ACCO Brands Corp (ACCO) 2007 Q2 法說會逐字稿

Good day, ladies and gentlemen and welcome to the second-quarter 2007 ACCO Brands earnings conference call. My name is Dan and I will be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question and answer session toward the end of this conference. (OPERATOR INSTRUCTIONS). As a reminder, this call is being recorded for replay purposes. I would now like to turn the call over to Ms. Jennifer Rice. Please proceed.

Good morning everyone and welcome to our second quarter conference call. On the call today are David Campbell, Chairman and Chief Executive Officer of ACCO Brands; and Neal Fenwick, Executive Vice President and Chief Financial Officer.

Before we begin, I want to let you know that we have posted a set of slides to the investor relations section of ACCOBrands.com this morning. These slides give a lot of detailed information to supplement this call and summarize items that have impacted our financial results over the past 18 months and factors that will likely impact results over the next 18 months. Our discussion this morning will refer to our results on an adjusted basis, excluding restructuring, nonrecurring and unusual items. A reconciliation of results to GAAP can be found in this morning's press release.

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. At the courtesy of others, we ask that you please limit yourself to one question.

Now I will turn the call over to Mr. Campbell.

Thank you, Jennifer, and good morning everyone. We are pleased to share with you that ACCO Brands had a very strong second quarter. We grew both top and our bottom lines, improving our adjusted gross margin for the fourth consecutive quarter. We achieved nearly an 80% improvement in our adjusted operating income as synergies and price increases built through the quarter. Many important strategic investments were also made in the business.

Additionally, we're pleased to see sales growth, particularly in a quarter that was generally slow across the industry. We are pleased with our sales gains in Computer Products and further expect gains in our Kensington brands in the second half of the year with the strong placement of new products in North American retailers.

Our adjusted gross margin increased 300 basis points, driven by the initial flow-through of integration synergies and the impact of price increases implemented in January of 2007. ACCO Brands' quarterly improvements are all the more impressive as these gains were made despite the ongoing transition costs of streamlining our U.S. and European distribution infrastructures. To date, our distribution costs have increased and we do not yet see the benefits of our distribution investments. We are still temporarily shipping products less efficiently than we will when our global distribution integration is complete.

The first benefits from streamlined distribution are on plan to be phased in starting in the fourth quarter of 2007 for Europe and the first quarter 2008 for the US.

Even in the midst of our merger transitions, we believe it is vital to invest in future organic growth. This is why we have accelerated our go to market initiatives. We have stepped up our go-to-market spend by almost 100 basis points in the quarter, increasing our investment in the quality of our sales, marketing and new product development initiatives. We believe our overall SG&A spend as a percentage of sales plateaued in the second quarter. Going forward, we expect to see flat or reduced spending as further integration synergies take old.

In our last call, I spoke about margin pressures in our Commercial Laminating business, which represents 9% of the Company's total sales. A competitor benefiting from low-cost Asian sourcing entered the high-speed laminating film category with discounted pricing. In response, we have chosen to match these price levels to defend our market position. Because we manufacture films in high-cost locations within the United States and the Netherlands, we are reviewing supply alternatives to address this issue for the long term. I'm confident we will identify and implement a solution later this year. Right now, we are expecting this segment's overall profitability to be halved for the year to approximately $6 million.

Before I pass the call onto Neal who will provide greater details on the quarter's results, I would like to make a few comments to update you on where we stand with our overall merger transformation process.

In January of 2006, we formally began the execution of a 36-month integration plan. June 2007 marked the 18 month, or halfway point, so I believe it is appropriate to take the time to provide you with some color on where we are in the merger process, what we have accomplished so far and what we expect to see over the coming 18 months.

Our first priority has been to reconfigure ACCO Brands into a business focused clearly on four well-defined consumer needs and provide each with strong leadership. These leaders are now managing our Office Products, Document Finishing, Computer Products and Commercial Laminating businesses on a global basis.

Within each business, we have positioned ourselves into the premium end of our categories, aiming to clearly occupy the number one brand position in each of our business segments. To date, we have consolidated product lines, reduced SKUs counts. We have already jettisoned $60 million in low-margin non-strategic business, including storage boxes and computer cleaning products. Additionally, we're in the process of retiring five brands. In the coming 18 months, we see a continuation to these efforts to streamline and simplify our focus around creating premium categories. Europe alone will reduce its SKU count in the second half of 2007, eliminating more than 2000 SKUs. Looking forward, new products we introduce must be appropriate for all global markets we serve. Our future organic growth will be dependent upon a strong stream of new product development, something which ACCO Brands has lacked in the past.

As merger integration savings begin to flow, we are strategically reinvesting a portion of those savings into product innovation. Within our go-to-market activities, we're reallocating our spending, focusing on high-value initiatives, such as upgrading the quality of our sales organization, creating product development centers of excellence, improving our merchandising programs and launching new products. Our repositioning around premium categories has been a significant catalyst to allowing us to realize our January 2007 price increases. These increases should yield $20 million of margin improvements in 2007 and an additional $10 million in 2008.

The second priority we communicated was to become a low-cost supplier in each of our categories. We have set out to accomplish this in two ways. First, by running each of our businesses globally, creating products that can be sourced and sold on a worldwide basis; and then, by establishing a cost-effective shared service infrastructure that provides a simpler organization with economies of scale. Over the last 18 months, we have begun to transition to move from a 60/40 make/buy ratio to a more outsourced 30/70 ratio. We have already ceased production in 10 of 34 factories, and within the remaining plant operations, we have introduced significant improvements in our demand planning processes.

As we have previously communicated, much of the improvements we're seeing in our gross margin is coming from these outsourcing actions. Currently, we have 94 cost-saving initiatives underway being managed by our project management office. During the next 18 months, the benefits of these initiatives will continue to improve our margins. While much effort has been undertaken in progressing our shared service infrastructures, little effect has yet to be seen on our bottom line. As we collapse key functions into shared services, including human resources, finance, information technology and supply chain, we expect to reduce SG&A expenses by 2%. Most of these benefits will not be reflected in our bottom line until the beginning of 2008.

Our third objective is to optimize our supply chain across all of ACCO Brands. We believe our customers' return on investment can be significantly enhanced by being a vendor that can improve the velocity of their inventory replenishment by providing exceptional order response time, reduced order size, improved fill rate and the elimination of errors. Accomplishing this requires a streamlined physical distribution and a significant investment in information technology and our business processes.

In North America, we have established our Booneville, Mississippi site as our primary distribution center. This will be operational by the first quarter of 2008. In Europe, we're collapsing multiple distribution centers into one primary mainland site Born, Netherlands. Worldwide, 11 small distribution centers have already been closed and seven additional sites will be closed in the next 18 months.

We have also successfully moved our U.S. and Canadian Office Products group operations onto our global Oracle-based IT system and the balance of document finishing will follow in 2008. In Europe, we're well on our way towards consolidating 14 IT system onto seven by mid-2008 and ultimately one by 2010. So far in 2007, U.S. Office Products customer service satisfaction ratings on orders shipped on time and complete have improved 4% and another 5% is expected in 2008. We have achieved these gains even with the disruptions of our integrations.

While we have accomplished a great deal that will advance our supply chain, little benefit is yet reflected in earnings. In fact, to date, our earnings progress has been made with the drag of creating this future benefit. In summary, then, halfway through the integration process, we have closed 22 facilities, reduced headcount by 1100 and eliminated $60 million in low margin sales. When we are finished with our plan, we will have closed or consolidated 39 facilities, reduced overall headcount by 2500 and eliminated $110 million of non-strategic sales.

In short, I am pleased with our overall progress against these three priorities. The transition of ACCO Brands is unfolding much as we anticipated. To date, we have restructured our business segments to align better with our targeted consumer categories; created a strong global leadership structure; streamlined our product offering, focusing on the premium end of our categories; repositioned as a low-cost producer; created a simplified cost-efficient shared service infrastructure; made good progress towards creating a superior supply chain; implemented price increases to catch up with prior years' cost increases and realized significant synergies. Importantly, this all works together to drive improvements in our top and bottom line. Moreover, we view the second quarter as a threshold to greater synergies savings and top-line improvements as we complete the work we began early in 2006. We believe the key to unlocking the value at ACCO Brands and realizing a long-term vision for the business is to continue to successfully execute against our plan.

Thank you for your continued confidence in us, and Neal and I will look forward to taking your questions later on in this call. Neal?

Thank you, David. All-in, the second quarter was strong. We achieved good performance across three of our four business segments and for the benefits of synergies, price increases and for overall mix, drove bottom-line improvement. All of this was accomplished even as we incurred high distribution and administrative costs and reinvested in the long-term growth of the business.

In short, this was a strong period for ACCO Brands and reinforces our ability to achieve overall expectations. (inaudible) sales increased 0.5% with comparable sales, which exclude the impacts of currency as well as exited business, were up 1% due to price increases of 2%, offset by underlying volume declines of 1%. We're now realizing the full benefit of our January price increase as well as price increases implemented in July of 2006, although these start to anniversary out next quarter.

Adjusted gross margin as a percent of sales was up 300 basis points, but the underlying story is even stronger. Driven by integration synergies, price increases and a favorable product mix, these improvements were partially offset by 50 basis points of higher year-over-year freight and distribution costs incurred as we transition our distribution footprint in North America and Europe. After our Born and Booneville distribution centers fully come online and get through their learning curve beginning in 2008, we will began to see a significant production in distribution costs by approximately 120 basis points on a run rate basis by the end of 2008.

Adjusted SG&A increased by a modest 30 basis points. Looking forward as we benefit from further cost reductions, we anticipate a steady reduction of SG&A percentage to sales, even though we plan to permanently spend more on marketing and product development. We will continue to reduce general administrative to offset this. We also anticipate a lower stock option expense in the second half of 2007.

The shift in our long-term incentives from stock options towards performance shares as well as the extension of our restricted stock unit vesting from three to four years for the majority of the awards mean that equity incentive charges for the year are now anticipated to be $5 million lower than previously estimated, or about $15 million. Foreign exchange rates continued to increases SG&A with $3 million of the $2 million increase in SG&A being currency related, the underlying $1 million reduction coming from lower equity incentive charges. As David indicated, we believe our SG&A costs as a percentage of sales have peaked in the second quarter.

Adjusted operating income in the quarter was $31.5 million and margin was 6.8%, or a 300 basis point improvement. This is despite 130 basis points of increased distribution and go-to-market expenses. Adjusted earnings per share for the quarter was also strong, up 250% to $0.21 per share. The adjusted income tax in the quarter was 30.4%. We now expect the tax rate for the year to be about 31%, or 300 basis points lower than we previously communicated. Cash taxes for the year are estimated to be higher at $24 million. These changes reflect the current FX rate and the increased share of international earnings now anticipated.

Turning to onetime charges, through the quarter, we booked restructuring charges of $2.4 million and associated nonrecurring charges of $8.7 million. Our European integration recently made a large step forward as we began to transition our French volume into our new centralized distribution operation in the Netherlands. The transition of France will complete in August and so far we are pleased with the progress.

Finally, looking at some balance sheet items, our working capital overall was similar to Q1 but reflects normal seasonal factors, such as back to school inventory. We also built extra inventory in Europe, effectively duplicating the French inventory to ensure a smooth transition for our customers as we continue to streamline our distribution model. Transition-related inventory amounted to approximately $8 million in the quarter. FX changes accounted for the largest increase in reported inventory value of $10 million compared to the prior year. Net-net, underlying inventory balances are down.

Our debt levels increased slightly at the end of the quarter as a result of short-term needs. As we said last quarter's call, we still expect to reduce debt during the second half of 2007. Our anticipation is for $50 million of real reduction for the year as a whole. We continue to expect our debt to EBITDA ratios to improve in 2007 and 2008 as we simultaneously improve EBITDA and continue to reduce debt.

Now I will briefly walk you through the performance of each of our four business segments. Sales for Office Products were down 2% with business exits of $15 million accounting for the decline. Although adjusted sales were up 2%, this was due to increased pricing of 4% and currency of 3% as volume was down 2%. The decline in volume resulted from weakness in the U.S. due to volatility in our customers' order patterns and inventory levels. While our customers, particularly those with large retail businesses, continue to shift to private-label products in certain categories within Office Products, beyond our own planned as exits, this shift is having little impact on our categories or our market share overall.

Benefiting operating margins in the second half, we still expect to see our European operations continue to improve profitability as they sequentially collapse their duplicate country-based infrastructure into our new centralized and European business model. This benefit impacts all of our reporting segments.

Turning to Document Finishing, sales increased 3%, favorable currency translation accounted for 3 points of the growth with price increases contributing 2. Offsetting these factors were the impact of business exits [of] 1% and a volume decline of 2%. The volume decline resulted from lower sales in the indirect channel, future volatility in our customers' ordering patterns and inventory levels, as well as a small share loss to private-label penetration, both of which offset strong sales in the direct channel. Operating income margins expended 130 basis points as synergy savings and favorable pricing more than offset continued investment in go-to-market activities and new product development.

Computer Products sales grew 4% for the quarter with currency of 3%, pricing of 2% and volume growth of 1% more than offsetting business exits, which were 2%. The volume growth was driven by international sales which for the first time accounted for more than 50% of all sales, surpassing U.S. volumes, which declined. U.S. sales performance is expected to improve in the second half of the year as new products gain retail placement for the back to school and holiday seasons. Operating income improved 42% and margins expended a strong 560 basis points, primarily due to favorable product mix, expense management and exits of low-margin SKUs.

Results in the Commercial Laminating Solutions group were as expected, again disappointing, and will likely to remain so for the rest of the year, although we do anticipate some improvement. While sales in the second quarter were up modestly, favorable currency translation was a primary driver. Sales volumes stabilized as we decided to drop pricing to maintain our market share. However, given that our cost structure in this business is not where it needs to be, margins were impacted. David has already spoken about our review of strategic alternatives for this business.

Despite the challenging environment, ACCO Brands remains optimistic about the balance of 2007. As planned, sales growth for 2007 will be impacted by approximately $75 million exit from non-strategic businesses. This will break down to approximately $20 million in Q3 and $12 million in Q4.

We remain confident that 2007 is on track based on the progress we have made in executing our integration plans and resulting synergies that we expect to yield in 2007. As a result, we're reaffirming our expectation for adjusted annual EBITDA in the range of 230 to $240 million. Importantly, the current outlook could be impacted by increased volatility in customer ordering patterns in the second half of the year. That said, the success of our year is much more dependent upon steady execution of our existing plans.

With respect to the mid to long-term outlook, we believe we are on track to meet our stated objective of a run rate adjusted operating income margin of approximately 11% by the end of 2008. I refer you to the slides posted to our web site that provides a bridge of our key ratios and their drivers from 2004 to date and how we anticipate they will develop to the end of 2008.

With that, I will turn the call over to the operator so we can respond to any questions.

(OPERATOR INSTRUCTIONS) Reza Vahabzadeh.

As far as your sales are concerned, I don't know if I got this right, you provide a lot of disclosure in the press release, but I haven't gone through every single line. It looks like Europe was a -- had a good quarter for you from sales a standpoint, and U.S. is sluggish to soft, even excluding divested businesses. Is that accurate?

That would be correct.

Can you comment more on that -- why is the U.S. soft, and why is Europe healthy?

Generally, I would say the biggest experience we have seen still in the United States is volatility around when our customers are ordering. If you remember at the end of Q1, we pointed out that we had a very low level of demand in March and that we saw a lot of orders come through immediately starting Q2 in April. We saw exactly the same development at the end of Q2 in June with the same flipping of when our customers are ordering. The impact of that was less pronounced obviously in Q2 because you had the pickup in April. So what we are seeing I think is the biggest effect in the United States, demand for general office products channel, it relates to customers' ordering patterns.

I think there is also a little bit of an impact in terms of a general belief that the retail market is flowing in the United States, and we probably had some impact of that.

Kensington is a slightly different issue. Their U.S. business has been soft, you'll remember, since the problems started with the -- last year with the indirect distribution channel there, and they have had the added impact of store closures. So it's much more pronounced in Kensington's case where sales, U.S. sales for the year, are down sort of mid-teens percentage and all of the growth is coming out of Europe. What we are seeing is a pretty mild decline in the office products channel and good growth in Europe. And partly, the good growth in Europe is coming, from Kensington's case, from gaining share and getting new placement of SKUs. And from the office products case, it's really just a question of continuing the execution that we have been discussing for a long time of gaining further penetration on mainland Europe. The economies in Europe are also turning up, whereas U.S. is turning down.

Right. How do we know if it's just volatility in ordering patterns by your customers, as opposed to actual inventory de-stocking for the whole year?

Because when you see them reorder it a few days later, you know it's volatility as opposed to long-term de-stocking.

I see. And then as we look into the second half, any input costs that are either rising more than you would expect, or declining? How should we think about the input costs (inaudible)?

It seems there's kind of three concern points on input costs, would be -- one that's going to affect everybody, which seems to be a change in Chinese VAT where the subsidies that are used to provide to certain regions seem to be being withdrawn. This second one would be ocean freight costs, which continue to rise. And the third one would be oil prices, which have just hit an all-time peak. So there would be the concern points on raw materials.

Got it. Thank you.

Bill Chappell, SunTrust Robinson Humphrey.

I should first congratulate you on a 12-page press release; that is an on-time record I think by half.

Thank you; we worked very hard at that, Bill.

I guess on the costs and as you look forward on pricing, were there any additional price increases taken in kind of the June-July time frame? Or, where do you see prices going for the back half of the year and into '08?

Sure. Let me first of all give a quick recap for folks and put this in perspective. In January of 2007, we did have a fairly significant price increase that is now flowing through the quarter. I think that was rather an unusual event for us in terms of a catch-up price increase where we were picking up costs that accumulated over the past 18 to 24 months. So having done that, and now having the flow through, I think we are monitoring well the cost increases we are seeing. We are right now looking and trying to put thoughts together as to what we would expect for price increases perhaps around January of '08. We don't see a midyear adjustment. I don't think -- I think that that has been well taken into account. So I think we're back into a normal cycle, I think that's the important thing. I think we tried to stress that while we don't see such a dramatic event taking place again as what we went through in January of '07, we see more of a normal approach.

Okay. And then on the costs, you talked about freight costs being high and being high on a go-forward basis. Is that all energy-related, or are there still capacity issues? How should we look at that for the back half?

One of the issues we have, we have the large investments going on in our distribution, both in the United States and in Europe. As a consequence of that, we are suboptimally shipping at the moment, and therefore part of our freight cost increases are of our own making and will stay with us certainly in North America through the back half of the year.

And, finally, on Computer Products, I know you have gotten some extended distribution at Best Buy and Circuit City and other retailers. When do we see the majority of that kind of sell in? Did we see that this past quarter, or will we see that the next couple of quarters?

No, I think we'll see it in the next couple of quarters. We've been very active in terms of -- with our new product development programs. The last really 12 months, I think that has yielded what we believe are some exciting products. We have shown those to our retail customers; that seems to get good acceptance. It's just happening now. The flow-through really I believe will be into the third, more the fourth.

One last -- I assume the tax rate is sustainable going into '08?

Yes.

Okay, congratulations.

Bill Schmitz, Deutsche Bank.

Can you quantify the impact of the Chinese VAT rebate change?

Actually, I can't. (MULTIPLE SPEAKERS). What I would say to you is, it's just like every other raw material increase that gets communicated to you by your suppliers. It's part of a negotiation that you go on with your suppliers. A lot of our view is that they were given a subsidy to help them start up and cover their start-up costs, and that we shouldn't be bearing it in any case. But whether we can continue with that line, I will find out over due course.

Got you. Is there going to be another wave of pricing perhaps if it doesn't get pushed back to the supplier?

Fundamentally, if the industry as a whole has to take this type of price increase, we will pass it through.

I very much agree with Neal's point. ACCO is in no way unique in that this is truly something that would affect all folks who source.

And our customers' direct sourcing as much as our competitors.

Correct, with private label.

Sure. And did pricing stick better this quarter than last quarter? Because I know there was January price increases, but it was early January I thought. And, if you looked at the pricing impact on the first quarter of '07, it was about 1.5%, and looks like it was about 2.6 this quarter. So was there a change in that dynamic of the stickiness of the pricing?

Part of what we've always tried to communicate is, although we officially have a January 1 price increase, it phases in during the quarter, depending on when different customers have their anniversaries at contract. So in Q2, you do see the full effect of it. You also will see what effectively is a peak issue because you have the full benefit also of the July '06 price increase, which obviously will start to phase out as we get into Q3.

Got you. Can you just tell me what the year-to-date impact is of eliminations, the SKU eliminations?

In terms of --?

Of the $75 million, how much have you realized thus far this year?

$37 million.

Okay, that's great, just sort of halfway. If I look at that great bridge you put together, about kind of how you're going to get to -- in the slide deck, which is actually really, really helpful. It doesn't have any incremental go-to-market investment in there. If there is money left over, are you going to spend back? Or what was the sort of thought process on that?

The whole process in that was fundamentally that what we have going on in there is a mix change that's going on, in terms of -- we have reached the spend level that we are comfortable with. What we're now doing is getting greater productivity out of that spend level and the transition away partly from selling costs towards more product development and marketing costs.

There really is a pretty aggressive program going on within the business to analyze the quality of our sales-marketing spend. So what we're really trying to do is make sure it's properly balanced -- sorry about that -- and so that we are not sort of overspending in one part of our selling-marketing and underspending in another. So I think that what we will see over the third and fourth quarters is a much better balancing of talent and resource on the areas that will really drive our business forward.

Okay, great, thanks very much.

Arnie Ursaner, CJS Securities.

Hi, it's CJS Securities. Real quick question. In Europe, you mentioned you're going to be eliminating 2000 SKUs. Can you just walk us through the process of how you do this? And if your retailer is sitting with these various SKUs, don't you think it would impact their purchases until they get out of the various inventories they have of discontinued products?

Sure, Arnie, I can speak to that. First of all, I think you have to understand that the nature of the distribution in Europe is a much more fragmented distribution today. So there is not the large, large retailers that we have today. So it's much, much smaller, more fragmented. I think as we have reviewed our SKU offering, again, what we do is just kind of take a look at an 80/20, and in this case, I think it's more like a 90/10, and say there are very clearly some areas that we are carrying SKU items that can be easily replaced or consolidated. That is in affect what we're doing. So there will be a lot of substitution kind of activity taking place, and that's really what we're finding.

I think this is a very important step in moving from a country-to-country-to-country type of way of running our business to a much more pan-European. The products that will be replacing these eliminated items are much more pan-European, can be sold in multiple countries. I think it's the right and logical progression for our business.

And on the gross margin, which obviously was one of the real positive surprises in the quarter, clearly this quarter was expected to be the best gross margin improvement year-over-year. You benefited from the full quarter impact of your Q1 price increases, you benefited from the mid-year increases that were put in more than a year ago and the cost synergies. Can you comment on your view of gross margin over the next few quarters? And obviously it's dependent on volume, but what do you see for gross margin trends over the next few quarters?

I've actually tried to give that color at the beginning of the year. We expect gross margins for the year as a whole to be up about 200 basis points over prior year, and so you are quite correct that this will be the largest expansion of gross margin, and you will see that taper down. And, again, if you remember in Q3 and Q4 of last year, you saw the big jump in synergies, and obviously that annualizes out in terms of the impact on gross margin.

Thank you.

Derek Leckow, Barrington Research.

Congratulations on a great quarter. Just to drill down a little further on the cost of goods sold issue. You faced higher freight costs, suboptimal shipping all year, yet your cost of goods sold are down about $40 million through six months. Can you help us understand that a little bit better in the next two quarters? You said there was going to be a comparison issue in the back half. Can you explain that a little bit better?

What I was trying to say in the back half, what you will see is that the big jump we had in synergies in Q3 and Q4 of last year annualizes, and therefore on the year-over-year issue, has less of a contribution to gross margin. We will, however, continue to generate some new synergies, but we will also continue with freight distribution costs in the United States that remain high. The good news is, we will start to reduce some of our excess costs in Europe, particularly with the transition of France which we'll complete at the end of August. So there maybe be a Q4 impact, but it will be a favorable one.

So the cost of goods improvement year-over-year probably gets lower, but your margins should still I guess rise with the price increase -- Is that how I should think about that?

Correct. You get both price and synergy, but some negative freight and distribution as a negative synergy [actually] offsetting.

How committed are you to the current prices? If you saw an input cost go up, couldn't you make that adjustment through the ordering in the back half of the year, or are those items that are already locked in?

I really don't think that we really do see something that will be a pop or a jump. I think the way that we have reconfigured our business is that we are now getting a level of visibility of costs coming at us sooner than we used to. We have also configured our relationships with our customers so that we can give them warning. So the combination of seeing costs coming from our suppliers and the ability to be able to communicate with a reasonable window to our customers really gives us the buffer I think to give our customers a six-month notice.

Okay, great. One more question on Document Finishing. Can you talk about the split between direct and indirect? How fast did direct grow? And then I just wanted to ask about their new product, the new presentation binders -- where do we stand on the launch of that product?

As a general sense, we don't want to get into the kind of sub-analysis of each of the segments. Takes you down to SEC disclosure we don't want get into. But, in terms of a general, is we basically saw the indirect channel have the same pattern as we saw in the Office Products channel. And so, the U.S. Office Products channel was down about 2%, and so it was all Document Finishing in the United States. And so the growth is really coming out of the direct channel as opposed to the indirect channel, and it comes from the ProClick type of product.

If I could just add a comment to what Neal said. I think as we develop new products, particularly in DFG, there is no question. Our direct sales force is just terrific at being able to bring that product into a customer, introduce it, demonstrate it, show it to people, because it really does require some education, some help to demonstrate to folks just how it works and how good it is.

Looks like a huge opportunity.

We think so too.

Then just on the guidance, the lower stock option expense. You did not raise the EBITDA guidance and I just wondered why, if you're going to be seeing that savings in the back half?

It doesn't have any impact on EBITDA. The way we do the calculation, it improves operating income, but it doesn't improve EBITDA.

Okay, just -- if I take out. Okay, thanks.

Rick Weinhart, BMO Capital Markets.

I had a couple of follow-ups. On that last question regarding the indirect and direct for Document Finishing. Is there a noticeable margin difference between those two channels when you get a sale from one item?

Yes, as there always would be on a direct sale business. There's also a lot more operating expenses running a direct sales business. It's a very different business model, higher gross margin, higher operating expense.

Yes, it's just different ratios.

Okay, but from an operating perspective, was there an impact in the quarter from that shift?

Marginal.

My second question, Neal, you were talking about the trends coming from some of your larger U.S. -- I believe probably the big box retailers that -- ordering trends shifting. So you get more of that up front in the quarter and then a fall-off in the back. Did that trend continue in the third quarter? And if so, then I would think you had some pretty good visibility at least into how the quarter could perform at this point.

We definitely saw the same impact of June going into July, but of course the issue is what happened in September.

Right, so then you're off to a strong start, you just don't know how weak it's going to be at the end? Is that paraphrasing it?

My personal view is that this is an ordering pattern that sets a stage just quarters out at the time it changed in Q1.

Okay, and my last question --.

Going forward, it has little impact on each quarter.

Right, I just meant that, it seems you give a lot more visibility now, at least on the front end. You're off to a strong start, though.

Yes.

Okay, thank you. And then the last question is on the Kensington product and the increased distribution. In the U.S., with some of the big box retailers, I think you've talked about the different types of partners you can have, whether it's promotional for the holidays or not. Is this increased distribution, is this something more of a short-term, or should we look at this as a long-term relationship where you will have this business for the full year?

No, this is mainly long-term. In fact, I've used before the kind of Best Buy measure for people. We got our Best Buy SKU count, which was only three last year, and for the back to school season this year, we're at nine. We believe we're going to get another three positioned in for endcap promotions. And so we've done well at getting in-line placements with U.S. retail, as well as continued penetration in European retail.

Okay, thanks and congratulations.

Seth Basham, Credit Suisse First Boston.

Just to follow up, in regards to July, sell-in versus sell-through, am I understanding this correctly that sell-in was a bit down, but sell-through in the U.S. office products was actually still pretty good?

In fact, the easiest thing we get quickest is inventory levels. The POS data we don't fully have at this point in time in terms of sell-through, so I cannot give you a full comment about that. But if I use inventory as the interpolation, then we believe that fundamentally what we saw was a very minor reduction in inventory levels, and that sell-through in the United States was down.

Got you, thank you. And then, in terms of the European office products business, can you give a little bit more color? You mentioned that it turned the corner. What kind of improvement year-over-year do we see in a quarter in operating profits there, and how should we think about that in the back half?

Very simplistically. One of the big drivers of our second half will be Europe. Europe made no money in the second half of last year, and this year we would anticipate it contributing about $10 million. So it's a big piece of what will drive the second half to be favorable, and that is really driven by a combination of the price increase and synergies starting to flow positively in Europe.

Okay. In managing the elimination of 2000 SKUs, over what time period do you expect that to occur, and when do you expect to shut those off?

I'm sorry, I missed the question.

Just in terms of Europe, I think you talked about eliminating 2000 SKUs. Over what time period do you plan to do that, and how do you manage that transition?

It really is taking place over the back half of this year, of 2007, and we will just sort of run down inventories, run down inventories, run down inventories; perhaps through wholesalers, eliminate the rest of it. It's kind of a standard process for us. We have sort of a sunset kind of process that we go through when we eliminate an SKU.

Let me just put it in perspective. Europe is still driven by annual catalogs, and so basically, the 2008 catalogs will not have these SKUs in them. And so over the back half of 2007, we will be working down this inventory. But if you understand, a lot of this is covered by two events. One event is, some of it is part of the $75 million of [disaffecteds] we've already communicated, and then the rest of it is a transition to pan-European SKUs. When you're transitioning to a direct substitute SKU, it doesn't matter if you like if you start supplying that SKU slightly early. And so we have a lot more ability here to manage inventory out without it being too painful for us.

Got you. And then finally in the Document Finishing Group, I think you mentioned private label had a small impact. Can you describe that a little bit more and what you're doing to mitigate that going forward?

Yes, we lost some share, particularly in Europe, to private label penetration taking share from us. And as we have explained before, this is all about developing new products. This is the business segment that we're in the invest cycle on right now, that really, you won't see the new products coming through until next year. As we bring those new products to market and as we get things like the ProClick more seeded, and particularly via the direct channel, you get this handwashing effect of the direct and indirect channel where as the market starts getting seeded with those types of proprietary items, so demand grows and you pull them back through the indirect channel and effectively regain the share that you lost. So it's about product development and about penetration of those products.

Very good. Thank you very much.

There are no further questions in the queue. I would like to turn the call back over to Mr. David Campbell for closing remarks.

Thank you very much, and thank you all for your good questions and your continued confidence in us. We look forward to being with you on the next call this fall. Thank you.

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