand. I think that will be a source of gross margin expansion for us in the quarters to come.

Stephen M. Schmidt

And then, Anthony, in the Europe, on the private brand side, our penetration rates are slightly higher than they are in North America. And as Kevin stated, we also see an opportunity to improve that penetration levels going forward.

Operator

The next question is from Aram Rubinson.

Alisa Guyer Galperin - Nomura Securities Co. Ltd., Research Division

This is actually Alisa Guyer on for Aram Rubinson, Nomura. Can you just help us out? I know that the income statement number for the pension item was different from the cash flow number because of currency translations, but what are the 2 different cash flow numbers? Why are we seeing the $49.8 million in investing and then the $58 million in operating?

Michael D. Newman

Yes, this might take a while. Yes, we had a cash flow settlement with the company that sold us Guilbert in 2003 of $58 million. Okay? We received part of that as a prepayment, so you should see another item on the income cash statement. There's a $49 million and a $9 million, which should add together to $58 million. The reason the income statement is different is we recorded $58 million of that as income. We also reversed $10 million of accruals related to other items that had to go with this settlement. So that's $68 million that you'll see in the income statement. And then we highlighted that there's about $5 million of legal fees that we had tied up on the balance sheet that we reversed at the time of the settlement. So that's the difference between the $58 million received and the amounts on the income statement. Does that help you?

Alisa Guyer Galperin - Nomura Securities Co. Ltd., Research Division

Yes. But what's the $49.8 million?

Michael D. Newman

Yes, we received the cash through 2 tranches. We received $49.8 million in February. We received $8.5 million earlier. And those are both related to the same settlements. If you add those 2 together, you should get something very close to $58 million.

Alisa Guyer Galperin - Nomura Securities Co. Ltd., Research Division

Got it. And then -- so do we correctly understand that there would have been no income statement effect at all had you not written down the goodwill however many years ago?

Michael D. Newman

Correct. If we had not written down the goodwill a few years ago, this would be treated as a purchase price adjustment. It would have gone against goodwill, and we wouldn't be having all this fun today.

Alisa Guyer Galperin - Nomura Securities Co. Ltd., Research Division

And then the pension payment would have been an operating cash flow item like any other pension payment?

Michael D. Newman

Yes. The pension -- yes, when the pension settlement came in, it was treated like a purchase price adjustment and ends up as an inflow in investing. And when we paid it into the pension fund, it ends up as an outflow for operating, so it has 0 impact on the cash flow statement. But if you're looking at free cash, it shows as a negative. If you look at investing, it shows as a positive. If you look at total, it shows as 0.

Alisa Guyer Galperin - Nomura Securities Co. Ltd., Research Division

Okay. And then just real quickly, the $23.6 million in P&L adjustments, that's $18 million add back of Europe impairment and $5.3-ish million corporate?

Michael D. Newman

That's correct. And of the $18 million in Europe, about $11 million of it relates to a closed facility that's a warehouse in the U.K.

Operator

The next question is from Alan Rifkin.

Alan M. Rifkin - Barclays Capital, Research Division

It's Alan Rifkin with Barclays. Most of my questions have been answered, but just have a couple. First, for either Neil or Kevin. You cited lower advertising cost as a source of gross margin gains on the retail side. I was maybe -- but yet obviously your comps are still down significantly. Can you maybe speak philosophically as to how you're thinking about advertising going forward in terms of trading off some gross margin dollars for comp gains?

Kevin Peters

Yes, Alan, this is Kevin. I'll jump in and then let Neil answer. I think our comment was that advertising was down year-over-year. I think again it's tied to being a little more thoughtful in strategic about how we promote, and I'll give you an example. When we looked at the utility of our inserts and determined that there were certain in-surge and in some cases, a broad set of in-surge based on product mix and promotion that just quite frankly weren't -- they were driving traffic but from a profitability standpoint, they just weren't sufficiently profitable. And so one of the things that we've done is we've reduced the spend in those inserts and tried to repurpose those dollars into marketing activities that have better returns for us.

Neil R. Austrian

What I'd add to that is that, as you know, we've got a new head of marketing, Bob Moore. And what we started to look at is, as Kevin said, the utility of the inserts but also, what can we do with broadcast advertising, both the mix of television and radio in specific markets to see if that can drive sales. And I think what we've seen is that when we tested our copy print and tech depot in 2 different markets, we found that advertising was able to drive comp sales. You won't see it on a profitable basis in the year that you run the advertising, but there's a long tail. And what we've seen in terms of our brand advertising and promotional advertising is that when we tag it with a technical or technology kind of product, it dramatically lifts sales. So what we're doing is being a little bit thoughtful. We have a new agency that we hired less than a year ago, Zimmerman, and I think together what we're finding is where and when we can run advertising that will drive the business profitably but also enhance the brand.

Alan M. Rifkin - Barclays Capital, Research Division

Okay. One follow-up, if I may. On the 700 stores with the enhanced customer experience that you said are doing better than the corporate average but not willing to quantify it, I mean, would it be reasonable for us to assume that hopefully the lease stores are comping positive? I believe you said in response to an earlier question that they'll be negative. I mean, can you just clarify that?

Michael D. Newman

Yes, I don't think it would be accurate to assume every store is comping positively. I do think it would be accurate to say that of the 700 stores that are on the in-store customer experience, they're comping materially better than the control group. Some stores, however, were comping negatively and they've had a significant improvement in, but still negative comps.

Alan M. Rifkin - Barclays Capital, Research Division

Okay, but the returns are sufficient such that you're continuing with the program. Is that right?

Michael D. Newman

We wouldn't roll it out if the returns weren't significant.

Operator

The last question comes from Joe Feldman.

Joseph I. Feldman - Telsey Advisory Group LLC

Telsey Advisory Group. I just wanted to go back to Europe for a minute and ask kind of how are trends through the quarter? Did trends change at all? Did they improve or get worse? And maybe -- I understand that Northern Europe seems a little bit better, but maybe you could take me through the flow.

Stephen M. Schmidt

Yes, Joe, this is Steve. The trends are actually right on in terms of what we thought the business would be. If you look at how we forecasted Q1, we're right on kind of what we had forecasted back in Q4 from a revenue standpoint. The overall revenue trends are slightly down versus Q4 of last year. So we continue to see economic headwind, but it's something that we believe that we have forecasted into the business right now and believe we have a good handle on where we think the business will be assuming that no incremental economic impact hits us in 2012.

Joseph I. Feldman - Telsey Advisory Group LLC

Got it, got it. And then there was one other sort of unrelated question. Wanted to ask about on the service side of business, I know Copy and Print is doing well. I noticed -- actually, I didn't hear you guys mention Tech Depot at all or any other initiatives. Maybe you could talk about some of that?

Kevin Peters

I think in the U.S. business, Tech Depot, I think, has largely followed the trends of our laptop and desktop business, so still doing a nice job with attaching for services and product protection plans. But the overall contribution is lower given the decline in sales in units.

Brian Turcotte

So that's going to conclude our webcast and conference call this morning. Thank you very much for participating, and I'll be available to take your calls later today. Thank you.

Operator

That concludes today's conference. You may disconnect at this time.

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