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Office Depot Inc (ODP 4.64%)
Q1 2019 Earnings Call
May. 8, 2019, 9:00 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Good morning and welcome to the Office Depot's First Quarter 2019 Earnings Conference Call. All lines will be on a listen-only mode for today's call after which instructions will be given in order to ask a question. At the request of Office Depot, today's call is being recorded. I would like to introduce Tim Perrott, Vice President, Investor Relations. Mr. Perrott, you may now begin.
Tim Perrott -- Vice President, Investor Relations
Good morning and thank you for joining us for Office Depot's first quarter 2019 earnings conference call. This is Tim Perrott and I'm here with Gerry Smith, our CEO; and Joe Lower, our Executive Vice President and CFO. On today's call Gerry will provide an update on the business including highlights of some of the noteworthy achievements for the quarter and progress toward our transformation, including steps we are taking to improve our operating performance. Joe will then review the Company's financial results for Q1, including our divisional performance as well as additional details of our business acceleration program and updated guidance for 2019. Following Joe's comments, Gerry will have some closing remarks and then we will open up the line for your questions.
Before we begin, I need to inform you that certain comments made on this call include 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 US Securities and Exchange Commission. During the call we will use some non-GAAP financial measures as we describe business performance. The SEC filings, as well as the earnings press release, presentation slides that accompanies today's comments and reconciliations of the non-GAAP financial measures to the most directly comparable GAAP financial measures are all available on our website at investor.officedepot.com.
Today's call and slide presentation is being simulcast on our website and will be archived there for at least one year. I will now turn the call over to Office Depot's CEO, Gerry Smith.
Gerry P. Smith -- Chief Executive Officer
Thank you, Tim, and good morning to everyone on the call today. It's a pleasure to be with you discuss our performance for the first quarter of 2019. We released our first quarter results earlier this morning which were consistent with the pre-announcement we issued on April 4th. As highlighted on slide 4, our performance in the first quarter of 2019 clearly did not meet expectations. Consolidated revenue was down 2% and operating margins were lower than we anticipated. The primary driver of our underperformance in the quarter was related to the poor result at CompuCom which fell short of expectations primarily due to lower project-related revenue with existing accounts.
Separately, rising production costs for paper and paper-related products also had a negative impact on margins in our BSD division. We have initiated action plans to address both of these challenges, targeting both top line initiatives and bottom line margin improvements. That said, we remain confident in our strategy of transforming Office Depot into a leading B2B integrated distribution platform despite the challenges we faced during the quarter. We made tremendous progress over the past year on our transformation efforts and we will build upon that progress in 2019.
For example, services revenue again grew double-digits in both our BSD and retail segments, a strong signal that our pivot to services continue to make progress. We're also continuing to make progress on other transformation initiatives, unlocking the value of our assets including expanding the use of our supply chain to serve third-parties, utilize their retail footprint to include store within a store, co-working an expanded product offering pilots, as well as through our collaboration efforts like the recently announced relationship with Alibaba.com.
Additionally, we continue to make smart investments in our business, improving our service delivery platform, enhancing our technology infrastructure and increasingly on-demand generation capabilities, all to support our growth platform for the future. Also, it is important to note that in the quarter our balance sheet remained solid with a strong liquidity position and lower net debt reflecting our sizable cash balance.
We also continued to return value to shareholders through dividends and opportunistic share repurchases. As a means to accelerate our transformation today, we're announcing a multi-year Companywide business acceleration program to drive down costs, improve efficiency and enable us to continue to invest in the business to fuel growth. These initiatives include implementing organizational realignments, flattening of staffing roles, consolidating responsibilities and leveraging the use of technology and automation in our facilities and offices. In addition to creating a more competitive enterprise, we expect this plan to provide significant cost savings in 2019 and beyond.
I'll provide more information on this important initiative later in my prepared remarks. Moving to slide 5, let me now turn attention to highlights with our business segments in the first quarter. We continued to strengthen our core business and in evidence BSD division continued to show year-over-year sales improvement. This result is particularly impressive given the last year's first quarter BSD results were very strong and represented the turning point for our year-over-year growth in this business.
Revenues were up 1% over last year, driven by strong results in our contract business plus the additive effect from our strategy of pursuing high quality tuck-in acquisitions. This was offset by targeted actions to improve profitability in certain categories sold primarily online, which had a negative impact to sales. We're winning net new business in our contract channel and continue to grow our adjacency product categories. Adjacency categories include Cleaning & Breakroom, Copy & Print, Furniture and Technology products. We began aggressively pursuing this strategy over the last year and a half and have built capabilities across the organization to support this growth opportunity. Cleaning & Breakroom and Copy & Print were the strongest drivers of growth across these categories during the quarter. Adjacency categories account for approximately 36% of total BSD sales and I believe we're still in the early stages of capitalizing on this growth opportunity.
Also contributing services revenue within BSD grew 13% year-over-year which I will address more fully later in my comments. One key driver for BSD continues to be our stated strategy of selectively acquiring leading players in local markets to expand our distribution reach and increase our customer base. We have completed several transactions over the past few quarters in markets where we have little to no presence. These markets have attracted customers across all of our segments, including a high number of small and medium-sized businesses.
These acquisitions have been a success and we're leveraging our scale while offering an expanded assortment of both products and services to enable additional growth. As related to our e-commerce revenue, actions to protect margins resulted in less sales during the quarter in our online channel. We are working to leverage key product categories, attractive shipping options and improved online experience to drive increased traffic and higher order volume in the future. While we are only at the beginning, the initiatives we've put in place are beginning to drive better trends in our online demand and average order volumes.
As I mentioned earlier, margins were weaker in the quarter largely due to increases in our paper production costs coupled with the inability to completely pass along these increases due to the contractual limitations and timing. Paper costs have increased over 20% during the past 12 months and we are implementing several initiatives to address this. We are working with our customers to mitigate and implement a more risk-adjusted approach when entering into new agreements. While these cost increases may continue to pressure our margins in the short run, we expect the actions we are taking will mitigate these impacts longer term.
Looking ahead for BSD, we will continue to leverage the investments we've made, capturing new customers through the pipeline of business we built and through the numerous cross-selling opportunities with CompuCom and we will continue to drive stronger demand through our enhanced online experience. In support, as we announced earlier this week, we brought a new sales leader in our BSD division with an extensive background and experience, driving growth in B2B markets. We are thrilled to have him join us and we look forward to his leadership as we profitably grow this very important part of our business.
Turning to slide 6, key metrics in our retail business continued to improve. We drove year-over-year sales trend improvements in our retail division despite the continued traffic challenges faced by most in the industry. The investments we made in demand generation and improving the in-store experience helped drive an improvement in reported retail sales trends compared to where we were one year ago.
Although retail sales did decline in the quarter versus the prior period, we did show a 300 basis point improvement in sales trend this quarter compared to prior year. Same-store sales were down 4% year-over-year, reflecting lower store traffic, partially offset by an increase in conversion rate and an increase in demand for our buy online, pick up in store offering, which was up 16% over last year.
Also contributing to the positive trend were services which were up 16% year-over-year. While we are obviously not satisfied with this performance, we do believe that the investments we are making in our services platform and demand generation and in customer experience have us on the right path to drive further trend improvements. We had several districts positive sales in the quarter, including in our Austin market. This is noteworthy and encouraging as Austin is one of our markets where we have more heavily invest in and improve the in-store experience, emphasizing business services with a more localized demand-generation model.
As I stated in the past, our retail footprint is the internal component of our overall distribution platform and a key differentiator versus online competitors. Most of our customers prefer human interaction and we have about 6 million small and medium business customers that are within a three-mile radius of our stores. Nearly 30% of our customers that shop with us through our retail channel are business oriented. To help drive traffic we are empowering our General Managers to utilize store locations as community connection points for businesses and schools.
We have a growing number of partnerships with small business associations that utilize our space for small business Saturdays. These are connection events, fueling innovation and business relationships. We are partnering with several local chamber of commerce and other group purchasing organizations or GPOs to host such events in our stores. All these efforts are beginning to drive increases in customer satisfaction and fuel incremental sales growth.
To that end, we continue to think about our retail space differently and are pursuing additional ways to drive value from our footprint. This includes evaluating store opportunities and innovative store designs targeted at our SMB customers. We remain enthusiastic about the co-working opportunity and the positive trends we are seeing in Los Gatos, our first working facility with continued strong demand and very positive customer feedback.
Demand for this service has been very strong and customer feedback has been terrific. We just opened two new co-working locations, one in Dallas and one in Chicago, and are excited about these and other upcoming opportunities in this space. We will continue to test and pilot these types of opportunities. Also, it is worth mentioning that we are continually evaluating the profitability and strategic value of each of our retail locations to ensure we optimize our footprint to benefit our customers and shareholders.
As we had indicated at the beginning of the year, we expect to further refine our retail footprint which will result in a higher number of store closures this year versus last year. Turning to slide 7, I'd like to spend a few moments highlighting our progress in growing our service offerings. As a primary component of our transformation strategy, services continued to gain traction in the quarter as our efforts to drive demand and the investments we have made continued to facilitate increased sales online and in our stores.
As mentioned earlier, we grew services revenue in our BSD and retail divisions 13% and 16%, respectively, over the same period last year. Importantly, average gross margins in our service offerings are nearly 1,000 basis points higher than our average product offerings. In our BSD division, services growth was driven by strong increases in subscriptions and in Copy & Print services, which include print marketing services, documents and finishing, and pack and ship.
On a year-over-year percentage basis, product subscriptions generated through our e-commerce channel were the largest driver of the increase in BSD service revenues; a true testament to the investments we have made in our e-commerce platform. In our retail division, subscriptions, Copy & Print, and tech services drove the year-over-year growth. Copy & Print services, a very large market for us, represents the largest single category in the retail segment and we are benefiting from the recently launched initiatives to drive incremental growth.
These initiatives have improved the customer experience with new online configurators, allowing customers to design their orders online and pick up in the store. Our commercial customers are also increasingly using store purchasing card, leveraging our stores for their quick printing needs. Equipment upgrades, including large format printers have also contributed to the double-digit growth we realized in this category.
I would now like to take some time to discuss CompuCom on slide 8. The addition of CompuCom was a key step in our transformation and an important strategic asset for us in developing our services business. They are world-class service offerings that differentiate us from the competition and position us for opportunities and partnerships that we couldn't pursue without them. That said, CompuCom's operational performance in Q1 was clearly disappointing and did not meet expectations.
Anticipated project-related revenue from our existing accounts did not materialize due to several industry and customer-driven dynamics and the miss directly impacted our operating results. Several projects that were expected to occur in the quarter either had a change of scope, or delayed or canceled. Our support cost structure was not adjusted, commensurate with the level of revenue and as a result the shortfall had a significant impact to our bottom line.
We are taking aggressive actions to address and put CompuCom back on track with its long-term expectations. We have refocused our customer relationship leaders to pursue solution selling and identify opportunities earlier in the process to help our customers generate value in their businesses. We have completely realigned CompuCom's operating structure and made improvements in the service delivery process to better align and meet customer needs. Under new leadership, we have realigned and reincentivized our entire sales organization for both project and hardware-related new business.
We're also increasing the use of technology and automation in our processes to improve both the cost and quality of our service. We believe these actions will have a positive impact to CompuCom's business through 2019 and beyond. I would point out a bright spot at CompuCom, related to these initiatives and sales incentives we put in place last year result in the lift in hardware sales and associated services and related margins. We exceeded our internal expectations in this area for both sales and margins.
We're also continuing to win new contracts in the quarter with 26 new local customer wins and we've significantly increased our new sales pipeline up over 50% versus a year ago. Furthermore, we are refocusing our resources to capture a large number of cross-selling opportunities at an accelerated rate. We are only at the beginning of this opportunity and expect our cross-selling success to continue to ramp up throughout 2019 and beyond. So, in summary, CompuCom is a big differentiator and strategic asset for our future. Their current performance is completely unacceptable and we are taking decisive actions to address it.
Turning to slide 9, I'd like to spend some time discussing the business acceleration program that we are announcing today. In order to accelerate our transformation efforts, our Board of Directors approved a Companywide multi-year business improvement program to create a leaner and more competitive enterprise, driving cost efficiencies to generate greater profits and the wherewithal to invest to generate future growth.
This effort encompasses the entire organization, including CompuCom, and improves our operational structure and go-to-market strategy while optimizing the use of our assets to the benefit of customers and shareholders alike. The program entails making numerous organizational changes to improve the way we do business and support our customers by flattening staffing roles and management layers, including the elimination of certain positions and leveraging the use of technology and automation in our facilities and offices.
As a component of this approach, we are realigning our sales force and field support teams to more effectively serve customers and more efficiently drive future sales. We are enhancing the way we go to market, improving our effectiveness and overall customer satisfaction by more closely aligning our merchandising, marketing and analytic teams while breaking down silos that impeded our speed address market changes.
Also under this plan, we intend to further optimize our footprint, closing additional underperforming stores and underutilized distribution centers, achieving additional cost savings. At CompuCom, we're making several organizational changes to improve productivity, achieve a balanced labor mix and drive automation to realize significant cost savings while improving customer service. We expect to generate significant cost benefits through this effort in the both near term and future years.
In the near term, we expect to realize cost savings of at least $40 million in 2019, beginning in the second half of the year. Longer term, we expect to achieve at least $100 million in annual run rate cost savings at maturity from this program. This program is effective immediately and one that we believe will ultimately create value for all of our key stakeholders, including most importantly, our customers. The initiative obviously impacts many of our team members. We thank them all for their dedication and commitment to make Office Depot a stronger organization and business going forward.
I'd now like to turn to the progress we're making with our collaboration with Alibaba.com as shown on slide 10. Our collaboration has the potential to create significant long-term value for our Company as it positions us to utilize our sales force, market presence and supply chain assets in unique ways to create value for our customers as well as our shareholders. This collaboration combines the relative strengths of both companies. Office Depot brings relationships with over 10 million business customers over 1,800 dedicated sales professionals and a local and trusted presence, one of the largest e-commerce platforms in the US and one of the largest supply chain networks in North America, combined with Alibaba.com, the largest e-commerce platform in the world with over 150,000 global suppliers, a vast catalog of products and a technology platform that provides small and medium businesses with a range of tools and services to grow their businesses.
As we stated when we announced our collaboration earlier this year, 2019 is about establishing pilots and work streams to determine how we can most effectively serve small and medium businesses together with relatively little revenue to be generated. We are encouraged with the progress we're making on the various work streams. While still very early, our sales teams identified many customers interested in expanding the scope of our relationship to act (Technical Difficulty) Alibaba global supplier network. We are working with Alibaba to determine the appropriate means and business model to facilitate those transactions. In addition, we are making progress with the supply chain pilot with plans to formally launch later this summer. We expect future announcements as we continue to develop the relationship and nature of the opportunity to collaborate.
With that, I will now turn the call over to our CFO, Joe Lower, for more detail on our financial results.
Joe Lower -- Executive Vice President and Chief Financial Officer
Thank you, Gerry, and good morning everyone. I'm happy to be here today to discuss with you our results for the first quarter of 2019. Consistent with previous quarters, we have provided our results on both a GAAP basis and adjusted basis from continuing operations. My comments will primarily address the performance from our continuing operations on an adjusted basis.
Also, please keep in mind that the Company's reported financials in any reference to year-over-year comparisons fully include the results for the CompuCom division as this acquisition was in our results for the entire first quarter of 2018.
Turning to slide 12, total Company sales for the quarter totaled nearly $2.8 billion, a 2% decline compared to the prior year period. Revenue results were lower, primarily driven by weaker sales at CompuCom, down 4%, and a decline in sales in our retail division, down 6%. This was partially offset by a 1% increase in revenue in our BSD division. Potentially lost in these reported results, service revenues increased year-over-year in our BSD and retail divisions by 13% and 16%, respectively, excluding the impact of the CompuCom acquisition.
GAAP operating income results were $24 million, down from $77 million last year. During the quarter we incurred approximately $43 million of operating expenses related to merger integration, acquisition-related costs and other restructuring activities. Of this amount, $25 million is related to the impairment of operating lease right of use assets recognized as part of our adoption of the new lease accounting standard. Excluding these and other items, our adjusted operating income for the first quarter of 2019 was $67 million, down from $93 million in the prior year.
Unallocated corporate expenses were $31 million in the quarter compared to $38 million in the prior year. Adjusted EBITDA was $118 million for the quarter compared to $141 million in the prior year. This included depreciation and amortization expense of $48 million and $47 million in the first quarter of 2019 and 2018, respectively. Excluding the after tax impact from the items mentioned earlier, the first quarter of 2019 adjusted net income from continuing operations was $39 million or $0.07 per share compared to $46 million or $0.08 per share in the prior year.
Finally, for the quarter cash provided by operating activities of continuing operations was $60 million with free cash flow of $14 million. Capital expenditures in the quarter were $46 million compared to $37 million in the prior year period, reflecting increased investments in our service platform, distribution network and e-commerce capabilities.
Let's now turn to slide 13 which highlights the performance of our BSD division. As a reminder, BSD is our B2B integrated distribution business, serving customers from the Fortune 500 to small and medium-sized businesses. Reported sales in the first quarter for BSD were $1.34 billion, an increase of 1% compared to the prior year period. The year-over-year increase was driven by acquisitions, strong performance in our contracts channel, offset by targeted actions to improve profitability in certain categories sold primarily online, which had a negative impact to some of our sales in our e-commerce channel.
Services revenue increased 13%, reflecting our focus on the strategic priority and product sales increased 1% versus the prior year. We continue to see strength in our adjacency categories, which were up over the prior year. The BSD division reported operating income of $46 million in the first quarter compared to $55 million in the prior year period. The decrease in operating income versus the prior year was primarily driven by increases in paper and paper-related production costs that we could not completely pass along due to the timing of price limitations in our contracts with certain customers. As mentioned earlier, paper production costs industrywide have risen over 20% during the past 12 months, causing pressure on margins.
We are aggressively pursuing initiatives with our vendors and customers to help address this issue. While we expect to have continued margin pressure related to this issue in the near term, we do expect that the initiatives we are pursuing will mitigate these impacts longer term. Also included in operating results, our continued investments in demand generation, upgrades to our e-commerce platform and enhancements to our services delivery capabilities, which will position us for future growth.
Turning to slide 14, reported sales in the first quarter for our retail division declined 6% to $1.17 billion compared to $1.24 billion in the prior year period. The decline in reported sales was partly due to the impact of store closures over the past 12 months and lower traffic. These impacts were partially offset by increases in conversion rates and average sales per customer. Same-store sales decreased 4% in the quarter, primarily driven by lower traffic, partially offset by higher conversion rates and an increase in our buy online, pick up in store sales, which were up 16% over the same period last year.
Product sales in the fourth quarter decreased 8% while services revenue increased 16% compared to the prior year period. Copy & Print, technology services and subscriptions, all increased year-over-year. We are encouraged by the growth in services both in terms of enabling a stronger, more sustainable connection with our customers, as well as generating higher margins on average.
The retail division reported operating income of $67 million in the first quarter of 2019 versus $72 million in the prior year period with relatively consistent performance as a percentage of sales year-over-year. The decrease in operating income was due to the impact of lower sales related to store closures and deleveraging across the retail footprint, partially offset by higher gross margins stemming from improvements in mix, distribution and inventory management costs, as well as lower operating lease costs recognized as a result of the adoption of the new lease accounting standard. Additionally, the retail division's operating income results reflect the impact of investments in additional demand generation capabilities, including delivery enhancements, targeted advertising, sales training and other customer-oriented initiatives. During the first quarter of 2019, the Company closed two stores and ended the quarter with a total of 1,359 stores in the retail division.
Looking at slide 15, we highlight the performance of the CompuCom division. As I stated earlier, CompuCom's results are now fully included when comparing performance year-over-year. Reported sales in the first quarter for CompuCom were $247 million, down 4% versus the prior year period. As Gerry addressed earlier, a large driver of the decrease reflects lower sales from project-related revenue within existing customer accounts. This was driven by industry-related dynamics within customer end markets and timing of project-related work. This impact was partially offset by a 35% increase in product-related sales versus last year.
The CompuCom division reported an operating loss of $15 million in the first quarter of 2019 compared to operating income of $5 million in the prior year period. This disappointing result was driven by the flow-through effect of lower-than-expected project-related revenue, compounded by less than commensurate reduction to the associated expenses. Profitability was further pressured by ongoing expenditures to develop and market additional service offerings. We are taking aggressive action to improve our future operating performance, as Gerry addressed in detail during his prepared remarks. We expect the actions we are taking will place CompuCom on a path to get back to long-term expectations, delivering improved growth and profitability in the future.
Turning to the balance sheet and cash flow highlights on slide 16, we ended the first quarter of 2019 with total liquidity of $1.5 billion consisting of $604 million in cash and cash equivalents and $943 million of availability under our asset-based lending facility. Total debt at the end of the quarter was $725 million, excluding $748 million in non-recourse debt related to the Timber Notes. It's very important to note that these Timber Notes have an associated $836 million receivable on our balance sheet and as such we expect a net cash inflow at the ultimate expiration. Taking into account our significant cash balance, our net debt at the end of the quarter stood at $121 million.
For the first quarter of 2019, cash provided by operating activities of continuing operations was $60 million, including approximately $7 million in acquisition and integration-related costs and $6 million in restructuring costs. Capital expenditures were $46 million in the first quarter of 2019 versus $37 million in the same period last year, reflecting increased investments in our services platform, distribution network and e-commerce capabilities. Incorporating capital expenditures, we generated $14 million in free cash flow in the first quarter. The primary drivers behind the year-over-year variance were significant working capital improvements in Q1 2018 that were not expected to be repeated in 2019 and lower earnings. Q1 and Q2 are typically two of our weaker quarters from a cash flow perspective.
On slide 17 we highlight our continued balanced approach capital allocation in the quarter. Our priorities were focused on investing in our business, servicing dividends, paying down debt, expanding our distribution network via acquisition and selectively executing share buybacks. During the quarter, after the $46 million in capital investments, we paid $14 million in dividends, repaid $19 million of debt, invested $5 million in acquisitions to expand our distribution network and bought back $11 million of our shares. Going forward, we plan to continue a balanced approach, addressing our business, shareholders and lenders.
Before we discuss our updated guidance, I want to provide additional information regarding the business acceleration program that we are announcing today. I would highlight again that we believe this plan will create significant value for all of our stakeholders, driving sustainable cost efficiencies and providing us with the wherewithal to invest in additional growth, improve customer satisfaction and enhance our go-to-market approach.
As Gerry outlined, we expect cost savings of at least $40 million in 2019, beginning the second half of the year and at least $100 million in annual run rate cost savings when fully implemented. To achieve these benefits, we will incur costs related to employee severance and transition, retail store and facility closure, and third-party support to execute the program. For 2019, the charges associated with the program are expected to be approximately $85 million, of which approximately $70 million will be cash. For the total multi-year program, including the cost for 2019, we expect to incur approximately $110 million through 2021, of which approximately $100 million will be cash.
I would now like to discuss our updated guidance as shown on slide 18. After a slower start to the year than we expected and anticipating continuing market headwinds, we are updating our guidance for 2019, incorporating the business acceleration program we announced today. We now expect sales to be between $10.8 billion and $10.9 billion; adjusted EBITDA of between $525 million and $550 million; adjusted operating income of between $325 million and $350 million; and free cash flow of between $300 million and $325 million. This guidance reflects stabilizing trends in our CompuCom division, mitigating supplier cost pressures and completing our planned retail store and distribution-related closures, and a continued focus on free cash flow generation.
It also includes the expected benefits in 2019 of at least $40 million in cost savings, beginning in the second half of the year from our business acceleration program, offset by accelerated operating expenditures to support our transformation initiatives, including our recently announced collaboration efforts. Free cash flow estimates exclude the recently announced cash settlement with the Federal Trade Commission for use of a third-party product for the years ended in 2016, as well as cash expenditures that we expect to incur related to the execution of our business acceleration program announced today.
With that, I'll turn the call back over to Gerry for his closing comments. Gerry?
Gerry P. Smith -- Chief Executive Officer
Thank you, Joe. And I'll provide a few wrap up comments and turn it over for your questions. When I step back and look at the strategic path that we've been on, we've made tremendous progress over the last several quarters in the transformation of our Company. That said, we've also faced additional market headwinds and unforeseen challenges at CompuCom that have pressured our results.
Our team has risen to the challenge in the past and is committed to do so moving forward. We're not deterred from our focus on transforming our business into a growing and profitable integrated B2B distribution platform, providing expanding mix of business supplies and valuable services. Our team is more determined than ever to execute on this plan and a create more valuable company for all of our stakeholders.
The business acceleration program we announced today enables us to accelerate our strategy, creating a more competitive company and more opportunities to drive profitable growth. We are excited by what we will accomplish through the balance of '19 and in the future.
I will now turn the call back over to the operator and we can take your questions.
Questions and Answers:
Operator
(Operator Instructions) Our first question will come from the line of Elizabeth Suzuki. Please state your company name and then proceed with your question.
Elizabeth Suzuki -- Bank of America Merrill Lynch -- Analyst
Hi guys. This is Liz Suzuki from Bank of America.
Gerry P. Smith -- Chief Executive Officer
Good morning, Liz.
Elizabeth Suzuki -- Bank of America Merrill Lynch -- Analyst
Good morning. As we look at -- you're going through some of the specifics of the business acceleration program, as you've assessed the organization and came up with this estimate of $100 million in annualized cost savings, it's basically 30% of your EBIT. So, where have you found the lowest hanging fruit in terms of cost cutting and if you could give some specific examples of areas where the Company has been overspending, it would just help us understand the real potential of what can be cut without impacting the top line?
Gerry P. Smith -- Chief Executive Officer
I think it was -- the way we approached it was a very systematic approach. This wasn't just a peanut butter spread approach that people use at times. We went -- really there is a restructuring component and there is a zero-based budgeting component. What we did is we looked across all aspects of the organization. We looked for automation. We looked at (inaudible), we looked at layers. We looked at how to use technology and automate using -- we looked at a low cost jurisdiction perspective as well.
So we're very, very systematic across the budgeting piece and really found ways and looked at opportunities to ensure revenues continue to be generating here in top line and while still making sure we put ourselves a completely different cost structure position. We changed our some of our approaches on sales. We changed some of our approaches how we support IT, et cetera.
I do want to point out, Liz, I think it's super important that we believe this is also important to your point of -- some of this, we want to make sure is reinvested back in growing the business and so we're going to continue to drive this program on a very systematic basis. I'll let Joe add some comments as well.
Joe Lower -- Executive Vice President and Chief Financial Officer
Yeah, Liz, I'd say it just simplistically kind of falls in my mind into three buckets. I'll call it, organizational efficiency, which is looking at how the organization is aligned, that's utilizing technology, that's utilizing automation, it's also recognizing where we can be more efficient across enterprise. It comes into customer delivery as Gerry referenced of how we more effectively cover customers and then finally it's discretionary spend.
And I think simplistically, it's kind of those buckets that as Gerry mentioned, we've really gone through in a very systematic approach, unique to each part of the business in saying how can we optimize the service offering at the lowest practical cost.
Elizabeth Suzuki -- Bank of America Merrill Lynch -- Analyst
Okay. And while all of the costs that are going into implementing that plan, the $110 million spent through to 2021, I mean is all of that going to be considered nonrecurring and gets back that of non-GAAP numbers. I just want to make sure we're modeling this properly.
Joe Lower -- Executive Vice President and Chief Financial Officer
Yeah, correct. The numbers we cited for the restructuring charge are all going to be accounted for accordingly and will be below the line, if you will.
Elizabeth Suzuki -- Bank of America Merrill Lynch -- Analyst
Okay, great. And how much -- just going into the retail division and the operating margin there, how much of that -- how much of an impact was the lease accounting change? Just looking at -- the negative mid single-digit comps must be causing some deleverage there. So I just want to get a sense of what the offset was from the lease accounting change?
Joe Lower -- Executive Vice President and Chief Financial Officer
Lease accounting is only a couple of million in the quarter.
Elizabeth Suzuki -- Bank of America Merrill Lynch -- Analyst
Okay. That's very helpful, thank you.
Joe Lower -- Executive Vice President and Chief Financial Officer
Thanks, Liz.
Gerry P. Smith -- Chief Executive Officer
Thank you, Liz.
Operator
Your next question comes from the line of Geoff Small. Please state your company name and then proceed with your question.
Geoffrey Small -- Citi -- Analyst
Good morning, guys. This is Geoff Small from Citi. Thank you for taking my questions. I just want to touch upon the guidance changes. Can you discuss the changes to your revenue and profitability expectations by division and is the top line guidance reduction entirely related to CompuCom?
Joe Lower -- Executive Vice President and Chief Financial Officer
No, Jeff, I say there's really four -- let me give you four general areas that impacted the guidance and the top line. One being CompuCom, largest; Second is a BSD, not quite as significant, but we did reference how there has been some impact from some of our efforts to address profitability and online sales. And then you have the incremental store closures. Right? So we indicated an increase in store closures and then the fourth piece, which may have been -- we divested a piece of CompuCom early this year, called the ClearPath and that also contributes to the decline. So there's really kind of four elements kind of in order of impact is I kind of went through them.
Geoffrey Small -- Citi -- Analyst
Understood. That's helpful. And can you comment at all on the proposed tariff changes, the impact that may have on your business and what is assumed in current guidance?
Joe Lower -- Executive Vice President and Chief Financial Officer
Yeah so, obviously this will impact everyone in the industry if and how and when it ultimately occurs. So, kind of have that as a caveat. For us, it's kind of two pieces. You have direct procurement which is less than 5% of our COGS. And in that regard we've already implemented several mitigation strategies to address whether it's alternative sources or negotiations with suppliers. The other piece, much larger piece is obviously our cost of goods sold, which is procured from other suppliers. Most have developed strategies, but ultimately that's going to be a negotiation, so we're looking at it closely. A good chunk of our near-term inventory obviously has been procured. So we'll continue to evaluate. We're not in a position today that we can accurately quantify it, ultimately because it's really going to come down too in many ways how the industry responds, but we have been implementing various mitigation strategies since this emerge late last year. Our guidance does not assume significant increase in tariffs from a standpoint of margins.
Geoffrey Small -- Citi -- Analyst
Got it, that's clear. Thanks again, guys. Best to luck in the second quarter.
Joe Lower -- Executive Vice President and Chief Financial Officer
Thanks, Geoff.
Gerry P. Smith -- Chief Executive Officer
Thanks, Geoff.
Operator
Your next question comes from the line of Mike Baker. Please state your company name and then proceed with your question.
Michael Baker -- Deutsche Bank -- Analyst
Hi, Deutsche Bank. Well, real quick, let me just follow up on that last comment, you said the guidance does not include a significant increase in tariffs. So in other words, your guidance assumes, well, I guess I was just asking, your guidance assume 10% tariffs on one, two or three, in other other words $250 billion that's already there and it does not include an assumption of 25%, is that right?
Joe Lower -- Executive Vice President and Chief Financial Officer
I would -- Mike, I would just say we have not incorporated the full potential of tariffs and in large part because ultimately how this get resolved, it's going to be a market-based dynamic. Right? So we have not incorporated clearly this latest tweet. I don't think anyone completely understands what it is and how that would impact. We've tried to look at what's been stated previously, incorporated a level of that, but obviously depending on how things are resolved, it will come down to working with our suppliers and customers to ultimately assess what is the impact to us and the rest of the value chain, if you will.
Michael Baker -- Deutsche Bank -- Analyst
Okay, understood. Two more questions. One, I want to ask you about the Timber Notes. So those have moved from -- I guess it moved into the current portion of your balance sheet. So, just remind us if you wouldn't mind where do those come off the balance sheet completely such that it's not an issue anymore. And you sort of alluded to, you'll get a cash inflow, but can you just remind us the split of exact mechanism of what happens and when so that we are sort of getting to the point where these are just no longer going to be part of the discussion I think.
Joe Lower -- Executive Vice President and Chief Financial Officer
By early 2020, ultimately the two instruments will be, if you will, terminated, expired, condensed and when that occurs, as I said, we will have a net cash inflow of a handful of dollars. If you can kind of do the math, understanding the incremental taxes and the difference between the two and that is expected to accrue to our benefit in early 2020. As you can see, the receivable is larger than the payable.
Michael Baker -- Deutsche Bank -- Analyst
Right. And so -- if it's in the current fortunate, I guess I'd have to go back to my accounting books, but that means that within the next 12 months it will be gone i.e., it would be there by 1Q '20 report?
Joe Lower -- Executive Vice President and Chief Financial Officer
Absolutely correct, and that's why they moved into current this year because within a 12-month period, as I said Q1, the two instruments ultimately will be extinguished.
Michael Baker -- Deutsche Bank -- Analyst
Right.
Joe Lower -- Executive Vice President and Chief Financial Officer
Retired, however you want to put it.
Michael Baker -- Deutsche Bank -- Analyst
One more question, if I could, just on your guidance (inaudible) through all the numbers I'm showing on, but it does seem to indicate much better trends both in terms of a lower sales decline and a much lower profit decline over the next three quarters compared to the first quarter and even if you give you guys credit for the $40 million cost savings, it still would be look a lot better over the next three quarters versus what you saw in the first quarter. So, why is that? Is that what you're seeing currently, or is that based on the initiatives and you expect that to happen. Just some comfort as to why the next three quarters should look so much better than the first quarter looked?
Joe Lower -- Executive Vice President and Chief Financial Officer
I would say that the primary one to identify as CompuCom. So if you look at the results of CompuCom in a negative $15 million, we clearly do not anticipate that recurring for the remainder of the year and that would be the most significant change, if you will, in trend. The others, I would not articulate is fundamental changes or shifts in trends rather continuation with our intent to improve by the initiatives we have in place. But the only one that is, I would say of significance would be a fundamental expectation change in CompuCom over the remainder of the year.
Gerry P. Smith -- Chief Executive Officer
And as I said in my script, this is Gerry. Obviously, we do believe, we have improving sales trends. The pipeline is growing and that's a positive. Lot of focus on the operational improvements of the Company and obviously our business acceleration program also applies to CompuCom. It puts us in a better cost structure and structure of customer-facing and service delivery across the business. So, a lot of work's been put in that business and we've continued to add talent to that leadership team as well.
Michael Baker -- Deutsche Bank -- Analyst
Okay, thank you, understood.
Joe Lower -- Executive Vice President and Chief Financial Officer
Thanks.
Operator
Your next question comes from the line of Michael Lasser. Please state your company name and then proceed with your question.
Michael Lasser -- UBS -- Analyst
Good morning, it's UBS. Thanks a lot for taking my question. Just to be clear, you've included the $40 million savings from the restructuring program in the year guidance, but no anticipated hit to your sales from all the changes that will be made. Is that right?
Joe Lower -- Executive Vice President and Chief Financial Officer
That's why I said -- let me answer it this way. Yes, the $40 million of savings is incorporated into the guidance we provided. What was the second point about sales, I missed that?
Michael Lasser -- UBS -- Analyst
But you have not incorporated any potential negative impact to your sales for making all these changes.
Joe Lower -- Executive Vice President and Chief Financial Officer
Our guidance reflects our estimate of the impact both to the top line and bottom line from the initiatives.
Michael Lasser -- UBS -- Analyst
And are you at the point or you are getting closer to the point where there might need to be some impairment charges for CompuCom given its performance?
Joe Lower -- Executive Vice President and Chief Financial Officer
As you saw in the 10-K, we look at that regularly, we looked at it again, it's something we'll continue to evaluate. At this point in time, we do not believe there is an impairment, but as we have disclosed we will continue to look at it on a quarterly basis.
Michael Lasser -- UBS -- Analyst
Okay, thank you very much. Good luck.
Joe Lower -- Executive Vice President and Chief Financial Officer
Thanks.
Operator
We have time for one final question. That question will come from the line of Chris Horvers. Please state your company name and then proceed with your question.
Chris Horvers -- JPMorgan -- Analyst
Thanks, good morning; JPMorgan. I want to focus on the BSD division a little bit, your sales were up 1% in the first quarter and it was up 3.4% last year. Can you talk about that 1%, is that an organic revenue growth rate, is acquisition in there? And compared to the growth rate that you saw last year, the 3.4%, how much of that deceleration is simply lapping through acquisitions versus the moderation in the organic side?
Gerry P. Smith -- Chief Executive Officer
This is Gerry. Yes, 1% is continued growth. We had a very big increase last year on a year-over-year basis. We're lapping through some of that -- as per my notes in the script, I was very pleased actually with the 1% because we grew so much last year and we're growing in the adjacency business, we're growing in services, 13%. So I'm very pleased with the sales engine and we have a new sales leader who we announced Monday who starts next week and we're really excited with that addition of that leadership as well. So we're on course, staying as part of strategy of growing organic, continue to do tuck-in acquisitions, driving adjacency and driving services. We really do believe it's a great asset to our B2B platform and we're going to continue to leverage that going forward.
Chris Horvers -- JPMorgan -- Analyst
I'm sorry, maybe I missed it, did you say earlier in the call that organic was down?
Gerry P. Smith -- Chief Executive Officer
No, what I said earlier in the call was we're going to continue tuck-in acquisitions. What I said earlier in the call was we had a very strong quarter last year and I was pleased that we continue to have growth year-over-year this year.
Chris Horvers -- JPMorgan -- Analyst
Understood. And so maybe could you -- and if that 1% being organic, how much of that is just -- you face the headwind right? I mean paper and toner, that's sort of a shrinking business, how much of that 1% organic growth is driven off of the balance between net new customer acquisition versus that sort of shrinking spend within existing customer base?
Gerry P. Smith -- Chief Executive Officer
1% to be honest is overall growth, right, that includes the tuck-in acquisitions. Let's be clear on that. All right. Number two is obviously paper is a big product for us and it is declining category, but we believe in -- because of our market share position in paper, which is very large, we want to continue to grow that market share position even as the market share declined -- overall market is declining, we want to accelerate our ability to grow share in that space and we have great relationships with our two primary suppliers to allow us to go up and go do that.
Chris Horvers -- JPMorgan -- Analyst
And so then -- OK, so then -- so did you -- was there net new customer growth?
Gerry P. Smith -- Chief Executive Officer
Yes, absolutely net new customer growth in BSD.
Chris Horvers -- JPMorgan -- Analyst
Understood.
Gerry P. Smith -- Chief Executive Officer
Which is very important.
Chris Horvers -- JPMorgan -- Analyst
And then on the paper production cost, you're covering this industry for 16 years, usually I think in the past you would see there is a lag impact of passing the paper, the paper price increases through to customers. And so, is that true? Said another way, so as you start to lap through these price increases, will you actually recapture the margin pressures and if that's the case could you quantify how much that pressure was specifically in this quarter?
Gerry P. Smith -- Chief Executive Officer
We won't be specific on the quantification, but it's all in my script I did mention clearly that we believe this is a short-term to your point, there is a lag effect and over the longer term we'll be able to incorporate these impacts into our business from a contractual as well as a customer pricing relationship perspective.
Chris Horvers -- JPMorgan -- Analyst
So you should be able to recapture the headwinds a year out?
Gerry P. Smith -- Chief Executive Officer
Yes, over a period of time.
Joe Lower -- Executive Vice President and Chief Financial Officer
Clearly from a margin impact in that category, that's correct.
Chris Horvers -- JPMorgan -- Analyst
Got it. And then my last question is just on the free cash flow guidance for the year, is that a GAAP number and if so -- if it's not, can you talk about what the sort of charges that your cash charges that you're backing out of that, so we can properly reconcile our balance sheets.
Joe Lower -- Executive Vice President and Chief Financial Officer
The two primary things that we are excluding from that number are the $25 million Federal Trade Commission settlement and $70 million associated with the business acceleration program. So as you think of our guidance, those two are excluded and we're tracking to a more, if you will, and adjusted with non-GAAP number consistent with what we have guided in the past and consistent with what we've reported previously. We thought it was more helpful to exclude those items as there was a better comparability.
Chris Horvers -- JPMorgan -- Analyst
Totally, yes. Just want to make sure we're reconciled for year-end. Okay, thanks very much.
Joe Lower -- Executive Vice President and Chief Financial Officer
Thank you.
Gerry P. Smith -- Chief Executive Officer
Thank you. I'd like to thank everyone for joining us on the call today and we appreciate your time and we will see you all as we announce Q2. Thank you very much.
Operator
Thank you for your participation. This concludes today's call. You may now disconnect.
Duration: 58 minutes
Call participants:
Tim Perrott -- Vice President, Investor Relations
Gerry P. Smith -- Chief Executive Officer
Joe Lower -- Executive Vice President and Chief Financial Officer
Elizabeth Suzuki -- Bank of America Merrill Lynch -- Analyst
Geoffrey Small -- Citi -- Analyst
Michael Baker -- Deutsche Bank -- Analyst
Michael Lasser -- UBS -- Analyst
Chris Horvers -- JPMorgan -- Analyst
