ACCO Brands Corp (ACCO) 2010 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2010 ACCO Brands earnings conference call. My name is Keisha and I'll be your operator for today. At this time all participants are in listen-only mode. We will conduct a question and answer session towards the end of this conference. (Operator Instructions) As a reminder, this call is being recorded for replay purposes.

I would now like to hand the call over to Jennifer Rice, Vice President of Investor Relations. Please proceed.

Good morning and welcome to our second quarter 2010 conference call. On the call today are Bob Keller, Chairman and Chief Executive Officer of ACCO Brands Corporation, and Neal Fenwick, Executive Vice President and Chief Financial Officer. Slides that accompany this call have been posted to the investor relations section of accobrands.com. These slides provide detailed information to supplement this call.

Our discussion this morning will refer to results for continuing operations and on an adjusted basis, which for 2009 excludes all restructuring and other charges and for 2010 applies a normalized effective tax rate of 30%. A reconciliation of all adjusted 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.

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

Thank you, Jennifer, and good morning everyone. Earlier this morning we released our second quarter results, and I'm pleased to report that we continue to make solid progress in growing both sales and profitability, all while maintaining good control of our expenses.

In spite of the challenging economic environment, we delivered our third consecutive quarter of profit growth and our second consecutive quarter of topline improvement. Our reported net sales increased 4%, and for the first time since the fourth quarter of 2006 we saw volume growth, as well, with volume up 5%. We recorded sales increases in all three of our operating segments and most of our geographies, a reflection of our share gains, our improved customer relations, our focus on category management and improved demand specifically for our durable products.

Our gross profit margin expanded 200 basis points compared to last year's second quarter and operating income increased 14%. EBITDA increased 11% to $38 million, and per-share earnings were $0.09 versus $0.11 in the prior year quarter with the decline due to higher interest expense.

In spite of the headwinds in the marketplace, we've made significant improvements in every area of our business from our financial stability to our operational metrics, but we believe we have significant opportunity to be a much stronger company. To that end we recently made some organizational changes that will improve our ability to compete on a global basis, make us more agile in the marketplace and more responsive to our customers. It will also generate efficiencies in our operations that will help us better control our costs and allow us to invest more in our future.

First, we have more closely integrated the Kensington global computer products business with the larger office products business to create new distribution channels for Kensington products, particularly in Europe. This will also allow us to take full advantage of the talents of our European computer products team in support of our office products business.

Related to this integration we've asked Christopher Franey, who we brought into the business 18 months ago to run our Kensington business, to take new responsibilities as President of ACCO Brands International. The computer products business will continue to report to Christopher.

Second, we've consolidated our marketing functions into one global organization headed by Tom Tedford who we recently brought into the organization as well to help us better leverage the power of our brands, drive new product development, and further develop our category management capabilities. In addition, he will be responsible for increasing our focus on corporate social responsibility as a strategic competitive advantage and as part of our culture.

Separately, we've also formalized a Lean Six Sigma team to attack process improvement opportunities in our operational and administrative functions. And finally we've streamlined our finance organization, creating clearer line-of-sight reporting relationships in our accounting and business support functions.

As I've said before, we're proud of what we've accomplished in the last 18 months but we've got a long way to go. I think all of these changes will help move us forward.

Shifting gears, our 2010 outlook remains largely unchanged. We still expect local currency sales growth of 0% to 2% with market share gains from last year's line reviews helping to drive growth. Given our current view of the global economic environment which calls for continuing volatility in the currency markets, our gross margin expansion is likely to be slightly less than we previously anticipated, but we will use SG&A levers to ensure that we deliver bottom line improvement.

Importantly, the initiatives to expand gross margin remain on track and are only being temporarily offset by macroeconomic headwinds. EBITDA margins are still expected to increase by roughly three-quarters to a full point this year over 2009 results, and our long-term goal is still to deliver EBITDA margins of at least 15% to 16% on a sustainable basis as business optimism and white collar employment improve.

To sum up, we've seen improvements in many of the markets that we serve, but it's still a difficult marketplace and we will continue to focus on those things that are in our control -- prudently managing our costs, improving customer service, investing in product innovation, and aggressively competing for additional market share while defending the business we already have.

And now Neal will provide a more detailed report on the numbers. Neal?

Thank you, Bob. Our second quarter performance is recapped on Slide 5. Reported sales increased 4% with currency adding nearly 2 points. Volume increased 5% with growth in all business segments.

Adjusted gross margin increased 200 basis points to 31.3%. The improvement was driven by favorable product mix and lower commodity costs which were extremely unfavorable last year due to a combination of adverse FX rates and commodity costs.

As we expected, SG&A was higher in the quarter, increasing 12% or 160 basis points to 22.7% of sales. Salary, benefits and incentive costs increased $9.6 million mainly due to temporary reductions in the prior year. Foreign exchange translation added $0.9 million to SG&A.

All in, operating income improved 14% on a comparable basis with margin expanding 70 basis points to 8.3%. Contributing to operating income was a $1.4 million year-over-year benefit from foreign exchange translation.

EBITDA increased 11% to $38 million and included $1.5 million of benefit from foreign exchange translation.

EPS from continuing operations was $0.09 versus a comparable $0.11 in the prior year quarter. Underlying operations improved but higher interest expense reduced EPS by $0.05 quarter-over-quarter. For the six months sales increased 5% with volume up 2% driven by growth in all business segments.

As shown on Slide 7, adjusted gross margin increase 210 basis points for the six-month period to 31%. Favorable product mix accounted for 100 basis points of the improvement. Lower year-over-year commodity costs accounted for 60 basis points of improvement, which is less than we had anticipated as the commodity cost environment is increasing. Supply chain initiatives accounted for 30 basis points of gross margin improvement.

SG&A is up 11% for the six months or 130 basis points to 22.9% of sales. Foreign exchange translation added $4.9 million to SG&A. Higher salary, benefits and incentive costs added $18.7 million mainly due to temporary reductions in the prior year. Lower overall expenditures offset these increases by 130 basis points.

Operating income for the six-month period improved 20% on a comparable basis with margin expanding 90 basis points to 7.6%. Foreign exchange translation added $5.1 million to operating income.

EBITDA for the six-month period increased 16% to $71.1 million, including a $6 million benefit from foreign exchange translation.

EPS from continuing operations was $0.12 using a normalized tax rate of 30% versus a comparable $0.10 in the prior year six-month period. Higher interest expense in the current period reduced EPS by about $0.10 year over year.

Turning to an overview of our segments on Slide 8, in the Americas reported sales and volume both increased 5%. The 5% volume growth is a significant improvement over the past several years. Market share gains, improved category management and increased demand have helped to offset continued declines in consumable product categories.

Operating income for the Americas increased 48% and operating margin expanded 250 basis points to 8.5% despite higher employee compensation costs. The increase was a result of lower year-over-year commodity costs and improved product mix.

International segment sales increased 2% with currency adding 2 points. Volume increased 3% driven by share gains and improved category management. Prices decreased in certain markets, reflecting fluctuations in local currency rates which also lowered our cost of goods in those markets. International segment profit declined 21% and operating margin contracted 170 basis points to 5.9% due to increased investment in new product development.

Computer Products sales increased 8% and volume increased 7% driven by strong sales of computer security locks and growth in all regions except Europe. Computer Products operating profit increased 16% and the segment operating margin improved 190 basis points to 25.4% principally due to substantial improvements in gross margin from a favorable product mix.

Slide 9 details our cash flow for the quarter and six months. We generated $24 million of free cash flow in Q2 and finished the quarter with no borrowings on our ABL. We still expect to generate $50 million to $60 million of free cash flow for the year primarily generated during our seasonally profitable fourth quarter which is also a period without interest payments. This outlook includes an estimated $9 million in cash restructuring payments associated with expenses accrued on the balance sheet. We will not have any new charges in 2010 beyond reserve true-ups.

Capital expenditure should be slightly lower than previously expected at approximately $15 million.

At this point Bob and I will be happy to take your questions. Operator?

(Operator Instructions) We will pause for a moment to compile a list. Your first question comes from the line of Mr. Reza Vahabzadeh with Barclays Capital. Please proceed.

Good morning.

Good morning.

So solid volume growth in the US, and you touched on that a little bit, existing business as well as gain business. Can you just elaborate on that? The volume growth certainly seems to be ahead of some retailers' sales trends.

Yeah, Reza, it is I think a little bit, and I think we've been foreshadowing that for the last six months. Just given the split in our business between durables and consumables, we said that we thought that the durable part of our business would react and come back faster than the consumables part because we believe that durables is more tied to business optimism and business financial health than it is to white collar improvement. And virtually all of the gain in the US business came from durable sales improvement.

Any particular product lines that did well for you?

Honestly it was across the board. All of our durables product lines improved sequentially.

And was this reflective of POS trends as opposed to shipments in advance of shelf space gains?

It is. It is reflective of the sell-through of the product.

Got it. And then on the FX front, you mentioned that that was helpful to EBIT and EBITDA. Can you just touch on the mechanics of how that was helpful and how that can play out for you in the second half?

Hi Reza. There are two different aspects to foreign exchange. The first one is just simply translating our results from the local currencies that we trade in into US dollars, and in the first half of the year that was favorable. Then we flip into the second half of the year, particularly in Q4, if foreign exchange rates stay the same as they are that will become unfavorable. And so although it was favorable in the first half, it will become adverse in the second half with Q4, and that affects our sales and our EBITDA and operating income translation.

The second aspect of foreign exchange is what it does to our cost of goods, and there is a time delay in cost of goods versus what you're paying at the vendor level, and the reason for that is it runs through an inventory cycle that fundamentally delays it for about three months. And so what we have seen is the very low levels of the euro in particular and the UK pound have significantly increased our cost of goods in Europe, and we saw some of that effect come through in Q2 but we will see more of that impact of business in the second half of the year.

And so for us the increased cost of goods will be a drag on the business in the second half, and although we did put through some price increases for July 1 in both Europe and the Americas, they were really to offset other cost increases that had already occurred. And we will be playing a bit of catch-up with the January price increase to offset the full impact on our business.

Got it. And then you lowered your CapEx and your cash tax forecast for 2010. Is that timing, is that going to get pushed into next year or is that a permanent change?

CapEx is really a function of what we're trying to do with the business, and so one of the projects we slowed down and it'll have more impact next year than this year is an IT project that we had in Europe. We reorganized the way we were implementing it which is the main reason for the lower CapEx. So it will increase our CapEx next year, but it's no more than we had already foreshadowed which would be in the $20 million to $25 million range next year.

And the cash tax lowering is really fundamentally driven by a situation I think most people appreciate which is we're paying no US tax at the moment and we're paying international taxes. And with more profit effectively coming through in the US side of our business and less profit coming through on the international side, we'll have less cash tax exposure.

Got it. Thank you much.

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

Hi, good morning.

Good morning, Arnie.

I think over the last few weeks your stock has been hit pretty hard. People have been quite concerned about the euro versus the dollar and the whole situation with Europe and how that could impact your business. Maybe you could step back and freshen up your exposure to Europe, what you are currently seeing in that marketplace and your outlook for the balance of the year in Europe.

Europe represents about a quarter of our business, and honestly in the second quarter the volumes in Europe were stronger than what we expected. We actually had volume growth in Europe in the second quarter, so from a demand point of view our expectations are that we're going to continue to grow that business based on the market share gains that we have had. We appreciate that it's a difficult marketing environment, and on the currency side we've got a little bit of a hedge just based on our inventory, on our supplier relationships and on the hedging that we do. And so our expectation is still that we're going to be able to deliver the bottom line that we've been speaking to.

It's also worth noting, Arnie, that Europe isn't one country like the United States. It's a series of countries and there is a big north/south divide in Europe between the southern parts of Europe where the economies are particularly poor and we have almost no exposure there. And so our main exposure in Europe is to places like the UK, France, Germany, Holland, and those economies are much more robust than the likes of Spain and Greece and Portugal and the southern latitudes.

My second question relates to your increase in comp, which one of the key elements of that is the Cliff executive bonuses that hopefully are being accrued. Can you freshen up if you can how much of the $18.7 million relates specifically to the Cliff bonuses that are hopefully being accrued and how we might think about that line item in the back half of the year when percentage-wise an even greater amount might be accrued?

There are two separate answers I'll give you, Arnie. First of all, from a US GAAP point of view you have to accrue on a projected basis, and so the accrual is always based on where you think you're coming in. Our accruals at the moment, as at the first half, would amount to about $4 million which would imply we're receiving about an $8 million cost to the year which is less than we had assumed coming into the year.

We're accruing it at something a little north of 50% of what our plan was which says that we've still got a fair amount of cushion left in the plan.

Okay. Thank you very much.

Your next question comes from the line of Bill Chappell with SunTrust. Please proceed.

Good morning.

Good morning, Bill.

I guess first I think I understand the durable side continuing to outpace consumables, but I was a little surprised when you said consumables was down year over year. Is that just more kind of lapping higher unemployment numbers or are you seeing any stabilization as we're moving to the third quarter and do you expect it kind of as we move to the end of the year?

So when we say they're down, flat would be an easier description. They're very slightly negative, and a lot of that is driven by European demand with us which is lagging.

And I think the consumables part of the business is more of a better reflection of how the industry as a whole is performing, so --

Yeah. Well, I mean I guess, Bob, on that maybe from ACCO's perspective, what has changed on the environment from the March quarter to the June quarter? I mean, have we gotten better? Are we pretty much flat? I mean, are there any real signs of encouragement for the second half?

I don't know about real signs of encouragement. We said at the end of the first quarter that we'd seen kind of spots of optimism in the first quarter related to the durable side of our business, which again we believe is related to business optimism and businesses' financial health. Our performance in the durable side of our business was much more consistent in the second quarter than it was in the first quarter.

The employment numbers are marginally better, largely driven by temporary labor but that tends to be kind of the step before people hire permanently. So full-time white collar employment I think the last time I looked was down less than a percent but temporary labor was up almost 19% year to year and so we're seeing a little bit of the pull-through on that.

We are, as everyone else is, concerned a little bit about the economic recovery in Western Europe and we're watching that closely, but so far it hasn't impacted demand and so we feel pretty good about that. And on a global basis we feel good about how the Americas are performing. We feel good about how Australia is performing. We're cautious about Europe. APAC continues to perform well, Latin America continues to perform well, so we are cautiously optimism about the environment. It's still tough out there.

Sure, but it sounds like I think what you said earlier, you're fairly confident that you can pass off price increases as needed going into 2011.

Yeah. We have initiated discussions with our customers about that, and we are not looking to use price increases as a vehicle to grow our business. We're using it just as a vehicle to pass through costs that everyone is seeing on a global basis, so raw material increases and currency fluctuation changes are the kinds of things that we want to pass along. We use external measures with our customers to measure those through indexes, and we're going to sit down over the next 60 days with our customers to talk about that in specific detail. But yeah, it's our intention to be neutral on the impact of raw material and currency fluctuation.

And then just one last one, and based on -- assuming there is no pickup in the overall environment, are you still comfortable you can kind of grow topline through market share gains in 2011?

We are. The line review process this year is a little later than last year. I think just given how challenging the economy was globally in 2009, everyone did line reviews on almost everything in order to try to squeeze some profit out of the mix. And the implementation of some of those line review changes has been maybe a little slower than a lot of us would have liked given that we were a net winner in that process. And I think this year people are taking it on a little bit more measured approach and they're more back half loaded. But we like how we're competitively positioned. We still think that there is significant opportunity to take share back and we are competing aggressively.

Great. Thanks so much.

Your next question comes from the line of Derek Leckow with Barrington Research. Please proceed.

Thank you. Good morning.

Good morning.

Good morning.

It's good to see that you're clawing back some market share and it's not coming at the expense of margin. And just wondered if you could maybe characterize the volume growth rate in your retail businesses versus your commercial, and is there -- are you seeing similar trends across each channel?

Again I think it comes down to the -- in our mind the split between durables and consumables, and the durables purchases would tend to be more on the commercial side and through our direct business. And so we feel better about business optimism than we do about consumer confidence.

That would kind of correspond with some of the comments I heard this week from some of the retailers in terms of their volume trends.

Yeah.

So which brands are the one -- is it more the boards business or which business is really the strongest in terms of durables?

It would be our binding and laminating and boards business, our stapling business is up, and so computer products, those kinds of things, so the brands would be GBC and Quartet and Swingline, Kensington, NOBO, Rexel.

Okay. And these trends, it looks like you're expecting them to kind of continue into the back half of the year. But then I just wanted to have you reconcile the guidance that kind of calls for 0% to 2% growth. Is that being offset by the pricing that you mentioned or what else is offsetting that in the back half?

From our perspective there are two issues. FX is going to obviously be a big issue for us in the fourth quarter, but we tend to exclude that from our guidance as you know because we can't control it. And for us Q4 will be a tougher comp year-over-year just because of some of the things that happened last year.

Okay. So I'll keep that in mind. And then on the expenses side, one of the issues that you had alluded to in the prepared remarks was freight and distribution as being sort of a targeted area.

Yeah.

And I know with your centralization you've had some cost benefits there. What was freight and distribution as a percentage of sales, and is there still room to improve that or are we going to see that maybe tick back up again? I know there's been some tightness of supply out there in terms of freight and distribution, so I wanted to get a better --?

We got maybe a little bit better. I think 30 basis points of our kind of gross margin expansion was due to the initiatives that we have on supply chain. I think we actually feel pretty good about where we are from the distribution portion of this, the pick and pack. We're not particularly happy about what's going on in freight.

Part of that is the external costs have risen -- the shipping cartels out of Asia have raised costs above what our original expectations were -- and part of it is that we're not executing as well as I'd like us to and we still have significant opportunity there. So we said that we thought that there was ultimately probably 200 basis points of improvement in F&D on a normalized basis, and we still believe that that's true and we've only gotten a fraction of it.

Okay. And just one follow-up to that. Some of the newer products that you have in the pipeline, are there any new launches going to happen in the back half or have we already seen that now in the front half?

In very large measure you've seen what's going to be out for the remainder of this year. Probably the one exception to that is we're bringing an auto-feed shredder to the marketplace which is a patented product, an outstanding product where you can put 100 sheets of paper into an auto-feed mechanism on a shredder and walk away. And it's new to the marketplace, it's innovative, it's priced competitively, and we think it's going to give us an opportunity to be more competitive in the shredder side of the business.

Some products that we've launched earlier this year in Europe we're going to bring to the US in the back half of the year. Our Capture product which is a flip chart pad that you can electronically move information from the pad itself to your computer, and we're going to bring Clicks to the marketplace which is our replacement for the paper clip. For those that don't know, ACCO stands for the American Clip Company and we were the first manufacturer of paper clips, and we're going to actually take that market back so we're pretty excited about that.

Okay, great. Well, thanks very much.

Your next question comes from the line of Karru Martinson with Deutsche Bank. Please proceed.

Good morning.

Good morning.

Good morning.

In terms of the July 1st price increase, what was kind of the feedback that you guys got from retailers on the acceptance there?

Well, again I think historically ACCO had viewed price increases as a way to grow the business, and we don't view it that way. The perspective we have is that there's going to be fluctuations in the marketplace relative to raw material costs and there's going to be fluctuations based on currency volatility, and those should be neutral to our relationship. And we're in an environment where those have gone up, and so we're passing on price increases. Our customers' expectation, and it's correct, is if those things came down that we would pass along a decrease, and that's kind of what happened.

The price increase that we instituted in July is reflective of kind of the back half and very early part of this year market conditions and there is a six- to nine-month lag on that. And the one that we're going to talk to them about for January 1st is kind of reflective of the first half and very early third quarter of this year. So our customers' reaction is anytime that there is an increase they don't like it. It makes their world tougher and we appreciate that, but they also appreciate that we're not trying to game them and so it is what it is.

As a market leader do you feel that people are going to be following this one or are you guys kind of widening that price gap there?

No, honestly we think that everyone is going to do this. This isn't something that is unique to us. Steel has gone up pretty dramatically. Most of the manufacturers in the industry are buying in dollars and selling in local currencies, and everyone is facing the same issues including our customers when they're doing their own private label stuff. So this is -- it's not like any of the stuff that we're talking to them about is a surprise to anyone. And it is merely a reflection of the components of the products that we sell which are consistent across our competitors and the marketplace.

On the freight and delivery we've been hearing a lot in terms of constraint in supply of shipping containers and obviously prices have risen. Are you having any difficulties getting product to market and kind of what's the outlook there?

We've been ahead of it so far. I think our team has done a great job. Everyone is paying a premium over what we came into the year with, but we have been able to manage shipments. We haven't impacted our customers' line on time and complete metrics at all based on shipping requirements.

Okay. And just lastly in terms of the private label opportunities, it's going to be a focus for you guys going forward. What's the timeline here for kind of rolling out or the development of those relationships?

Yeah, the issue is less about us trying to dramatically expand our private label capabilities. It's about wanting to help our customers manage categories, and to do that you have to be willing to compete at the opening price point products. And we are willing to do that, but in the scheme of things it is not in our best interest or our customers' best interest for them to sell a bunch of the opening price point. But they need it in order to have a competitive fighter brand in the marketplace. And so we have talked to all of our customers about our willingness to do that as part of our category management strategy, but we are largely unchanged a year later in spite of the increase in volume in terms of the percentage of private label we do. We actually see more of our customers moving towards branded products than towards private label products in terms of what their preference is so it hasn't had an impact to us.

All right. Thank you very much, guys.

Sure.

Your next question comes from the line of Arun Seshadri with Credit Suisse. Please proceed.

Good morning. Thanks for taking my questions.

No problem. Thank you. How are you doing?

Good, how are you?

Good.

So just a few questions. First, your product investment that you talked about in international, could you talk about how -- give us some color on what areas you're focused on and then how should we think about the next few quarters in terms of operating margin impact of those product investments?

I think the single biggest thing that is different now versus a couple of years ago is that we are introducing new products that we have developed in Europe before we introduce them in the US because the European line reviews and their catalog process is actually several months earlier than the US. And so what we used to do was we'd release in the US and that would mean by definition that Europe was a year behind and it would give our competitors an opportunity to see what we were going to do in Europe and have a year to respond to that.

That wasn't particularly crisp, and so we've flipped that and we brought out our Capture product which is the electronic flip chart pad in Europe first and we've taken the learnings from that as we release it in the US in the fall. And so Europe will be a lead market for us now as opposed to a trailing market, and our expectation is it's going to allow us to be more competitive in the line review process.

So in very simple terms, Arun, you effectively in the year of change get a doubling up of the new product costs that gets sent through the European market, international segment.

Got it.

And one of the things that we did a week or so ago was we consolidated marketing under one individual on a global basis, and part of the rationale for that is just what I was talking about. We want to make sure that as we do things in Europe, that we're able to leverage those on a global basis much more effectively than we had before. And our customers are becoming more global, so if you listen to Office Depot they clearly have an emphasis on their international business, and that part of the business has been performing well for them. Staples acquired Corporate Express and just acquired the remainder of that business in Australia. And both of those businesses are global businesses, and we need to -- our organization needs to align with their organization in terms of what they need in order to grow their business.

Makes sense. Then in your Computer Products business, just wanted to confirm still most of the strength you're seeing is all security lock driven. Is Europe still weak? And then just in terms of growth, still a very strong growth but a little bit lower than the previous quarter. Should we just continue to see that slightly moderate over the next couple of quarters as it returns to a stable level?

You're talking Computer Products specifically?

Yes, that's right.

So for Computer Products, the business area has been one that has recovered quicker economically than Office Products, and so there has been an increase in spend which has particularly been driven through the markets which are more advanced from an economic point of view. In Europe we have some specific factors in that market mainly associated with parts of the retail environment in Europe which is making Europe look less attractive, particularly in the first half of the year.

As Bob mentioned earlier, from an Office Products side we have seen an improving trend in Europe, and so my expectation is that you will see pretty sustained performance through the second half but you will get more balance going into the second half as the US starts to lap strong results in the prior year and Europe starts to improve versus prior year.

The other piece of that is you asked about security, and yeah that is a focus. We're seeing two trends going on in the marketplace. One is durables are recovering and people are starting to buy laptops and things like that again and there is clearly a correlation to that in our product sales. But the other thing is just given how tough the economy is, how challenging the economy is, the increase in computer theft is significant. Actually on a reported basis it's the highest it's ever been for the last four quarters, and so there is a correlation to laptop sales and the sales of our security products we think or a mitigating factor.

Got it. That's been extremely helpful. Thanks. And then just wanted to get a little bit more clarification on what you said on gross margin expectation for the year. Previously you had looked for 200 to 300 basis points, but now you've said a little bit less obviously given all the macroeconomic factors. Could you parse out macroeconomic versus FX per se, and then can you talk about scale in terms of how much you expect gross margins to be weaker and therefore need to be made up maybe in SG&A reductions?

Yeah, I don't know that we're going to get into that kind of level of specificity. We think the FX thing is part of the macroeconomic environment, and our expectation is that it's going to be more challenging in the second half and so we don't know if we're going to be able to deliver what we originally said. We do believe that whatever happens we're going to be able to balance it with managing our SG&A costs so that we're going to be able to deliver bottom-line dollars.

And the easiest way to think about FX is in terms of commodities. And so if you think about the cost of steel in the US up about 20%, in the euro it's up about 40% because of the currency impact on top and so that's a big piece that you have to look at. And when we call out our own gross margin slide -- if you look at the deck of slides it will be included on Slide 7 -- we don't call out specifically what happens to FX in terms of cost of goods because that's always netted in what we do with price. And so our job in international markets is to move price when foreign exchange moves.

And in fact if you look at the biggest impact on our business in the first six months, there's actually price reductions going through the international market and that was due to the recovery of things like the Australian dollar which was a significant flip around and was a price increase/price reduction that we put through exactly as Bob described earlier as we respond to the market to reflect that through to a neutral point for us.

Okay. Again extremely helpful. Last question for you. Could you just talk about volume linearity during the quarter, and then just talk about channels and how if there is any sort of variation across the channels? And that's it. Thank you.

Honestly it's still lumpy on a week-to-week and month-to-month basis, but it was more consistent than it was in the first quarter. And we think the combination of the increased business financial health, the increase in temporary labor have contributed and will continue to contribute to a strengthening in that part of the marketplace.

Thanks guys.

Your next question is a follow-up from the line of Arnie Ursaner with CJS Securities. Please proceed.

Yeah, it's a follow-up to the question you just had. The price decline of 2% or so in the quarter was a little surprising to me given your much higher costs. I think you just touched on how Australia and some other things could impact it, but I just want to clarify why -- where we saw the price declines in Q2.

The significant price declines that appear in Q2, a lot of that was driven by our international business where you have exactly what we described earlier. The same effect happened in areas like Canada which appears in the Americas market, and also part of the change a little bit in terms of this year versus last year is what's happening on customer rebates. Our customer rebates, this time last year we released a significant amount of rebate reserves in the second quarter, and this year we don't have rebate releases and therefore it looks like a price increase in the way we do the analysis. I'm sorry, a price decrease in the way we do the analysis.

Right. And obviously the implication of that is last year people weren't meeting their volume commitments and this year they are.

And Bob, could you give us an update on the mass market? I know you've obviously had a number of products that were working their way into the mass channel. But until you could get your -- the previous products out of the marketplace and your customer sold his inventory, it was more going to be a back half of the year process. Can you freshen up where we are in this process?

Yeah. Honestly we feel great about the impact that we've had in that market and that they've had frankly on us. Our relationship with Wal-Mart and Target are terrific. The sales of our products into both those customers is exceeding our expectations, and from a service point of view we're doing a terrific job for them. And this is an important season for us because they compete very aggressively obviously in the back-to-school season and we're looking forward to seeing how that plays out.

And a question for Neal, can you highlight your priorities for free cash flow, and specifically do you have any upcoming debt payments we should all be thinking about?

Just from a seasonality point of view, Arnie, we will generate cash in the third quarter, but we reap our interest now twice a year in Q1 and Q3, and so most of the cash we generate in Q3 will go out the door as an interest payment. And so effectively Q4 is going to be when we generate the vast majority of the cash flow for the year effectively in the way the cycle works now.

And so part of what we will do in our cash is look to build some cash on the balance sheet a little bit, partly because we know some of it disappears in Q1, and partly because in the long term what we've always said is we want to get to the point where our senior secured leverage gets to the right leverage test so that we have more options as to what we do with cash. And that will be sometime in the future in 2011, but it's really driven by improving EBITDA as much as it is getting our net debt down.

But acquisitions are not in the near term horizon the way you're looking at your cash flow and balance sheet. Is that a fair way to think about it?

I think if there was an acquisition it would be opportunistic, something popped up that we thought made an awful lot of sense and would be either an incredible competitive advantage moving forward or would be accretive in the near term.

Bob, good luck in your upcoming family event. See you soon.

Thanks. Two and a half weeks to go to Sarah's wedding so everybody is a little nervous at this point.

If there aren't any more questions, I appreciate everybody joining us today. I think we had very solid -- a very good second quarter and we're proud of what we've accomplished, and we appreciate that we've still got a long way to go and it's a tough world that we're competing in. We're committed to delivering to our customers, to their customers, our consumers, our employees and our shareowners, and again thanks for joining us today.

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