ODP Corp (ODP) 2011 Q1 法說會逐字稿

Good morning, and welcome to the first quarter 2011 earnings conference call. All lines will be on a listen-only mode for today's presentation after which instructions will be given in order to ask a question. 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.

Thank you, and good morning. With me today are Neil Austrian, Interim Chairman and Chief Executive Officer, Mike Newman, Chief Financial Officer, Kevin Peters, President of North American Retail, Steve Schmidt, President of North American Business Solutions, and Charlie Brown, President of International.

Before we begin, I would 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 is 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. For a reconciliation of the non-GAAP measures to the 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 Austrian will now summarize Office Depot's first quarter 2011 earnings. Neil?

Thanks, Brian, and good morning. Before I review our first quarter 2011 results, I'd like to update you on our CEO search. Our search committee continues to meet with the short list of candidates, and we hope to conclude the process soon. However, as I said in the past, we will take as much time as we need to find the right leader for Office Depot. In addition, I would like to make it very clear that the 2010 restatement announced on March 31 has had no negative impact whatsoever on our CEO search process.

In regard to the restatement, it's unfortunate that the Internal Revenue Service denied our claim to carry back certain tax losses to prior tax years under economic stimulus-based tax legislation enacted in 2009 and that we needed to correct the 2010 financial statements. While we are disappointed to have had to restate our 2010 financial results, it's important to note that this restatement had no impact on our previously reported 2010 EBIT or EBITDA and no net impact on 2010 cash flows.

Turning to Office Depot's first quarter 2011 results, sales totaled $3 billion, a decrease of 3% compared to our first quarter results in 2010. Excluding sales related to asset dispositions and deconsolidation in the fourth quarter of 2010 and an acquisition in the first quarter of 2011, total Company sales decreased 2% versus prior year. The Company reported a net loss after preferred stock dividends of $15 million, or $0.05 per share in the first quarter of 2011 versus earnings of $20 million, or $0.07 per share in the same period one year ago. The first quarter 2011 reported results include a 164% tax rate that Mike will review in detail later in the call.

First quarter 2011 results also included charges primarily related to restructuring and integration activity costs, and actions to improve future operating performance. Excluding these charges which totaled $8 million before tax, net earnings after preferred stock dividends were marginally profitable. Total Company gross profit margin decreased about 20 basis points in the first quarter compared to the prior year. This was driven primarily by gross margin pressures in the International Division. In North America, gross margins were flat for retail and only slightly down for Business Solutions in a weak sales environment.

Total Company operating expenses adjusted for charges were down $7 million compared to the first quarter of 2010. EBIT, adjusted for charges, was $34 million in the first quarter of 2011 compared to EBIT of $62 million in the prior year period. The year-over-year decline was related to a number of factors, but the negative flow through impact from lower sales without a gross profit offset in the first quarter was the primary driver. Mike will go into more first quarter financial details later in the call. I will now ask Kevin to review North American Retail's first quarter 2011 performance.

Thanks, Neil, and good morning. In the North American Retail Division, first quarter of 2011 sales were $1.3 billion, down 2% versus one year ago. Same store sales were down 1% versus the prior year period. Average order value rose modestly during the first quarter versus the prior year while customer transaction counts declined after two quarters of growth, due in part to the negative impact of weather in January and February.

If we look at the product categories, furniture comp sales were positive again in the first quarter as seating remained strong. Other key product groups showing year-over-year improvement in the first quarter include paper, writing instruments, laptops, and printers. Total peripheral sales comped negatively in the first quarter, but we have identified actions that we can take to drive sales within that group going forward.

As I've mentioned on past calls, growing sales of our high margin service offerings continues to be a great opportunity for our retail business. In the first quarter, Tech Depot Services again reported double-digit sales gains versus the prior year, and Copy and Print Depot comped positively for the fifth consecutive quarter. We are encouraged that these value-added services are gaining awareness with our customers, and we will continue to allocate resources to drive their growth.

Our direct import of products continues to go well. Penetration in North American Retail is at a double-digit level and increased as a percent of sales versus last year. If we look at our first quarter, same store sales on a regional basis, four regions showed flat to improving trends including California. Of the regions that showed year-over-year declines, most were impacted by winter storms during the quarter.

Our North America store count at the end of the first quarter was 1,141 stores. During the quarter, we opened 1 new store, closed 7, and relocated 2 stores. We also remodeled four stores during the quarter. Of the four remodels and two relocations, we successfully reduced the space in those locations by about 20% on average.

We announced last week that we will close our remaining nine stores in Canada in early June of this year. However, it's important to understand that Office Depot is not leaving Canada. We will continue to serve our Canadian customers through BSD. The decision to close the stores was part of our ongoing real estate portfolio review, and that we believe the changes that we will make will strengthen the North American Retail business going forward.

North American Retail operating profit in the first quarter was $58 million versus $73 million one year ago. This decline was driven primarily by a number of factors including the negative flow through effect of lower sales volume, rolling over the shrink benefit reported one year ago, incremental advertising expense to drive brand awareness, and additional investments in our key initiatives. We offset some of these margin pressures with lower property costs.

Last quarter, I provided four initiatives for North American Retail to drive sales and reduce costs. I will now update you on our progress with those key initiatives. First, we have completed Phase 1 of our plan to improve the in-store shopping experience which included a comprehensive in-store field study and competitive diagnostics to understand customer journeys and break points in a number of stores. This early work allowed us to define key operational and service opportunities for immediate remediation. Reduce nonessential low risk tasks. Make improvements to current sales and service activities. And identify a list of potential quick win ideas to be launched in later phases.

Second, we continue to invest in our Copy and Print Depot and Tech Depot services. These two solution-based businesses continue their strong year-over-year gains in revenue, margin, and market share while providing Office Depot the opportunity to differentiate in the market. As an example, our exclusive national, multi-carrier shipping platform continues to distinguish Office Depot from the competition. Additionally, we remain on track to further accelerate and scale Copy and Print Depot and Tech Depot services while working to improve awareness, trial, and retention.

Third, we are focused on improving the productivity of our stores. This includes remodeling about 50 traditional stores into our M2 format in 2011 and reducing our average store size wherever possible. We continue to test our new smaller concept store in a number of markets, and the results are encouraging to date. And then fourth, we continue to pursue opportunities to improve margins including increasing direct import penetration, conducting product line reviews, pursuing the harmonization and rationalization of SKUs, and reviewing our practices and policies in regard to product pricing.

In summary, our North American Retail business remains focused on delivering on its key initiatives, and our profitability should improve over the long-term as the investments mature. Looking forward, the second quarter is traditionally our weakest sales quarter. We mentioned on April first that we are excited the first quarter -- we exited the first quarter with positive same store sales in March. That trend continued in April, and we anticipate that our second quarter same store sales will be slightly positive, and operating profit, excluding charges, will be flat versus last year.

Before I turn the call over to Steve Schmidt to review the first quarter 2011 results for the North American Business Solutions Division, I would like to thank Steve Mahurin for his contributions to our North American merchandising efforts over the last three years. Steve left Office Depot last week to return to his roots in the home improvement industry. Our merchandising group will continue to report to me, and given my merchandising background at Grainger and Home Depot and the strong merchant team currently in place, we will assess our needs in terms of replacing that position in the near future. Steve?

Thanks, Kevin. Good morning. In the North American Business Solutions Division, first quarter sales were $806 million, down 3% versus the same period last year. Although the rate of sales decline was consistent with the fourth quarter of 2010, we are encouraged that we were able to offset the adverse impacts from the winter weather experienced in January and February through our growth and solutions and sales to large customers. Essentially the entire year-over-year sales decline in the first quarter relates to customers not retained during the transition from our previous US communities agreement to our new purchasing consortiums.

Looking at our first quarter sales by product category, we did see positive year-over-year sales growth in seating and cleaning and break room supplies. We continue to gain traction in break room supplies with the sales rate improving at a double-digit rate in the first quarter. Despite the recent reports on the secular trends of paper consumption, we continue to see improving sales trends with only a 2% decline in the paper group versus last year. Declines in paper consumption are nothing new, but we have successfully managed our mix and actually increased the gross margin contribution of the paper group. We also see opportunities to mitigate any lower paper sales to an increase in sales of services and solutions to our customers.

Geographically, the first quarter sales rates in Texas and California versus the prior year were better than the overall BSD business. This is the first time in a number of years that our California region sales have performed better than the overall BSD business.

BSD's first quarter average order value is flat to last year as the big ticket discretionary purchases remain elusive. Although the main driver of our sales decline again this quarter was lower customer transaction counts, the rate of decline was actually improved sequentially each quarter since the second quarter of 2009. If we look at the direct channel, sales in the first quarter were flat versus one year ago. We continue to improve the website and provide greater functionality for our customers which positions us well for future growth.

Turning to the contract channel, sales declined about 3% versus last year. As I mentioned, this decline was essentially driven by customers not retained during the transition from our previous US communities agreement to our new purchasing consortiums. Regardless of the noise in the marketplace, I'm pleased to report that we continue to retain this business at about an 85% rate. This can be attributed to the strong relationship our sales teams have built with our customers over the years and the great product and services we provide them. Although pleased with this level of retention, we are not satisfied, and our goal is to win back these customers that we did not initially retain.

In regard to other parts of our contract business, we continue to see weakness in state government areas as well as some signs of volatility within the federal government business. Conversely, sales to our large national account customers continue to improve, and we achieved positive sales growth for the first time since the fourth quarter of 2007.

We are pleased that our sales to small- to medium-sized business, or SMB customers, in the first quarter were flat versus the prior year. This is the first quarter where sales had not declined year-over-year in a number of years. SMB customer growth remains a priority in one of our key initiatives to grow sales.

First quarter operating profit for BSD was $16 million, down from $20 million in the same period one year ago. The decrease in operating profit was driven primarily by the negative flow through impact of lower sales. Increased marketing and sales costs related to back to business and rolling over the shrink benefit reported one year ago. Partially offsetting the items were reductions in selling and other operating costs achieved as part of the initiatives to improve the Division's cost structure.

In North American BSD, we are focusing on three key initiatives to drive sales and improve margins in an environment that remains difficult. I will now update on our progress with these initiatives for you. First, we are determined to increase our customer mix of small- to medium-sized business customers. This initiative continues to be a priority, and we feel that we were gaining traction as evidenced by our recent performance in this group.

Second, we are continuing to grow our copy and print business. We have been successful at expanding the service with our contract customers in most markets using Office Depot's regional print facilities. Third, we continue to look at every area to offset margin pressures and improve the bottom line. This would include reducing overhead and supply chain expenses and reviewing our practices and policies in regard to product pricing.

In summary, we continue to win new business and retain existing business in the contract channel. And our direct channel continues to perform well and maintain its competitive position in this market. As we move forward this year, we look forward to even better performance from both channels.

In regard to the second quarter outlook, we expect our sales to be flat to slightly up versus last year, and both our operating margin and profit to be up significantly. Before I turn the call over to Charlie to discuss his first quarter 2011 results for the international business, I'm pleased to report that we have tapped Office Depot's 8 year veteran, Steve Calkins, to manage the contract channel's national sales organization. He is a talented executive with significant contact channel experience and will be a great asset to me in driving our profit-enhancing initiatives. Charlie?

Thanks, Steve. Good morning. The International Division reported first quarter sales of $846 million. That's a decrease of 5% compared to the prior year period in US dollars and 6% in constant currency. Excluding the revenue impact from our recent portfolio optimization activities, the constant currency sales were flat versus the same period a year ago. These activities include the negative sales impact from divesting our businesses in Japan and in Israel and deconsolidating our joint venture in India late in 2010. Finally, the positive sales impact from acquiring Svanstroms in Sweden during the first quarter of 2011.

As I speak to year-over-year sales comparisons, please note that I will do so in constant currency. Geographically, our sales results were mixed across Europe. The UK, our largest market, reported positive sales growth while sales in France and Germany were relatively flat compared to the prior year. Our business in Asia reported double-digit sales growth in the first quarter excluding prior year sales for both Japan and India.

In the contract channel, our European business continued to report positive sales growth in the first quarter. The UK and German contract businesses performed well while France was relatively flat. In addition, our contract business at Asia reported double-digit sales growth, excluding the divested businesses I mentioned earlier.

First quarter sales in the direct channel were lower than a year ago. As I've mentioned in the past, we are not satisfied with the performance of our direct business in Europe, and I believe we have a great opportunity to drive profitable sales growth in this channel through a number of initiatives that I will review in a moment.

For the retail channel, sales in the first quarter grew at a high single-digit rate compared to prior year excluding the 2010 sales from our divested business in Israel. France, our largest retail business in Europe, continues to report positive sales growth in the first quarter driven by higher customer transactions.

The International Division reported operating profit of $27 million for the first quarter compared to $42 million reported in the same period last year. Excluding $6 million of charges primarily related to our business restructuring actions and acquisition integration costs, adjusted operating profit was $33 million in the first quarter of 2011. The balance of the year-over-year operating profit decline was primarily driven by a reduction in gross profit margin due to both cost increases in paper and more competitive pricing in ink and toner. These items were partially offset by lower operating expenses as a result of the divested businesses and the benefits created from our continuous process improvement initiative in the first quarter.

I'd like to take a moment to dive a little deeper into the gross margin issue given all of the questions we have received. There are two factors at play here. First, we received price increases on paper from our vendors in Europe toward the end of last year. And second, we faced some competitive pressures in ink and toner. Most regions have done a good job in passing the paper cost increases through thus mitigating the margin pressure. Unfortunately, one region's efforts to pass the higher price paper cost through in a timely manner were less successful. This region accounts for more than the total year-over-year operating profit decline. We have taken actions in that region to increase the level of resources and modified our strategies in order to improve its performance going forward. As a result, we are already seeing improved performance in this region in the second quarter.

Turning to our initiatives, we continued to concentrate our efforts on implementing our strategic plan to enhance sales and overall probability of the International business. Let me update you on three of these initiatives. First, as part of our portfolio optimization strategy we discussed last quarter, we closed on the acquisition of Svanstroms in Sweden. This is an attractive market, and we see further opportunities to grow throughout the Nordic region. Based on the initial results, we expect this acquisition to be accretive going forward.

Secondly, we are making progress on the business restructuring and continuous improvement process improvement initiatives in Europe launched during the fourth quarter of 2010. These initiatives reduced G&A in the first quarter, and we continue to find opportunities to enhance our current processes and leverage our resources enabling us to further reduce our overall cost structure.

Third, we remain focused on winning new SMB customers. We will launch the rebranding of Viking next month in the UK and Germany to drive our direct channel growth. The rebranding includes a needs-based, customer segmentation model, a new look and feel, better layouts for our catalog and websites, sharper pricing on many products, and an overall enhanced customer shopping experience. This rebranding, which is the first such effort in many years, is designed to improve our competitive position within the direct channel.

So in summary, the international contractor retail channels continued to perform well in the first quarter, and we are pursuing opportunities to profitably grow our direct channel. Looking forward, we will continue to carry out our strategic initiatives to profitably increase sales and reduce our costs. In regard to our second quarter outlook, we expect our sales in constant currency to be up low single-digits on a like-for-like basis versus the prior year, and operating profit, excluding charges, to be down slightly from the prior year. With that, I will now turn it over to Mike who will review the Company's first quarter 2011 financial results in more detail.

Thanks, Charlie. I'd first like to give you an update on our restructuring actions and benefits. Let's start with restructuring. In the first quarter, we reported $8 million of charges, $6 million of which related to European process improvements and acquisition integration costs that Charlie discussed earlier. We also had charges of $2 million for business process improvements at the corporate level. If we look at the remainder of 2011, we anticipate an additional $60 million to $70 million in charges primarily related to global process improvements and cost reductions. By quarter, we are projecting approximately $30 million of charges in the second quarter, $20 million in the third quarter, and about $10 million in the fourth quarter. The full-year negative cash impact from these charges could be in the $65 million to $70 million range in 2011 and relate mostly to severance and facility closure costs.

Let's now discuss the benefits from both the restructuring actions and our previously announced business process improvement program. In the first quarter of 2011, we realized about $15 million in gross benefits, mostly from International Division restructuring activities. After some reinvestment in our business, net P&L benefits in the first quarter were approximately $5 million. As a reminder, we anticipate reinvesting about $40 million to $50 million of the $80 million to $90 million in projected gross benefits back into the businesses in 2011. Although the net benefits did not significantly impact our first quarter EBIT, we still anticipate the full-year 2011 net benefits to be more second half-weighted and in the neighborhood of $40 million to $50 million. By quarter, we are projecting about $10 million of net benefits in the second quarter, $15 million of net benefits in the third quarter, and $20 million in the fourth quarter. As a reminder, the P&L benefits expected from the business reinvestments are not built into the projected benefits stream.

Turning to our first quarter results, the effective tax rate for the first quarter of 2011 on a reported basis was 164%. This rate is based on an annual estimated effective tax rate. Because the Company has valuation allowances in several jurisdictions including the US, operating losses in those jurisdictions do not result in the recognition of the deferred tax benefits. Accordingly, tax expense recognized on positive earnings in our International Division in no tax benefit on losses in the US caused the effective tax rate to exceed net pre-tax earnings. It's unlikely that the effective tax rate on a reported basis could exhibit -- it's likely that the effective tax rate on a reported basis could exhibit significant variability throughout the course of the year due to changes in the income projections in the mix of income across jurisdictions.

For the full year, we estimate that we will pay a total of $20 million to $25 million in taxes on a book and cash basis excluding any discreet items. For the second quarter, we project zero cash taxes. The effective tax rate on our earnings, adjusted for charges, dropped to 43% for the first quarter. This rate is significantly lower than the reported rate because it removes the charges that do not get tax benefits in our GAAP calculation. This rate can show significant volatility over the course of the full year if results vary across countries with valuation allowances.

I'd now like to expand a little further on something I reviewed on our recent conference call. Throughout 2010, we were able to successfully offset most of the deleveraging impact of lower sales volume through year-over-year gross margin expansion which averaged about 90 basis points per quarter and cost control. In the first quarter of 2011, we had a similar sales decline to the previous four quarters but actually had a gross margin rate decline of 20 basis points. Most of that decline was driven by paper cost increases and competitive pricing pressures on ink and toner and International that Charlie described, and we think we will be able to offset a significant amount of those impacts later in the year. We also have a number of margin-enhancing initiatives in place that the business unit Presidents described, and these initiatives should continue to mitigate deleveraging if we should continue to see lower sales volume.

I'd also like to revisit some earlier comments we made in regard to winter weather impact on first quarter EBIT. Upon completing the analyses of our North American businesses, we determined that all the -- although the weather disruptions did cost us sales on days when stores and distribution centers were closed, the bottom line impact was less than previously expected. As a result, we did not call out any weather-related, year-over-year operating profit impacts in either North American Retail or BSD.

Taking a look at cash flow, we ended the first quarter of 2011 with $123 million use of free cash flow which was principally driven by higher inventory investment, the timing of accounts payable, the normal payment of year-end accruals, compensation-related items, and restructuring activities. Despite the heavy use of cash in the first quarter and the projected use in the second quarter as well, we believe we will end 2011 with free cash flow of $20 million to $30 million.

As I mentioned on our recent call, we expect to receive a cash dividend from our Mexican joint venture partner in the second quarter of 2011. Our portion of the cash dividend totals MXN300 million which translates to approximately $25 million at current exchange rates. We also have other opportunities to drive incremental cash flow as well in 2011.

Shifting to Cap Ex, we invested $29 million in capital expenditures during the first quarter, primarily to cover maintenance in all business units as well as North American retail store downsizes and relocations. Full-year 2011 guidance for capital spending is now estimated to be in the range of $165 million to $170 million. That range is down from the original estimate of $180 million, but the decline won't negatively impact the execution of our strategic initiatives.

During the first quarter, we recorded a dividend on our convertible preferred stock of approximately $9 million which was paid in cash in April. And moving to our balance sheet, we ended the first quarter with $494 million of cash on hand, lower than the same period in 2010. Including availability from our asset-based loan facility of $684 million, our liquidity totaled about $1.2 billion at the end of the quarter. We did have borrowings of about $70 million in Europe on our ABL at the end of the first quarter, and this was related to our acquisition of Svanstroms in Sweden.

Inventory totaled $1.2 billion globally, slightly up from the first quarter of 2010. The majority of this increase was driven by timing and should moderate as we go forward. However, we did increase our stocking levels of certain high margin, high velocity SKUs in our retail stores in the first quarter to drive sales and that higher inventory level should remain in place. Receivables of $990 million were down $20 million compared to the first quarter of 2010.

Looking at our outlook for the second quarter of 2011, we expect total Company sales to be flat to slightly up versus the prior year, and that includes the unfavorable impact on sales from the divestiture of our businesses in Japan and Israel. Second quarter EBIT, excluding charges, is anticipated to be up compared to last year as a result of the restructuring benefits and progress made on our initiatives at the business level and corporate. With that, I will now turn the call back over to Neil.

Thanks, Mike. I remain excited about the opportunities we have to move Office Depot forward. As I've told the numerous investors that I've spoken to our met with since taking the helm in October, we are not waiting for the new CEO to arrive to drive positive change at Office Depot or for a rising economic tide to lift all boats. For example, we have made organizational changes that strengthen the team and created opportunities for improved financial performance. We have a deep and talented bench at this Company, and it's time to re-energize the organization and bring fresh new ideas to the table. In addition, I have engaged a number of our associates across Office Depot to take the first steps toward an honest assessment of our culture, discuss where we are as a Company, and more importantly, highlight what behaviors we need to exhibit to effect necessary change across the enterprise. It may not sound like an important objective to some of you, but I have seen some really amazing progress made at companies where everyone is aligned and pulling in the same direction. I am convinced that we have the same opportunity here at Office Depot. Operator, we are now ready to take questions.

(Operator Instructions) Our first question comes from Kate McShane. Your line is open and please state your company name.

Hi, thanks. Citi Investment Research. I was wondering if you could go into a little bit more detail about some of the improvements that you saw in your international markets, specifically in the UK and Germany. What is driving some of those better results?

Hi Kate, this is Charlie. I think the results that we are seeing in some of our markets like the UK, for example, all focus around [vendors]. As you probably recall, we had some difficulties in the UK about three years ago. And we put a new management team in place, and I'm happy to report that our execution there is probably the best in Europe from my perspective, and that's allowing us to grow that business even though the economy in the UK is not strong. When you move to markets like Germany, the economy there is still soft as well, although their exports are picking up. But there's not an increase in white collar workers. But again, we're holding our own, particularly in the contract business.

Thank you very much. And also in terms of the North American Retail business and your guidance that second quarter same store sales will become more positive. Can you talk a little bit more about what you are seeing in terms of traffic and conversion? And how much you think is being driven by just an overall improvement in the economic recovery? And any possible market share gains you might be benefiting from.

I will take that, Kate. This is Kevin. I think, as we commented, as we exited Q1 we saw some improvement in March -- slightly positive comps in March, and that continued into the month of April. I think it's a little bit of a mix of traffic, but I think as important -- perhaps more important -- better execution which is translating into conversions. I think our conversion inside the store is getting much better, partly I think from the investments that we started making improving the in-store experience. We're hopeful that that trend continues, and that as we see changes in white collar workers that that flows through to improved traffic in retail as well.

Okay. Thank you.

Our next question comes from Chris Horvers. Your line is open. Please state your company name.

Thanks. Chris Horvers, JPMorgan. Good morning. Can you talk about how much that shrink impacted overall gross margin in the first quarter? And as you talk about your initiatives to offset some of the paper pricing and the ink and toner pricing issues from International. Will gross margin -- was 1Q an anomaly? Where perhaps at the total Company level we could see gross margin begin to expand again in Q2? And then build from there?

Hey, Chris. Mike Newman. I think going forward with the -- Charlie talked about the issues in International that related to first quarter gross profit that the team is working on that relate to paper pricing and competitive prices on ink and toner. And when you look forward and you look at growth of services, Steve Schmidt talked about the fact that our direct business in BSD is outperforming our contract business that helps us mix up. And we've got quite a few initiatives in the business that we are starting to get some traction on. We've had a number of quarters in a row where we've had margin expansion. I don't think it will be to the same extent we saw in 2010 where we were up 100 basis points a quarter. But I do expect going forward that we will see margin improvement. And also as the economy comes back and sales start to grow, we should get some leveraging impact from that if that happens later this year or not. We will see. Based on our guidance of being -- sales being flat to slightly up, if we are up this is the first quarter that we'll be up since late 2007. So that should certainly help on the leverage side.

And Chris, this is Charlie. On the International side, I'll reiterate that our issues on gross margin were really confined to one region. We had cost increases across the board, but our execution in one of the regions was not what it should be. As I commented on, we are already seeing improvements as we go into the second quarter in terms of our execution around those price increases. So should be better -- should moderate in the second quarter.

And then, Steve, on the top line, being flat to slightly up in 2Q is a pretty big change from what you saw in the first quarter and the past couple quarters. Obviously, that has to be something that you are seeing in the business there. Any commentary?

Chris, we are pleased with the trend that we are seeing at this point. If you recall, we talked about gaining share in the large segment during the second half of 2010. That's obviously carrying over into 2011. So we are starting to see growth in our large customer segment. In addition, I talked about SMB being flat, and we're hoping that that trend continues in the right direction. And all of that was used to offset the decline that we experienced from the US communities transition, which again, we feel very good about. Those factors really are contributing to those positive trends.

And then, Mike, on the tax rate side. Could you just clarify how we should think about perhaps the tax rate in the second quarter? You usually lose money. So will you have a tax benefit flow through where -- should we use that flat -- zero cash rate in the models?

Yes. The way to think about it is if you look at our International business, and we will pay -- on a GAAP basis, taxes should be $23 million to $25 million in 2011. It's principally driven by international taxes, and so the losses on the domestic side do not get any tax benefit as I said in the script. That should flow fairly evenly with the exception of Q2. Q2 is going to be about zero. From a dollar basis -- and the effective rates as we talked about will bump -- will jump all over the place.

So $23 million to $25 million for the year. 2Q relatively flat with the balance of the $23 million to $25 million to come in Qs 3 and 4.

Chris, we didn't answer your question on shrink. We had a shrink adjustment in 2010 of about $7 million last year that we obviously did not -- that's not recurring. We did a lot of good work operationally to drive shrink down. We have shrink at very low levels today. I don't think that we will see any improvement off those levels unless we have some new process change that I'm not aware of. We were up against a pretty tough adjustment from last year.

Thanks a lot.

Our next question comes from Matt Fassler. Please state your company name.

Thanks so much. Good morning. It's Goldman Sachs. Couple questions. First of all, want to get some insight into your thinking on the return profile of some of the investments you have made. Namely, the business process improvement given the charges that you outlined today. And then also just some insight on the ad spending that you put in place in Q1, and what kind of return you think you are getting on that investment?

Want to take the ad spending first?

Yes. Matt, this is Steve. On the ad spend, we spent in Q1 summer to Q1 of 2010, we measure a return on that through a third party company, and we feel generally fairly good about advertising during back to business. It's one of our most productive times, and we do track an ROI on that. Obviously, no advertising totally pays for itself, but we do feel good about that. And we are assessing our advertising plans for the rest of the year. We did announce a change in agencies as part of a proactive approach here. We are continuing to reevaluate our advertising as we go forward.

On the -- go ahead.

Matt, you are talking about the investment return on the reinvestments we are making back into the business from a result of the restructuring benefits?

I guess it's the $60 million or so in charges for business process improvement which is a pretty big number at the outset. How should we think about the payback that you get on that investment?

The payback on that is we've talked about this year -- the charges -- the benefits that we were looking at. Our guidance is we are talking about $80 million to $90 million for the year. We've picked up some of that in Q1 with a lot of that coming yet in Qs two, three, and four. A significant piece of that relates to International. Initiatives we've talked about previously. But we've also got a number of other initiatives in the business that we talked about for the last year. We've got indirect cost reductions. We got finance process improvements where we looking to outsource some of our processes in finance. A lot of that benefit we've talked about in the past. I think those initiatives are going very well.

The one thing we have not called out yet is the return on the reinvestments from some of these benefits that we've talked about making. We talked about reinvesting $40 million to $50 million of that back into the business in areas like in-store experience. Copy and print, Tech Depot. We started to look at some pricing initiatives. We're starting to get our hands around what some of those returns could be, but we're not in a position to talk about them yet. We will probably come out with some guidance on that later this year.

And of those dollars that are allocated to the charges, can you roughly break out for us how much is severance and how much relates to facilities?

I don't have that off the top of my head.

Got it. And just a couple of housekeeping notes. If you could help translate Charlie's guidance on international local currency adjusted for divestitures, acquisitions, and such into more of a stated US dollar -- or local currency number, whichever you prefer, just so we can understand.

In Q2, Matt?

In Q2, yes.

We are going to pick up a significant benefit in Q2 from currency. And so the guidance in Q2 on a dollar basis may be up as much as 5% to 7%. And so when he talks about his guidance on International was that he would be up low single digits, constant currency, like-for-like on a dollar basis. And this includes acquisitions, dispositions. This is all-in. We could be up as much as 5% to 7% in Q2.

And just to understand the impact of acquisitions and dispositions as you net that all out in terms of percentage impact on the business.

Yes. In Q1, we called out that the total sales number adjusted for acquisitions, dispositions was [minus two]. The dollars are about approximately in Q1 were approximately $50 million of lower sales year-over-year. About Israel and Japan exit, it was about $60 million, and then we picked up approximately $10 million from Svanstroms going the other way.

And then Svanstroms, I guess, is bigger in the later quarters just because of the timing of the deal?

We only had one month on the third quarter, Matt.

That's right.

So it will be fully into the balance of the year.

It's much closer to a wash, I guess, in subsequent quarters?

No, I think it will still be a reduction of -- .

It will still be a reduction of [25].

And then very last question just by way of clarification, you talked about better EBIT year-on-year. Last year, you lost money on an EBIT basis. Are you implying a smaller loss? Or are you implying the possibility of break even?

We are implying a smaller loss. And we will see how some of the sales trends develop as we go through the quarter. I'm pleased with the fact that we are starting to see some improvement on the top line though.

Thank you so much.

Our next question comes from Emily Shanks. Your line is open. Please state your company name.

Hi. This is Mike Perez on behalf of Emily from Barclays Capital. Thank you for taking our question. Regarding the Svanstroms acquisition made during the quarter, could you discuss what the purchase price was of that acquisition, and how you funded it?

Yes, Mike, this is Charlie. The purchase price was -- it was done in Swedish Krona -- but the translated amount was $69 billion US dollars. How we funded it was under our ABL, we have a restriction. We were able to bifurcate the purchase executing part of it in the fourth quarter and the remainder in the first quarter. It was financed under the ABL.

Great, that's helpful. What was that on multiple basis?

On a multiple basis, it was -- if you give me a second I can get it for you . It was about 8 -- between 8 and 9 multiple EBITDA

Great. And one more if I may. Regarding your plans for your footprint, are you planning on shuttering any stores in fiscal year 2011? International and domestic.

International or domestic?

Well, could you discuss footprint plans for both as far as shuttering stores is concerned.

On the -- Mike, this is Kevin. On the North American Retail side, we have about 100 leases that come up each year for renewal. And we take a look at each of those to determine whether or not we have opportunities to relocate, downsize, or close. Aside from the Canadian stores that we talked about earlier, there are no current plans for any major structural closure of stores for the balance of the year.

And for International, again it's part of the larger plan that we announced in the fourth quarter of last year. There is a small, single-digit number of stores that we will likely close in Europe.

That's very helpful. Thanks.

Our next question comes from Colin McGranahan. Your line is open. Please state your company name.

The company is Sanford Bernstein. Just following up first on the BPI initiative. Of the $45 million to $50 million net this year, how much of the reinvestments are what we should consider to be recurring? In other words, if you expect to get $80 million to $90 million gross benefit this year, are any of these reinvestments one time? Or is the ongoing net benefit $40 million to $50 million?

Yes, this is Mike. We have some of the reinvestments back into the business are to benefits and merit increases from our employees. And so some of that will be recurring. That's about $10 million to $15 million of the total. The balance are mostly project-driven reinvestments -- in-store experience, Copy and Print Tech Depot -- although that may expand and be a broader initiative. But the balance of the non-people piece is project-driven, and after a period of time can probably be reset to zero and we'll look at other things.

Okay. And then just thinking on the unallocated, or I guess the total G&A overhead. It's flat in the first quarter. Should we expect it to be down this year even though sales are now starting to hopefully inch up? Can you take more dollars out of the G&A nut?

I don't have the guidance for the year on G&A. I think a lot of it will depend on what we do from a performance basis. We took back -- we were much lower last year in bonuses than we probably would like if we hit our numbers. So aside from that, I would think that G&A will be down as a result of some of the initiatives that we've got going through the business.

Okay. And then on working capital, it sounds like there some of the inventory was getting some high velocity SKUs back in stock into a level you want in retail. How much of the working capital performance should reverse through the year? Because it looks like even with the business improving excluding the $25 million dividend from Mexico -- you are going to be excluding that -- you'd be free cash flow negative this year largely on the working capital issue.

Yes. One of the things -- our inventory in Q1 on the domestic side of the business typically will go down following the back to business period by about -- it averages about $90 million if you look at the last three years. And I will adjust 2009 for the stores that we exited in the inventory reduction that went with that. We were down in first quarter domestic inventories, but we were only down in the $20 million range. So we were about $70 million heavier than we would be in prior years. And of that, I think about $20 million of that relates to increased inventories and high velocity SKUs. We had some increased inventory due to some of the direct import penetration. But of that $70 million that we would normally be down, the remaining $50 million is a lot of it relates to timing.

That's helpful. Just a quick final question for Neil. I know you are still in the process, and the Board is looking at CEO candidates. But it's been about six months now, and I think initially we thought it would be something like a six month process.

Can you provide any more insight into what the final candidates look like? Do you have final candidates? Any more insight into the timing, and where you are in the process today?

No. Actually, Colin, I think we've made a lot of progress. We said initially it would take about six months, and we are at the six-month number right now. I think as you look part of the timing issue was when we started in terms of putting a search committee together. Getting a search firm. You had Thanksgiving first, and then you had the Christmas holidays which made it a little bit difficult, and we probably should have said it might take seven months. I'm optimistic that within the next 30 days or so, we will be able to announce something.

That's great. Thank you very much.

Our next question comes from Steve Chick. Your line is open. Please state your company name.

FBR. Thanks. Just to close a loop or follow up on that, Neil, is it safe to say -- are we thinking it's definitively an external candidate at this point for the CEO spot?

No. I'm not going to comment on where the candidate might come from.

Okay. And then separate then, for Steve, on your guidance and your commentary about BSD margins in the second quarter being up significantly. I was wondering if you could give us a thought on what significantly would mean. And then secondly, as you think about when sales come back. What kind of incremental margin are you thinking that EBIT will garner with -- eventually when we go sales positive?

Regarding Q2 guidance. As we look at Q2, obviously during Q1 we spent fairly heavily in back to business, and some of those expenses don't reoccur as we go into Q2. But we balance that with also investment that we want to put behind our solutions business as well as if we start to see continued pick up from a revenue standpoint you have to decide when you start to hire and bring back some incremental head count costs. So we are trying to balance that equation. If you compare it versus year-ago, we had a weak Q2 due to significant investments that will not reoccur this year. As we go into Q2, we feel positive about our ability to drive incremental profitability across the BSD business. And I prefer not to at this point to define significant other than we feel like that trend definitely will be in the right direction pretty significantly in Q2.

Okay. So I guess if -- could it be -- could the EBITDAs for the segment be up north of where Q1 was?

The bottom line profit will be higher than Q1, yes.

Okay, that's helpful. So just as you look at your cost structure, if and when sales do turn positive, how should we think about kind of the incremental EBIT dollars that will rise with rising sales? I don't know if you've looked at it that way.

Yes, Steve, the way I would guide there is simply we have advised that we need to get this business and should be able to get this business back into the mid-single-digit margin level. And that's been the guidance we provided. The question will be is how fast can we get there based on what happens in the economy, and obviously, what we need to judge is how fast do we reinvest in the business as we start to feel some tailwind from the economy. And so that investment would include head count. Obviously, investment behind solutions, investment behind marketing dollars. And so the balance will simply be to do that. But with a deleveraged cost structure, we should be able to see some positive margin growth going forward, assuming we see the economy continuing to show some tailwind behind us.

Okay. Alright. Thanks, Steve.

Our next question comes from Dan Binder. Your line is open.

Hi, good morning. Few questions. I was curious, could you review with us today how many stores are actually unprofitable on a four-wall basis? And why, if there are any, why you wouldn't be just taking one whack at this and closing them as you are in Canada?

Dan, this is Kevin. We won't -- we aren't going to talk about unprofitable stores other than to say if you recall in Q1 of 2009 we closed roughly 120 or so stores that we deemed to be unprofitable. That was a fairly significant structural change in our store base. We now have done the same thing in Canada with unprofitable stores, and as I said earlier, we don't have plans to shutter any more stores at this point.

Okay. And then separately in response to one of the last questions, you said that there were significant reinvestment in BSD a year ago that wouldn't repeat this year. I'm just curious, what that reinvestment is, and why it wouldn't repeat this year?

Dan, if you recall last year, we had invested significantly behind head count. Specifically in anticipation of the economy turning around which didn't happen. So we placed a bet. That bet didn't pay off. So we then reduced our overall G&A expenses in the third and fourth quarter which then turned around and led to the incremental margins that you saw in the BSD business.

So we simply have righted our cost structure as we entered 2011, and we've maintained that lower cost structure basically at the level to support the business as it exists today.

Okay, and then on the paper pricing issue. I was wondering if you could give us a little bit more color broadly. I don't know if it's specific by region? Or international versus domestic? But when you experience a price change in paper, what is your -- how tied up are you in commitments? And for how long before you can pass that through? Then specifically to the International region that you spoke about, how long will it take to get that pricing increase all the way through?

Dan, this is Charlie. In terms of the issue with paper, I think first of all we are talking about a European issue. And largely, the paper suppliers that we use in Europe are different than the ones we use in North America. For the most part. Also the competitive set itself, there is overlap between ourselves and Staples. But obviously, you have Lyreco and other players in Europe that you don't have in North America. First of all, you are dealing contextually with a different environment. The paper price increase that was given to us in Europe in the latter part of 2010, there was not a paper price increase in North America. So the process that you go through because our business in Europe is mostly delivery in either direct or contract, for the most part, you have to deal with catalogs that you have out in the market. And you have to deal with conversations with customers and contract business.

So in some of those -- in most of our markets in Europe, we handled that fairly aggressively. Most of the margin erosion was pretty small. Within one region, as I commented in my earlier statements, we didn't do such a great job. What we have done is we took action in the first quarter to right the process, and the reason we are giving guidance down a little bit from prior year to second quarter is because it will take us through the end of the second quarter to get most of that passed through. But we should be back on track. We are actually doing better in the second quarter than the first quarter. Much better, actually in that regard, and we passed a number of prices along. This will take most of the second quarter to get our way all the way through it, and we should then be back on track in the second and third.

Is this -- this business has been volatile through the years. Are there generally agreements between you and your customers whether it's in the contract or even in the catalog business with these sort of exceptions that are made? In other words, if I'm a contract customer, should I expect that you are going to take paper pricing up? Or is there actually commitments that force you to keep it in place for some period of time? I guess that's what I'm driving at. How long is that period if there are those commitments?

Generally speaking, our contracts in Europe are very similar to the contracts in North America in terms of duration and how they are structured. There is not an -- this is a negotiated thing. So there is not an automatic clause that you can put into the contract. It depends upon the competition that will let you automatically pass price increases along. And given the economic environment that we are coming out of, we found in some cases that some of our customers just simply said, no. They said, look, my costs are up everywhere, and so therefore I'm not going to accept it. Then we are put in a position where we have to then decide what our reaction to that is going to be.

Typically, when it comes to price increases we get two or three months of notice and no more than that. Because we are dealing with an oligopoly when it comes to the paper industry, you really don't have much choice but to accept it. So then it's all hands to the pump to figure out how best to deal with it.

Great. Thank you.

Our next question comes from Joe Feldman. Your line is open. Please state your company name.

Yes, Telsey Advisory Group. Hello. So I wanted from a bigger picture perspective, it sounds like the large business environment is starting to pick up a little bit. Your small- and medium-sized business is -- sounds like it's flattish, maybe even starting to look slightly up. I guess am I reading too much into this that maybe the macro is finally getting a little bit better? That you are starting to feel good about the back half if there is a tailwind here coming from the macro? Or are we not there yet?

I wouldn't go so far as to say we're feeling good. But it gives us hope, and when we look and do analysis on the macro indicators that we tend to track which would be employment and whatnot. We see -- we should see trends improving going forward. That's what the macro indicators would tell us. A couple of people on the sell side that we've talked to have done the same analysis, and that's what they say as well. Certainly, when you see flat to slightly up sales the first time since 2007, we are encouraged. We'd like to watch it a little bit longer to see what it means and understand it and see how the margins flow. The earlier question about how do you lever up and what kind of -- it all depends on mix. It depends on how furniture does. It depends on how services work through, and we had huge mix shifts that have hurt us on the way down. Are we going to see those mix shifts help us on the way back? There is a lot of questions we have. I would say we are encouraged. We're cautiously optimistic would probably be the best way to put it.

At the same time -- this is Neil -- as you look at some of the consumer surveys that have been done, there isn't a whole lot of optimism right now in the economy. There is not any sense of where this budget is going to go. More people are concerned about the deficit, and we have not seen small businesses start to hire at a rate that would give us optimism in your words.

Got it. That's helpful. Then another question. You had mentioned Services, and that was an area we wanted to ask about, too. Can you share the percent of sales it is these days, and maybe what kind of margin you get? Is it still -- do you get almost two X the normal margin on it, or -- ?

Copy and Print Depot and Tech Depot services -- this is Kevin -- which are two of the principle services that sit inside of the North American Retail store organization. Those margins are roughly 2X the house average.

Got it. That's helpful. And then one final thing. In North American Retail, thank you for giving us the cadence -- March into April. I was wondering if you could do the same with the BSD Group?

Yes, Joe. We haven't been specific other than to say the trends that we see hopefully we will continue, and the trends clearly will be better in Q2 than in Q1. We were down, as we said, 3% in Q1. And with some headwind -- or excuse me -- some tailwind and other things, that trend should continue to improve. And hopefully we will start to see the business get closer to flat and heading in the right direction.

And another thing I will point out. We probably said it earlier in the script, but we were down 3% in BSD with almost all of that being driven by the US communities business that -- the 15% that we didn't retain. When you compare that to previous trends that we've had in the last four or five quarters in BSD, it's showing improvement.

Got it. That's helpful. Thank you very much. Good luck.

We have time for one more question. Our final question comes from Aram Rubinson. Your line is open. Please state your company name.

Hi, this is actually [Alisa Geyer] in for Aram Rubinson at Nomura. Two questions. Thank you for squeezing us in. First off, on the double rebates between January and June on the TCPN contract, can you help us think about how that might affect the flow of BSD revenues through the year? Is there any chance of front-end loading those revenues as people work within that first six month parameter?

Yes, Alisa. This is Steve. No. When you think about what happened -- just think about the old US communities contract ended basically at the end of December. We then had to transition customers to one of two cooperative agreements that we have that one is with TCPN and the other is with national IPA and the State of Florida. Those customers had to decide who they wanted to go with, and so the retention rate that we spoken about is where we are at and that will be consistent. And I also spoke to the fact that we are out trying to bring some of those customers that left back into the fold. You will not see any significant swings from where we sit today.

Okay, great. And then just on sort of looking at Canon's commentary around the supply chain recovery taking until June or July. Do you expect any sort of impact in terms of ink and toner? And if so, can you give us a sense of magnitude or timing or anything like that?

This is Kevin. Certainly, the disaster in Japan has impacted principally the consumer electronics market. Certainly, Smartphones are heavily impacted. I think the other area that is impacted is probably more toner in our business than it is ink. So we are certainly working with our manufacturers today to -- one, buy early to protect our customers. Then two, put plans in place to transition customers to alternate products if the national brands aren't available.

We are also working with the manufacturer to look at production and potentially shift production from SKUs that are for older printing units that are close to the end of their service life. Pulling those SKU manufacturing dates back and reallocating that production to more popular toner SKUs. Right now, I think toner is on allocation. We have got a watch out. But at this point, it certainly hasn't impacted the business yet.

Great. Thank you so much for taking our question.

That concludes our webcast and conference call this morning. Thank you very much for attending, and I will be available later today to take calls if you have any more questions. Thank you very much. Have a great day.

That does conclude today's conference. Thank you for participating. You may disconnect at this time.