ODP Corp (ODP) 2007 Q3 法說會逐字稿

Good morning and welcome to the third-quarter 2007 earnings conference call. All lines will be placed on 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 begin now.

Before we begin, I would like to remind you that the Private Securities Litigation Reform Act of 1995, also known as the Act, provides protection from liability and private lawsuits for forward-looking statements made by public companies under certain circumstances, provided that the public company discloses with specificity the risk factors that may impact its future results. We want to take advantage of the Safe Harbor provisions of the Act.

Certain statements made during this presentation are forward-looking statements under the Act. Except for historical financial and business performance information, statements made during this presentation should be considered forward-looking as referred to in the Act. Much of the information that looks towards future performance of our Company is based on various factors and important assumptions about future events that may or may not actually come true. As a result, our operations and financial results in the future could differ materially and substantially from those we have discussed in the forward-looking statements made during this presentation.

Certain risks and uncertainties are detailed from time to time in our filings with the United States Securities and Exchange Commission. You are strongly urged to review all such filings for a more detailed discussion of such risks and uncertainties.

During portions of today's presentation, we may refer to results which are not GAAP numbers. A reconciliation of non-GAAP numbers to GAAP results is available on our website at www.officedepot.com. Now I would like to introduce Office Depot's Chairman and CEO, Steve Odland. Steve?

Thank you and good morning. Thanks for joining us for Office Depot's fiscal 2007 third-quarter conference call. With me today are Pat McKay, Executive Vice President and Chief Financial Officer; Chuck Rubin, President of North American Retail; Charlie Brown, President of the International Division; and Steve Schmidt, President of the Business Solutions Division. With me also is Brian Turcotte, Vice President of Investor Relations.

Our press release and accompanying slides are available on our website at officedepot.com. Just click on the Company Info and then Investor Relations.

Let me start by speaking to the independent review by our Audit Committee of the Company's accounting for certain vendor program funds. The review, which arose from a whistleblower complaint, revealed that during the period beginning in the third quarter of 2006 through the second quarter of 2007 funds due or received from vendors previously recognized in the current quarter should have been deferred into later periods. To be clear, this is solely related to the timing as to when those funds were recognized. Pat will review this matter in more detail later in the call.

I would like to just a moment to respond to some of the questions we received regarding this review during our quiet period but could not answer at that time. First, I would like to make it clear that the vendor program funds recognition timing issue was identified through our internal processes and now has been corrected, impacting a limited number of our vendor arrangements over the past four quarters.

Second, we issued the press release the day before original earnings date because we had hoped to complete the review in time to announce earnings as scheduled. Unfortunately, that didn't happen.

Third, the press release distributed October 29 was limited in its scope because we were not yet in a position to provide complete information regarding either the actual program dollars involved or the periods affected. We would certainly have provided more information if at all possible, but needed the additional two weeks to conclude the review.

We are pleased that Kim Maguire has joined us in the new role of Executive Vice President of Merchandising. Kim brings 30 years of retail experience to Office Depot, including about two years at QVC, three years at Circuit City, and more than 20 years at Target Corporation, the last eight as senior vice president of merchandising in their hard-lines goods. Kim's track record of driving sales and profitability make him the perfect executive to lead our important merchandising team after the disruption caused by the events surrounding this restatement.

Now turning to the third quarter, although we grew our Company's sales by 2% versus the third quarter last year, we are very disappointed with our results. Third-quarter 2007 net earnings on a GAAP basis were $117 million compared to earnings of $129 million in the same period 2006. GAAP earnings per share on a diluted basis were $0.43 for the quarter versus $0.45 in the third quarter of 2006.

For the first nine months of 2007, GAAP earnings per share have been up 5% versus the same period in 2006. On an adjusted diluted basis, earnings per share were $0.43 for the quarter, down 9% versus the same period a year ago.

In addition, it should be noted that the net results significantly benefited from a reduced tax rate that resulted from specific events which occurred in the quarter.

Operating earnings were impacted by weak late quarter performance in two of our businesses. In North American Retail the quarter was highly promotional, with disappointing sales and margin impacts, and vendor program support was less than expected. This lower-than-expected vendor program support was unrelated to the recognition issues that delayed the earnings.

In International, a weak performance in the United Kingdom negatively impacted results. As expected, our North American Business Solutions Division, we had impact of customer mix and cost increases contributing to the weaker results through the quarter.

All three of our businesses experienced operating margin compression in the third quarter compared to last year. While we are reacting to some of the external factors affecting our performance that are beyond our control, such as the US economy, it is clear that we need to execute better both in the short term and over the long term.

In the third quarter, we took actions to reduce costs in discretionary spending across the organization. As a result, operating expenses as adjusted decreased as a percentage of sales by approximately 50 basis points, primarily reflecting lower performance-based variable pay commensurate with the reduced operating results and benefits from cost management initiatives, which were partially offset by investments to support growth in our International business in addition to some other items. Unfortunately, these efforts were not sufficient to mitigate the gross margin compression that we experienced in the quarter.

While we are still making some investments for the future, it is important to understand that Office Depot is not chasing sales growth for the sake of growth itself. We are targeting profitable growth that allows us to better leverage our fixed costs and improve our operating margins.

So what does this mean for Office Depot in 2008? First let me say that we continue to believe that we have the right long-term strategies. You will hear from each Division President about the action steps they are taking to improve the margins and drive sales growth, but let me give you some highlights of some areas that we believe we can do better.

First in North American Retail, we are moderating capital spending by reducing new store openings, moving to about 70 stores overall for 2007, with a new target of 75 stores for 2008. We are continuing with M2 store remodels, a critical investment in our future; and we are focusing on improving our offering to small-business customers while tightly managing our expenses.

In North American Business Solutions, we're refocusing our efforts on attracting small and medium-sized customers, including those lost during the Allied integration, and expanding operating margin.

In International, we need to focus on improving our performance in the UK while continuing the good progress we have made in developing markets that we have entered. Operating margin expansion is a key to our success in the International.

In all three businesses, continued private brand penetration is the area where we have intense focus.

We continue to believe that share repurchases are a good use of cash. We thought it was a good investment a year ago, which we did. It is an even better investment now. We have been focusing on cutting capital spending and improving our cash flow so that we can do more of it.

We continue to review our overall capital structure. We spend a lot of time on this, looking closely at all the options available to balance our short-term and long-term capital needs while maximizing our ability to return value to shareholders. We will talk more about that later in the call.

Chuck Rubin will now take you through the third-quarter results for North American Retail. Chuck?

Thanks, Steve. Good morning, everyone. Third-quarter sales in the North American Retail Division were flat at $1.8 billion. Comparable store sales in the 1,111 stores in the US and Canada that have been open for more than one year decreased 5% for the third quarter.

Challenging economic conditions, particularly in some of our most profitable geographies, drove declining sales. Actions taken during the quarter to moderate those sales declines have had minimal impact to date.

Virtually all of our comparable sales decline was related to macroeconomic variables, mostly housing econometrics. A multivariate regression model developed by a third-party research firm has found a direct correlation between our sales decline and the high inventory of homes on the market and the extended time required to sell them. The concentrations of weaker consumer spending have occurred in Florida and California, two states which combined represent about 26% of our sales and about 25% of our total store contribution to operating profit, and accounted for about 40% of our total comparable sales decrease in the third quarter.

Many of our positive comping markets are in the Northeast and Canada where we have a limited number of stores. Mexico is also strong, but it is not included in the Division's North American comparable sales.

Other drivers of our negative comparable sales include cannibalization from the new store buildout of about 70 basis points; competitive intrusion of about 50 basis points; and private brand penetration of 10 basis point.

Design, Print and Ship continue to perform well, adding about 30 basis points of comparable sales growth during the third quarter.

Market share as measured by the NPD Group was down slightly for the quarter, driven by sales declines in Florida and in California. This occurred in July and August, with gains made in September. We believe that the share gain in September is due in part to the relaunch of our customer loyalty program, which I will discuss in a moment.

Looking at our core product categories, our technology share was flat in the quarter in the broad consumer electronic market, although down in the office supply stores market due to competitors entering what had previously been an underpenetrated market for them. We did achieve strong comps in notebook computers, calculators, software, cameras, and GPS systems.

Our supply share was down slightly for the quarter, but up in September with improvements across many categories. In furniture, we gained share on a unit basis, but lost share on a dollar sales basis as we transitioned to a lower price point take-with mix. Finally our Design, Print, and Ship business, which had strong comps, gained share for the quarter.

We're very disappointed with the North American Retail Division operating profit of $80 million for the third quarter, a decline from $114 million in the same period of the prior year. This has occurred after 14 straight quarters of operating profit growth.

Some drivers of this operating profit margin contraction were specific to us, while others, such as the weak business conditions, were attributable to broader economic factors. As expected, the third quarter was highly promotional as a result of a very competitive back-to-school season, with office supply stores, warehouse clubs, drugstores, and discount stores all taking aggressive actions to stimulate sales.

These influences lowered our gross margin by approximately 110 basis points. We also pursued inventory clearance activities, which mitigated inventory risk but further compressed our product margins by approximately 50 basis points. Lower-than-expected vendor program support further reduced our margins by approximately 40 basis points.

Gross margin for the quarter was also negatively affected by a shift in category mix of about 60 basis points; a deleveraging a fixed property cost of 50 basis points; and higher supply chain costs and other items of approximately 40 basis points.

These negative factors were partially offset by approximately 160 basis points of lower operational expenses, comprised primarily of approximately 60 basis points from lower performance-based variable pay commensurate with lower Division performance, and approximately 40 basis points of lower advertising expenses as we redirected our ad spend to programs with the highest return on investment.

Our current payroll model affords us the flexibility needed to address the current business environment. Our strategy is to reduce operational task hours in the stores but maintain the other hours focused on selling activities.

Importantly, we continue to focus on providing the highest level of customer service. In fact, I'm very proud to report that our customer service index scores not only improved both year-over-year and sequentially during the third quarter, but achieved the highest levels since the program was introduced in 2002.

As background, our customer service index consists of independent third-party audits which are conducted multiple times per month in all of our stores. In addition, direct customer feedback is measured and also administered by an independent third party.

Comparable average sales per square foot in the third quarter were $250. Average order value was about flat in the third quarter. So essentially the entire comparable sales decline was due to lower store traffic.

At the end of the third quarter, Office Depot operated a total of 1,212 office product stores throughout the US and Canada, including our newest store opening in Puerto Rico at the end of the third quarter, which brought approximately half of our stores into the current M2 format.

We continue to be very disciplined in evaluating both individual new store openings and our overall execution strategy, based on our internal hurdle rate and the current business environment. As a result, we have scaled back our expansion plans from the original 150 new stores targeted in 2007 to about 70 stores this year. We anticipate opening approximately 75 stores in 2008, down from our previous plan.

We continue to believe that we have significant opportunity to expand our store count and that the stores are productive over the long term, but have moderated our rollout strategy in response to the current environment in order to lower expenses and redirect operating cash flow.

We remain focused on refreshing our existing store base. During the third quarter, we completed 31 remodels. Total remodels for 2007 should total 177 stores. Our goal is to have most of our North American retail stores in the M2 format over the next few years.

The combined cumulative performance of our remodeled stores over the past two years has produced gross margin expansion and increased sales by approximately 75 basis points, when compared with our control stores, after considering any cannibalization impacts.

As a reminder, since we are in catch-up mode, our level of store remodels in a given year is proportionately much higher than that experienced by most, retailers. As a result, we have excluded the brief three-week construction period from our comparable store calculation, in an attempt to best present our store performance without most of the noise resulting from the disruption in sales during this remodel period.

The third quarter represented another quarter where we have demonstrated our ability to manage costs, and these efforts will continue. However, we need to improve our sales and margin performance to better position us to benefit when external conditions improve. There are actions we can take and are taking, in our combination of back to basics and an intensified focus on our small-business customer.

First, we will expand our private brand assortment. Penetration continued to expand in the third quarter as furniture, supplies, and technology all increased. Private brand percent penetration for North American Retail is in the high 20s. We believe there continues to be opportunity for further growth as we continue to expand our assortment to achieve potentially 35% to 40% penetration in coming years.

We believe that private brand products can contribute 500 to 1,000 basis points to gross margin over comparable nationally branded products. The additional margin and exclusivity makes private brand very attractive, especially in the office supply industry where there are many product categories that do not have brand loyalty. We will offer private brands across our good-better-best price tiers. However we will balance our assortment between private brands and national brands to satisfy customer demand.

With our new Global Sourcing Office in Shenzhen, China, we will leverage global purchasing power and increase our direct import of office products. We believe direct sourcing will add hundreds of basis points in incremental margin.

Our second focus is that we will grow our loyalty program. In September, we relaunched our Worklife Rewards customer loyalty program, which we believe is now the best in the industry, providing a stronger value proposition to our small business customers by offering 10% back on all ink, toner, paper, and Design, Print, and Ship services, plus 1% back on nearly everything else, with unlimited earnings potential. Additionally, we offer discounts through our affinity partners that our customers will find valuable.

Our Worklife Rewards program will continue to expand and offer new benefits to our customer base. This new program has been very well received by our customers and is less costly than the previous program. While not in place long enough to impact the entire quarter, we are encouraged by its initial performance. We believe our September share gain was driven by the relaunch of this program.

Another component of our loyalty program is our recently launched Worklife Rewards Visa card, which rewards 5% back to customers on Office Depot purchases, and offers additional benefits to our customers during this holiday season.

Third, we will continue to enhance our Design, Print, and Ship offering. In the third quarter, our DPS business grew to grow at a rapid pace, posting double-digit sales growth and contributing 30 basis points in overall comparable sales growth as we increased customer awareness and expanded our service offerings. Our investments in more self-service equipment and training through our exclusive Xerox certification program and new technology, including our large format and upgraded color equipment, position us for long-term growth.

Fourth, we will refine our assortments to offer better value propositions for our very small business customers. This is particularly true in supplies, where greater options for smaller pack sizes, entry price points, bonus packs, and stock-up pricing are provided. This also means moderating the promotional calendar in some of our assortments.

Fifth, we will expand our exclusive offerings to address our small business customer needs. These include expanding our successful Tech Depot service offering, adding a new exclusive identity protection service and providing small business financing options through a third party, which is unique to Office Depot.

Sixth, increasing store productivity by further reducing and simplifying store operational tasks. This will accomplish a number of things, including allowing greater sales focus; improving our supply chain model to make getting products to the store shelves faster and more cost-efficient; and redirecting current inventory investments into best-selling SKUs to improve our in-stock levels. We will reinforce this with our guaranteed low-priced value proposition and our in-store guarantee.

Seventh, manage our marketing expense to target our most valuable customers through the highest returning vehicles. This includes increasing direct mail and e-mail, particularly focused on our Worklife Rewards program, where the database increases the productivity.

Looking forward, we don't know how the retail environment will develop for the holidays. We have a conservative outlook, with tight controls on expenses and inventory.

As we look to 2008, we have the action plan in place to deliver improved sales and margins, particularly in the second half of the year. Although sales will remain challenged in the first quarter, we hope the comp will be close to flat in the second quarter. I would like to remind you that Easter, which has a historically negative impact on our business, occurs in the first quarter in 2008 compared with the second quarter in 2007.

I don't know when the economic conditions will change; but I am confident that we have a great team in place and believe we are taking the right course of action to ensure the long-term health of the North American Retail business, while not pursuing unprofitable short-term comparable sales growth. Now I would like to turn the call back to Steve.

Thanks, Chuck. We are going to probably go a little longer than the hour. We have a lot of detail to share. We want to make sure that you understand the diagnostics around the quarter, but also our plans going forward here and how we are approaching the business.

Since this is the first time participating in an Office Depot earnings call, I just want to introduce Steve Schmidt, who joined us in August as President of North American Business Solutions. We are very pleased to have Steve on board.

He brings 30 years of diverse business experience and leadership to Office Depot, most recently from AC Nielsen, the largest marketing information research company, where he spent 12 years in senior management roles, most recently as president and chief executive officer. His background gives him a wealth of experience in management of a large sales force, e-commerce, direct marketing, as well as overall business operations particularly in the B-to-B arena. Steve's experience there brings us -- is relevant but it also brings us a fresh perspective on the ways to grow our business. Steve?

Thanks, Steve. Total sales in the North American Business Solutions Division were $1.2 billion, down 3% compared to the third quarter of last year. Sales in our direct channel were down 10% due to less effective marketing and issues with our outsourced telephone account manager partner.

Sales in the contract channel were down 1% in the quarter. These declines in sales to our small to midsized customers overshadowed solid quarter in sales to our national account customers of 8% within the quarter and double-digit growth in sales to the public sector.

I am pleased to report that our global Internet sales continued to grow in the third quarter, with sales in the previous 12 months totaling $4.8 billion, compared to $4.7 billion one quarter ago.

We had operating profit of $69 million for the third quarter of 2007 versus $97 million reported for the same period last year.

Operating margins declined by 210 basis points as expected versus the third-quarter 2006, reflecting a 220 basis point decrease in gross margin, which was slightly offset by a net 10 basis point reduction in operating expenses. The decrease in gross margins resulted primarily from lower-margin customers in our sales mix and cost increases from paper-related products, which negatively impacted gross margin by 100 and 120 basis points, respectively.

The decrease in operating expense reflects 50 basis points from lower performance-based variable pay commensurate with lower Division performance and approximately 50 basis points from lower selling-related expenses, which were largely offset by 90 basis points from deleveraging fixed cost and other items. Although our operating margins were down again this quarter, the rate of decline has improved and we're positioning to begin expanding margins beginning in 2008.

We're seeing encouraging results from the new additions to our contract sales force added in the fourth quarter of 2006. The prospecting sales personnel or business development managers began making positive contributions after nine months. Historically, we have seen them reach breakeven returns after being with the Company for nine to 12 months. The issues have been retaining the new business developed and not growing our positions with the small to midsize customer base.

I will now take a few moments to share what I have been doing since I joined Office Depot in mid-August. I spent my first two weeks traveling around the country meeting with both our valued customers and associates. What I found was an organization with dedicated associates, a strong customer focus, and a desire to win. At the same time, I discovered a number of areas that require immediate action.

I now will review the key issues and detailed action plans we are using to restore this business. We have key issues that need to be addressed quickly to meet our sales and operating profit targets.

First, I would like to take a moment to discuss the Viking transition. We expected and realized sales degradation from that specific customer base. The plan was that these reductions in sales would be made up from cost savings realized in the elimination of redundant systems, catalog production and the mailing, and lowering of inventory levels. This went according to plan.

However, we had expected the direct channel sales post-integration to stabilize. This did not happen, as we lost sales in our small size customer base and retention levels suffered, which is exasperated further by the softness in small business spending in the US economy. I should note that about 30% of the Division's sales are in Florida and California, which, as Chuck mentioned, are concentrations of weaker customer spending.

We have not been great direct marketers and recognize that we must change this trend. So the Viking transition went according to plan; subsequent declines, however, need to be addressed. We have initiated steps that I will speak to in just a moment to address the attrition in this very important and most profitable customer segment.

Second, we are seeing positive trends in Allied customer recovery. These sales have stabilized since June through focused recovery efforts following a short period of service issues. After retention plans expired, we lost key salespeople and their customers. We're aggressively working to reacquire the lost business.

Third, over 50% of our total Business Solution Division customer base is comprised of large customers that typically have lower margins than small to midsize customers. Our largest but lowest-margin customers have been growing at the fastest rate, further compressing margins.

Fourth, coverage and retention issues exist with small to midsize customers due to the current design of our sales organization, resulting in margin pressure as this customer base has declined.

Fifth, the existing incentive system limits accountability in P&L responsibility among our associates.

Sixth, there has been a strong focus on acquiring new large customers by our business development managers, but not enough emphasis on growing share with the existing customers, or customer retention, which is the responsibility of our account managers.

Seventh, the contract sales organization is often engaged in nonproductive administrative activity which can occupy a significant amount of their time and distract them from driving sales.

Finally, the current organizational structure and functional silos are resulting in limited true marketing, market research, proper merchandising support, and no clear accountability.

Okay. Those are the eight issues; so let's detail our action plans. As is the case with North American Retail Division, we're going back to basics. This action plan has a multichannel perspective, with some benefits stretching across both the direct and contract channel.

Okay, first, we must restore growth to the small to midsize customer base. This will be accomplished in a number of ways. We're reorganizing the mix of business development managers and account managers to increase coverage. We're developing a detailed behavior-based contact strategy which I will talk about in more detail shortly. And we're employing a third-party sales organization to significantly increase our prospecting of new customers in this important area.

Second, are partnering with our vendors. Business Solutions has conducted detail vendor reviews, and we're creating specific account and coverage plans, new catalog and Internet layouts to increase revenue and margins, and developing solution-based programs.

Third, we're currently developing a comprehensive consumer-based segmentation program for our customer segment. To be launched in the first quarter, this program will ensure that we have the right content, catalog, online, e-mail, and overall contact strategy to optimize revenue and profit.

Fourth, we implemented a North of East turnaround strategy. The plan, which was rolled out in this quarter, focuses on continued rejuvenation of the former Allied business, driving customer reacquisition, and includes a revised contact strategy and a new service model.

Fifth, we are launching a new strategy for our telephone account managers to re-energize small customer growth. We're implementing new hiring standards, key performance metrics, revised training programs, and a comprehensive marketing support program to accelerate profitable growth.

Sixth, we are minimizing the contract sales organization's engagement in nonproductive administrative activities. We discovered that 40% to 50% of our contract sales organization time was being spent on non-customer-focused activities.

In the fourth quarter, we are launching three initiatives including a new service process, whereby all customer issues will be centrally handled; a new target and incentive system that reduces complexity and increases team focus; and the contact strategy that I just reviewed.

Seventh, we are launching a revised marketing, merchandising, field sales, and inside sales operational structure in the fourth quarter. The new marketing structure leadership will own and drive accountability for overall product, segment, and business strategy. Additionally, we're testing an incremental customer contact strategy in the fourth quarter.

To summarize, we have numerous opportunities to improve the operating margin in this business. We believe we can increase the number of our small to midsize customers; improve the pass-through of price increases on ink, toner, and paper; increase sales of higher margin SKUs; provide our customers with high-margin solutions like Design, Print, and Ship; and finally, expand private brand penetration.

Looking forward, we believe that the North American Business Solutions fourth-quarter sales decrease may be consistent with our third-quarter performance; and operating margin compression versus one year ago should moderate. We expect sales to begin to improve year-over-year in the first half of 2008. And operating margins should increase sequentially as we benefit from the actions currently underway.

Charlie Brown will now review the results of our International Division. Charlie?

Thanks, Steve. Good morning. At almost $1 billion, the International Division reported a sales increase of 13% compared to the prior year. Total sales in local currency increased 5% and organic sales growth totaled 2%. This marks the seventh consecutive quarter of sales growth in local currencies.

In particular, the contract channel continued to grow by double digits in local currency, due in part to our prior acquisitions of the contract sales force and our continued focus on new account acquisition in international markets.

Division operating profit of $47 million for the third quarter compares to $55 million in the same period of 2006. Operating profit margin at 4.7% is 160 basis points lower when compared to the same period last year.

About 90 basis points of the margin decline is due to the impact of previous strategic decisions, such as establishing regional offices in Asia and Latin America; centralizing support functions in Europe; opening a Global Sourcing Office in southern China; and expanding our sales force in China and Europe; as well as acquisitions. We believe these investments, which results in the contraction of short-term operating margins, position us to deliver operating margin expansion and increase shareholder value in the longer term.

The remaining components of margin decline include a weak UK performance of 140 basis points and less favorable channel mix of 10 basis points due to the lower-margin contract channel growing at a faster rate than the more profitable direct channel, and selling related and other items of approximately 40 basis points. Partially offsetting the decline was lower performance-based variable pay commensurate with lower Division performance of 140 basis points.

Over the last two years, we have put in place a number of actions in Europe to simplify our operations and reduce our operating costs. We have previously communicated many of these initiatives, which range from the unification and consolidation of our branding, the consolidation of our distribution network, to the creation of a first-ever shared service center for our back-office function in Eastern Europe.

While executing many of these changes requires review by regulatory parties that can impact the timing of the implementation, we're pleased with the considerable progress made to date and the commitment of our European management team.

In total, we expect cost savings from these initiatives by 2010, with some small portion of the savings beginning in late 2008 and growing throughout 2009.

Despite actions to reduce costs of lower performance-based variable pay, the results for the International Division have not met our expectations because of the UK performance. We are (technical difficulty) signs of an economic slowdown in the UK which, if it persists, could provide continued challenges to our operations there in the future.

Operations in the UK have historically accounted for about 30% of the Division's sales but about 50% of the operating profit. As a result, UK's poor performance in the third quarter could not be fully offset by the strong improvements experienced in our other International operations during the quarter. Our Division's performance was also hampered recently by transition issues related to our supply chain and call center areas in the UK.

We continue to believe International represents a significant opportunity for the Company to realize continued top-line growth and even stronger operating profit growth and margin expansion. But we need to execute our restructuring efforts to eliminate duplicate costs.

For example, our large and growing operations in France are burdened with high costs stemming from our legacy of operating as three different brands. Many of the initiatives we are currently executing in Europe to streamline and integrate supply chain, call centers, merchandising, and back-office operations will address our cost structure and allow us to more fully integrate operations across Europe.

To address the short-term challenges we currently face in International, we have developed an action plan. First, we have instituted an action plan to improve the financial performance of our UK business. Aggressive actions are already underway. Our plan is focused on improving the service levels in our call centers and in our supply chain.

Second, we are curtailing discretionary operating investments, reducing capital spending and acquisitions, and aggressively managing our support costs. Examples include freezing the hiring of new sales staff and the opening of new stores, and targeting spend only on those initiatives with near-term cost implications that can realize more immediate returns.

Third, we're maintaining a sharp focus (technical difficulty) to get significantly more productivity out of our existing business. This is key to delivering improved and sustainable performance in the International Division while continuing to capture growth opportunities which we believe exist in all regions. For example, in the contract channel, we have stopped the growth in the sales force and are focusing on increasing the productivity and effectiveness of our investments both in Asia and in Europe.

Fourth, we are increasing the penetration of private brand and expansion of direct import into Europe, taking advantage of our Asian sourcing office, which will allow us to significantly grow our margins.

I should also mention that the acquisitions made in 2006 provide us with a strategic opportunity to expand our global footprint into important growth markets such as China and Korea, while also leveraging our network to meet the needs of our global customers. These acquisitions are largely on track with their acquisition pro formas; and we continue to grow the top line and expand operating margins to improve purchasing leverage.

Looking forward, International fourth-quarter sales are expected to grow at a lower rate than the third quarter. Operating margin will improve sequentially but will be lower than the prior year. We believe our sales growth should remain slightly positive, and operating margins should expand in the first half of 2008 as a result of the initiatives and investments that we have made.

In closing, the integration and synergy between the Company's three Divisions has never been stronger. These synergies include leveraging our global purchasing power with increased direct import through our Global Sourcing Office in Asia; sharing best practices across a variety of functions; leveraging the Office Depot brand globally; and more importantly, providing outstanding service to our global customers, who increasingly look to (technical difficulty) for a strong partner who can consistently support their own expansion plans.

With that, I will turn it over to Pat McKay.

Thanks, Charlie. Before reviewing our third-quarter financial results, I would like to take a few moments to make some comments with regard to the vendor program recognition issue. As a result of the review, the Board of Directors of the Company approved a restatement of the Company's 2006 financial statements including changes in amounts reported in the third and fourth quarters of that year and the first and second quarters of 2007.

The Company has amended its Form 10-K for fiscal year 2006 and its Form 10-Qs for the first and second quarters of 2007. Those documents were filed this morning.

These restatements have resulted in reductions of previously reported Company gross profit of approximately $29 million in total for those periods. Approximately $4 million of vendor program funds due or received in the third quarter of 2007 were also deferred as a result of this review. The aggregate deferrals will be recognized in decreasing amounts through 2010, with approximately $12 million expected to be recognized in the fourth quarter this year and $15 million in fiscal year 2008.

We do remain committed to executing our turnaround plans and doing everything possible to cut our costs and get our profitable growth back on track. We implemented a global initiative to identify and implement cost management and other profit expansion opportunities throughout the Company, to improve our cost structure and our competitive position. We currently have approximately 150 projects that are in process across the organization.

We have developed another 450 brainstorming ideas for new projects that are based upon 30 brainstorming sessions we have conducted. We're in the process of summarizing those ideas, rating their overall benefits and capital requirements, and are working with the project owners to launch a series of new projects during the fourth quarter.

We do believe that over the next three to five years we have the opportunity to increase our EBIT margins by approximately 300 basis points. We have identified specific actions that we will be implemented over time.

We anticipate that our private brand strategy coupled with direct sourcing will contribute approximately 150 basis points. In addition we believe that reductions in SG&A, including supply chain, procurement, information technology, and other support functions will produce another 220 basis points of margin expansion.

Turning to our third-quarter results, total Company sales increased 2% to $3.9 billion in the third quarter. Gross margin declined 230 basis points as previously outlined in the Division reviews. Operating expenses as adjusted decreased as a percentage of sales by approximately 50 basis points, reflecting benefits from cost management initiatives and lower performance-based variable pay.

EBIT as adjusted was $128 million for the third quarter or 3.3 as a percentage of sales, versus an adjusted EBIT margin of 5.1% in the prior period.

Results for the quarter also included tax benefits of approximately $33 million, resulting in a negative 5% effective tax rate for the third quarter and on a year-to-date basis 21%.

We regularly evaluate the organizational structure to minimize our taxes. The third-quarter tax benefit resulted from restructurings effected in the period as well as certain book to tax return true-ups related to prior year. The effective tax rate for the fourth quarter is expected to be approximately 28% but may be subject to future volatility.

During the third quarter of 2005, we announced a number of material charges relating to asset impairments, exit costs, and other operating decisions. This announcement followed a wide-ranging assessment of assets and commitments which began in the second quarter of that year.

We indicated that these actions would continue to impact our results for several years and that expenses associated with future activities would be recognized as the individual plans are implemented and the applicable accounting recognition criteria were met. As with any estimate, the amounts may change when expenses are actually incurred.

From inception through the third-quarter 2007 we have recorded approximately $370 million of those charges. The charges had no impact on EPS for the third-quarter 2007 and a negative impact of approximately $0.02 per diluted share in 2006. We recognized $1 million of net pre-tax charges during the third quarter of '07 and anticipate charges of approximately 17 $million for the remainder of this year and $74 million in 2008. However, future charges make change as plans are implemented.

We have provided a reconciliation of GAAP to non-GAAP results that you can access on our website at www.officedepot.com, under Company Info, and then click Investor Relations. Please note that that we will continue to update this information each quarter in our earnings call slides, our 10-Q, and in the MD&A section of our 2007 annual report.

Turning to cash flow, during the first nine months of 2007 cash provided by operating activities totaled $455 million compared to $792 million during the same period last year. Changes in net working capital and other components resulted in a $205 million use of cash in 2007 compared to a source of approximately $139 million in 2006, primarily reflecting the timing of cash payments in both periods.

As discussed last quarter, the timing of payments is subject to variability quarter to quarter depending on a variety of factors. These may include the flow of goods, credit terms, timing of promotions, vendor production planning, new product introductions, and working capital management. We do anticipate for the full year working capital changes will continue to result in a use of cash for 2007.

Year-to-date free cash flow before share repurchases was $121 million versus $575 million in the prior year, with $338 million due to operating cash and $116 million due to higher capital spending. Depreciation and amortization totaled $206 million year-to-date, about the same as last year. EBITDA was $726 million.

Capital expenditures on a year-to-date basis were $334 million, up from last year due to the implementation of previously announced plans. Capital expenditures for 2007 are now expected to be reduced to the 450 to $475 million range, in part due to a decrease in planned new store openings in 2007 from 125 to about 70. This level of spending is about 3% of our total annual sales, which is right in line with the retail industry.

Capital expenditure estimates for 2008 have been revised downward to $400 million, which reflects a reduction in the number of planned new store openings from 150 to about 75. We will continue to evaluate capital spending in accordance with our overall operating performance and financial guidelines, and in conjunction with the overall business environment.

Year-to-date, we have repurchased approximately 5.7 million shares of our common stock for $200 million. The Company has also previously announced that its Board has authorized the repurchase of an additional 500 million of its common stock. Current plans are to repurchase common stock over the next year as cash flow allows.

Over the past three years we have returned approximately 135% of our adjusted after-tax earnings, 100% of our operating cash flow, and 180% of our net cash flow excluding share repurchases to shareholders.

Now on to the balance sheet. We ended the third quarter with $187 million in cash and short-term investments. Our investment in inventory totaled $1.6 billion globally.

Inventory per store was $916,000 at the end of the third quarter of 2007, 1% lower than the same period last year. On an average basis, inventory per store was just over $1 million for the third quarter of 2007, 3% higher than the same period last year. We expect that year-end inventory levels will be about 3% higher than last year due to abnormally low inventory levels at the end of 2006, particularly in computers in advance of the Microsoft Vista software launch, which occurred in the first quarter of 2007.

Working capital increased by 166% as compared to the third quarter of the prior year. But excluding the impact of our adoption of FIN 48, working capital increased by 136%, which reflects the effect of acquisitions completed in the prior year.

The majority of the increase is related to higher inventory which results from the increased number of stores, higher imports, and the effects of foreign exchange. Contributing factors also include a lower accounts payable to inventory ratio and the slowing in our core supplies sales.

Our long-term debt at the end of the third quarter was $581 million, while adjusted debt including leases was approximately $4.7 billion. Adjusted debt to EBITDAR was at 3.1 times. Our outstanding 2013 Senior Notes are rated investment grade by both Moody's and Standard & Poor's.

We have sought independent advice during the quarter regarding our capital structure from four investment banking firms. They unanimously have advised us to maintain our current capital strategy. This strategy is to use excess cash for share repurchases and maintain debt at the bottom end of the triple-B-minus investment-grade rating. The rationale for this is to optimize the cost of capital given the more cyclical nature of our business.

Further, we have retained Peter J. Solomon Company to provide ongoing analytical support and advice around capital structure alternatives.

Return on invested capital for the trailing four quarters adjusted for charges and credits was 13.9%. Our return on equity adjusted for charges and credits for the trailing four quarters improved by 60 basis points to 20.3%. That concludes my remarks, and I would like to turn the call back over to Steve.

I mentioned earlier that Kim Maguire has joined our team as Executive Vice President of Merchandising. I would also like to mention that on October 5 Kevin Peters joined us as our new Executive Vice President of Supply Chain. Kevin brings to Office Depot more than 25 years of expertise and leadership in the supply chain arena. He comes to us most recently from WW Granger, where he spent five years; and then before that as senior vice president at the Home Depot for 11 years.

Now turning to the US economy, the Fed Chairman in recent comments said that while most recent data suggest a resilient economy, the growth should noticeably slow in this quarter and the first half of 2008 as the housing slump intensifies. He said he expects the economy to strengthen later next year, and the Feds' recent rate reductions have put risk to growth and inflation roughly in balance. Additionally, we understand that the UK markets may be softening further.

So it is with that in mind that we are taking a conservative view of our near-term business conditions and focusing on the things that we can control. We're reducing our capital spending and our discretionary spending in order to drive greater cash flow generation. In the near term, our Divisions are executing back-to-basic plans that are focused on optimizing our existing customer base and infrastructure, and exploiting initiatives that we have tested and that are effective in driving results. Of course, we will also tightly control spending during this time period.

In North American Retail, our key strategic growth priority is to improve store productivity. Given the current environment we have substantially reduced our overall growth plans for 2007 and 2008. We plan to open about 70 stores in 2007 and 75 in 2008. We will continue to refresh our existing store base by converting them to the M2 format, but at a more moderate pace.

Our key strategic growth priority in North American Business Solutions is to profitably grow market share by a refocused and deliberate effort to win small and medium-sized customers. We will accomplish this, as Steve said, through the re-energize and focus new customer acquisition process and disciplines and, to a lesser degree, new product and service offerings.

We also anticipate that the expansion of our contract sales force which occurred at the end of 2006 should drive profitable sales as our business development managers move up to full productivity.

In International, our key strategic growth priority is to improve our cost structure by continuing the consolidation efforts and to profitably grow market share in Europe, continuing to leverage the executions. We will also leverage the emerging market acquisitions that we have made. In the near term, we also need to drive improved UK customer service that compressed some of the Division results.

We are very disappointed in our third-quarter results and remain concerned about the economic environment over the next few quarters. We are also very unhappy with our stock price. Unfortunately, we have cleared the balance sheet of cash, and our operating cash flows declined, so we don't have the opportunity to buy back shares at a time when we believe they are a huge value. We will continue to do everything we can to generate excess cash flow to enable us to take advantage of the opportunity. We will work with Peter J. Solomon on the options as we discussed.

In the fourth quarter, sales quarter to date in all Divisions have been a little softer than quarter three, driven by (technical difficulty) a lower small-business spending, primarily in the US and the UK. We will also likely continue -- have continued operating margin declines versus last year; but we will work hard to moderate that amount, so it is not as severe as the third quarter. We don't anticipate another tax benefit like the third quarter so we will have more significant earnings per share decline.

Again, until these macroeconomic conditions improve it will be difficult for us to rejuvenate the top-line growth. This may carry over through the first half of next year until the comparisons become easier. We will do everything we can to produce for our shareholders while simultaneously taking care of our customers and continuing to make progress on the long-term growth strategy.

When we emerge from this macro slowdown, we feel strongly that we will have the business model that once again can deliver mid single digit top-line growth, repurchase shares with excess cash, and lead to midteen earnings per share growth.

In total, we also believe, as Pat said, that we have margin expansion opportunity of about 300 basis points over the next few years.

So before opening up to call to questions, I would like to mention the Office Depot will be hosting an investor and analyst conference in the first quarter of 2008. We will provide details on date and location shortly.

Now I would like to open up the call for questions. I apologize again; I hope that you understand we were trying to provide as much detail about the analytics of our business as well as our plans, so we will run past the hour to try to take as many questions as possible. So we will start that now.

(OPERATOR INSTRUCTIONS) Danielle Fox.

Thanks. Good morning. Can you talk a little bit more about what motivated the decision to explore alternative capital strategies?

Well, we have -- we worked with four different investment banks in the quarter to try to understand all the different options available to us regarding our capital structure. They have unanimously come back and said that this capital structure we have is the appropriate one for our business for today.

But we want to make sure that we continue to explore that going forward, so we have engaged Peter J. Solomon Company going forward to continue to look at capital structure alternatives and to make sure that we're doing the right thing for our shareholders, while balancing the risk levels as well as our cost of capital going forward.

Okay. Then the next question is just broader. Can you talk about the efforts to balance cost-cutting and efforts to rejuvenate sales? Because just reading through the press release it sounded like some of the things that you are doing to cut costs, for example at the Business Solutions Division, like marketing effectiveness and outsourcing, were actually hurting the top line.

You are also cutting variable pay across the organization. So how do you rally people behind new initiatives when they are getting paid less?

Yes, I think it is really clear that we be clear on this. We are not cutting costs that impact the stores; and we're not cutting costs that impact sales. What we're trying to do -- the variable pay that we talked to is that we are off our plan for this year, and so our expected bonus payout has been lowered. So the variable-pay components relate to bonuses.

The issue is though, as you mentioned, balancing the level of costs with continuing to drive sales. We are trying to drive that pretty carefully here. Our labor costs in the stores are something that we have moderated a little bit of our part-time labor in order to adjust for sales. But we continue to have a higher amount of our full-time labor, and our labor as a percentage of sales has not changed versus prior year.

The same thing in BSD. We are trying to get a little bit of a mix change in our sales force, from focusing on just hunting the new sales to more retention and development of share of wallet in those sales. So you're right, it is a balancing act. What we're trying to do is to make sure that we have got the appropriate balance of cost savings while at the same time continuing to drive our business.

Just one final question, then I will turn it over to others. But can you talk a little bit about whether there are any material differences between Florida and California? Just to isolate the competitive impact, which I guess was new to Florida but maybe not a factor in California. Thank you.

Both of those states are extremely competitive, and we wanted to make clear that people understood our weight of business. In the Retail business we have 25% of our sales in those two states. In the BSD business, it is 30%. And I am not sure that that was completely understood.

So we believe that we have the most concentrated of anybody in the industry in those two states, which serves us well when those two states are doing well. But they are -- those states in a severe housing recession and small-business pullback right now; and we have been hit largely in those two states. Our trends would be -- and the results of the business would be significantly different if those two states were even up to the average of the rest of the country.

Thank you.

Brian Nagel.

Hi, good morning. A couple questions. First off, with respect -- in the prepared remarks you talked about price competition. It sounded like this was mostly around the back-to-school season, but just wanted to clarify. Is this something you have seen beyond back-to-school, and it's more in the core office products category, and it's something that persists today?

Good morning, Brian. As you mentioned, the price competition was very intense during the back-to-school time frame. It is a little bit early to tell what is going to capital with the holiday market. Within the office products industry, outside of back-to-school it has been pretty rational. But we are just warming up for holiday. We will see how that develops.

The second question I have with respect to the more tempered store growth plans now, as you look to pull back from this plan, did you decide not to go into certain markets or strategically decide not to open certain stores? Or was it a broad-based pullback?

Well, we pulled back on our stores. We have lots of sites identified that we still believe are great opportunities. I wouldn't say that there are markets in particular that we have pulled back on. It is really trying to balance the portfolio.

But long term -- I think we have talked about this before -- we believe in our current format. We're seeing good performance out of it. This is a reaction just to some of the general conditions we're facing.

I think it is important, because some of the reports have come out saying that our stores are not -- our new stores are not performing. That is not the case. The new stores continue to hurdle our 13%, as do our remodels.

The issue is that we are trying to moderate our expenses, because there are P&L impacts to those new stores as well as to the remodels, and our capital spending. So we are trying to adjust our CapEx and the expense, and hit a happy medium here with the 70 stores this year and the 75 next year.

We believe that the stores are very productive. We believe that they are on track. And we believe that over the long run we can continue our store buildout, but we have just ramped back.

The other thing, Chuck, that I think is important is to say that we are seeing cherry-picking in the stores.

Yes, to that point, customer cherry-picking. So they are coming in, they are reacting to promotional pricing, they come in. In times past you would see a market basket go along with that, and we're seeing some limits on that market basket. So the customer is responding to that low advertised price and not attaching at the level that we would hope.

Thank you very much.

Matthew Fassler.

Thanks a lot and good morning. A couple questions for you. First of all on the International front, can you just give us an update on how you plan to work with the transition of the Viking brand? That is something you had discussed in prior calls. I don't believe you spoke much about it today. Then I have a follow-up question.

Good morning, Matt. This is Charlie. Well, the first step of our rebranding is really just a cobranding strategy. In September, what we have done is taken all the Viking catalogs and added a tagline, An Office Depot Company, underneath the Viking logo as you would have seen it in the past. We are letting that flow through the market and gauging customer reaction.

I think as you could probably anticipate, the ability to appear as one face to a broad range of customers is strategically very important. However, Viking is also a source of great profitability. We have a huge and loyal customer following. So our plans are going to be very, very tempered. So right now all we have done is just added that tagline, An Office Depot Company, to the Viking logo.

I think this is really important for people to understand. This is entirely different. We're not merging multiple catalogs. We're not changing the brand proposition. We're not changing pricing. We're not changing products. What we're doing is we are cobranding so that people in Europe understand that Viking is an Office Depot company.

The best example of that, Matt, is what we had in France where at one point in time we had Office Depot stores, Viking catalog, and Guilbert contract; and there was no ability to serve customers across multiple channels. We know from our own research here in North America that customers that shop multichannel are -- they spend more with you, and they are more loyal.

Understood. A couple follow-ups. Can you talk about exactly what kind of outcome you could see from Peter J. Solomon? I mean, it looks sounds like you are not looking to lever up further, which would seem like the biggest change you could make to your capital structure. The fact that you retained an adviser would suggest that there could be more significant decisions that you can make. I am just trying to think about what the possible outcomes of this collaboration could be for you.

Well, we don't know is the answer. We have explored virtually every possibility that has been suggested by our shareholders, as well as by analysts. The four investment banks have come back and said -- and recommended where we are.

What we want to do is we just want to make sure that we're monitoring current conditions. We have looked at -- should we divest certain portions of our business? But all these businesses, all three Divisions, are integrated, they're leveraging global customers, there are synergies between them. So we don't have an extraneous business that we could lop off and monetize.

At this point, given the cyclicality of this business, the investment banks are concerned about expanding leverage significantly. Frankly, if you add -- pick your favorite number. If you add $1 billion in leverage, it would hamper our ability to grow in the future. And at the same time it would add just a little bit of shareholder value, frankly, which we could easily get by expanding our multiple, if we could get the growth rate to go up.

So there are trade-offs to be made here. I wanted to share that the analytics have been done by independent parties. They have been reviewed by our Board. But that we don't want to just stick our heads in the sand and say that is it. We want to be analytical and we want to be recognizing whatever is going on in the marketplace. So Matt, I don't know what will come out going forward, but I just want to make sure that we are constantly looking at possibilities.

Then finally, Pat gave guidance for inventory up I think 3% at the end of the year. Pat, I think that was for the whole Company. I believe that on a year-to-year basis it was up quite a bit more than that, and that the growth outpaced sales in the third quarter.

So if you could give us some color as to the current inventory position and then whether I kind of heard you right.

Yes, let me clarify. That 3% up is actually just in the North America inventory per store.

Okay, so the increase in inventory beyond that, which business does it sit in? Are you comfortable with the inventory position up a bit from last year?

Yes, I think we're comfortable with where the inventory position is relative to last year. As we have continued to share, we have been trying to manage in this changing sales environment, to make sure that we get our inventory right.

The sharing that we have provided to you in terms of the inventory per store in North American Retail gives you some perspective in terms of some of the things we have been able to accomplish. But we are very comfortable with where inventory positions are with each one of our Divisions.

I think what we said is we have controlled it very well in the third quarter, and it has been reasonably constant versus year ago. We said in the fourth quarter, we are reminding people that last year was artificially low, and so that we are going to increase it slightly.

Remember, last year we had the Vista sell-down in computers. We ran out of computers at the end of last year. So we wanted to remind people we will go up a little bit in inventory versus year ago, to a more normalized level in the fourth order. That is all we were trying to say, Matt.

Understood. Thank you so much.

Steve Chick.

Thanks. Maybe just further on the sales trend within business services -- or Business Solutions, rather. As I recall, I thought in the US the Viking migration happened or started in September of '05 or so. By my math, if I adjust for what I think your acquired sales was in that division, it looks like over the last four quarters in total the organic rates of decline have been in the area of, say, 3% to 5%.

Yet we are kind of, I think, in year 2 of that migration. So what exactly -- I guess in addition to macro, what exactly is the persistent problem there? It sounds like your guidance in the fourth quarter doesn't really expect that to get any better.

Yes, Steve. This is Steve Schmidt. When you look at the overall revenue within the BSD Division, as we articulated we are showing very good growth on our large contract customer base. In fact, in our top customer base we are growing 8%-plus. The real issue is in our small to medium-sized customer base and with our TAM business, which is showing decline. That is really where we are putting our focus and energy.

Regarding the Viking integration, just to be accurate, that was really around June of '06 that that began. So when you look at the Viking integration, you look at the Allied integration, as well as the other activities that we undertook, clearly the pressure has been on that small to midsize customer base.

That is really the action plans that we have detailed for you in terms of getting that turned around and then maintaining the growth on our contract business. The combination of the two, hopefully, will bode well for the future.

But just to be clear, Steve, the Viking transition in the US happened and completed this summer. That went largely as planned. I think Steve Schmidt outlined that in his comments, and the cost savings that we expected to get from that paid out.

The issue is, subsequent to that, we started seeing a slowdown in small-business customer. All Viking was extremely small businesses, and so that hit us about the same time. So the issue is we have got to see a rejuvenation in this small-business customer, and we talked about the trends to do that.

The other thing that -- I have seen some things that -- some misnomers on the Allied business. The transition went well up until the point that the retention packages expired for a lot of the salespeople. We did have a few weeks of a sales service issue, which we have talked about over and over again. The issue has been in the retention of these people, and they left with their customers.

But if you look at our business, we have 30% of our sales in North American BSD in two states. We had been unable to develop a business in New York. We acquired the Allied business, and we did so in order to get a foothold in New York. Now, we're building back on that business. It still is projected to exceed our 13% hurdle rate on that acquisition.

We would like for it to -- we would like to have retained more of those sales, but it comes down to almost 10 or 20 salespeople that took the majority of the business with us. And we work with them as well. So that is moving in the right direction as well.

The key issue on this business is the small business customer right now. It is the highest-margin customer. So while we are growing it large in the large contract and in the public sector business, which I believe is up double-digit, it is the lowest-margin component of this business. So I think Steve Schmidt and the team are focused on the right things by focusing, refocusing on this small business customer.

Okay. Despite easing, I guess you could say, comparisons, your plan right now is that sales -- we will start to see sales improvements by the first half of '08? Is that in your plan? I missed it when you said it earlier.

Yes, I think what we talked about was that we should hopefully start to see margin improvement in early 2008; and from a revenue standpoint, we should start to see revenue growth reoccurring in the business as we enter 2008.

But we have got to see some improvement here in the macro areas in Florida and California, specifically for this business.

Okay. Then, a second question if I could, and it relates to kind of the capital structure work that you do with your advisers. You mentioned that the idea of divesting businesses, I think you said is not possible because they are all integrated.

Can you speak a little further about kind of what synergies there are with an International Division? How, like for instance, how many customers are both a US and a global based customer, and what the SKU overlap broadly might be?

Yes, good morning, Steve. This is Charlie. The overlap between our customer base is actually one of the bright spots. I know in Europe our global accounts is the fastest-growing portion of our contract segment. Furthermore, we get repeated requests from customers who, for example, we service in North America, like General Motors, to provide solutions for those -- their operations in geographies as distant as Australia.

So, but it goes beyond just the customer base itself, because our customers are looking for global solutions. It goes to systems. It goes to sourcing. The sourcing office that we opened this year in Shenzhen, China, for our direct import is not just for the International Division, but actually is focused on sourcing. That reports up through me, but it is focused on sourcing for the entire operation globally.

So it is beyond just the customer base, and as we move forward in the sharing of best practices and systems that integration will obviously continue and be more tight than it has been in our history.

Steve, another way to think about it is, the margins on all of our businesses are comparable. So. And the brand name is comparable, the system, the processes, the business processes are comparable. The customers are shared. The skill sets are comparable.

Usually when you think about divestitures, it is in businesses that don't fit or are strategically inconsistent. In this case, it is all one business just different geographies.

So yes, we could divest ourselves of stores in North America. We could divest ourselves of customers in North American BSD or countries. But essentially that would be a decision not to -- it would be decision that we wanted to just sell assets to raise cash, rather than trying to deal with a strategic situation.

So the advice has come back that strategically this business fits as one. The issues are around trying to make all those assets more productive going forward. Does that make sense, Steve?

Yes, that's helpful. You know, I guess also -- so in the advisory stuff that you guys discussed, was it all -- did you also think about kind of alternatives for the Company as a whole? I guess just given the stock price. Steve, you know the stock price is lower than level where it was I think when you arrived. So I'm wondering if you kind of really are open-minded about all your alternatives.

Well, we have been, and the Board has reviewed all of our alternatives, every one that you could possibly think of. But we continue to look at them, as I have said. We're not happy with the stock price. Nobody is.

But clearly we have --. Look, our earnings per share are actually up this year. I think there is a misnomer. Some people have published that we have been down for four quarters which just isn't the case.

Our earnings per share are up 5% so far year-to-date. Now that is not great, and we're having a tough fourth quarter, and we had a tough third quarter. So. But we are trying to deal with the macro issues at the same time and govern the business according to that.

What has come down significantly is the multiple, and the multiple is under 10 right now, which is hugely below a market multiple. So I think we are keenly aware of this and the advisers have focused on it. The issue is what to do.

What we come back to is we've got to weather this period of time; save the costs that we can; conserve the cash; and get through this macro period of time. In which case all of these cost reduction efforts that we have taken will -- should start to leverage the other way and we should start to see our natural growth model again.

So that is what has come back at this point. But again we don't want to be close-minded to things that we haven't thought about going forward.

Okay, that's very helpful. Last question if I could, just the swing of the Easter comp from Q2 into Q1, have you quantified that, on what the expectation is? I don't remember the -- you might have said something about it last year.

I'm not sure that we talked about it last year, but it has an impact on the overall comp, a measurable impact. Because you have changes in vacation timing and just the shopping pattern. So it will suppress first quarter.

We're not a consumer business, Steve, just to remind. Our business is almost all small businesses. So whereas the holidays help a lot of retail businesses, the holidays don't help this business.

Okay, no, I just -- you mentioned it, so I wanted to make sure we kind of -- I don't know if it is 100 basis points on the first quarter or something. But we can do the math and figure it out. Okay, thank you.

Colin McGranahan.

Good morning. First, thanks for the helpful detail on the slides. That gave us a little bit more insight into the issues and what you are doing.

I wanted to focus first on the direct or catalog business and just to follow up on the last question. Understanding, obviously, that the Viking shutdown occurred; but then the businesses remained quite weak following that. Surprisingly weak.

How much of that is a function of response rates being much lower; intent or actions you have taken to reduce prospecting in the past; average order volumes falling; or just a function of the geography of where that business is located in the soft markets of Florida and California?

When we talk about the catalog and direct business, and Viking in particular, the Viking business clearly was a catalog-driven small market business. They distributed upwards of 100 type catalogs. What we have done on the small customer base is continue to focus on catalog effectiveness and efficiency. We continue to distribute multiple catalogs across these segments.

From a response rate, as we look at our catalogs, we continue to improve response rates. In fact, we have one of the higher response rates today on both our catalog and online performance in the business.

So we intentionally through the Viking integration knew we were going to reduce the number of customers, that we were going to save the cost as part of that integration. And we do believe that our ability to drive revenue through catalog and online continues to be a priority for the BSD Division. So that is there.

With that said, as we look at the whole direct business, which includes kind of catalog and TAM as well as our online performance, we're not pleased with the overall performance. That is really the action plans that we are implementing around the TAM restructuring.

We have reevaluated and are looking at every aspect of the catalog. We're looking at every single page in the catalog to determine ways to optimize the efficiency of each page from an upsell standpoint as well as pricing, graphics, and consumer appeal. As well as we're exploring all online activities to make sure that we are doing everything we can to rejuvenate this business.

But you know, another way to look at it is when we cycled the Viking transition, we started to see considerable improvement in that business, and it flattened out. It was only subsequent to that, when we started seeing the huge business slowdown in Florida and California, where that business is concentrated -- the direct business again is concentrated in Florida and California. When we started to see that is where the trend started moving the other way.

So what Steve was saying is we have got to get more effective at bringing the business in and deepening the share of wallet in those small businesses, and trying to grow share essentially in Florida and California given the weak small business environment.

Okay, that's helpful. Then just secondly to come back to Peter J. Solomon, and I don't mean to beat a dead horse here. But given that you have done a fairly thorough look at the capital structure, concluded that additional leverage doesn't make sense -- and I think that is a prudent decision -- concluded that divestitures don't really make sense, I guess I just don't understand what Peter J. Solomon is doing currently. Are they there on retainer to respond to developments that might occur in the sector?

Clearly the latter. They are on retainer. But we have asked them to go through and come up with any other ideas that we hadn't considered. But also to continue to look at the state of our business going forward.

So I don't know what else we're going to look at, because I think we did a very thorough job in the quarter with four different investment banks. But we want to make sure that we have got somebody helping us ongoing here, so it is more of how you characterized it in your last statement.

Okay, and given they were Office Depot's advisor in 1996 with the proposed merger with Staples, is it fair to say they're intimately familiar with the issues that might occur around something like that again?

Colin, I think everybody in the world is intimately familiar with what happened then. I think just for the people who don't recall, the FTC blocked the merger of Staples and Office Depot in '96 and '97. That materially set back this Company for a very long period of time, as we had essentially effected a large portion of the merger during that period of time and lost a lot of our people and supply -- and our store base and so forth.

But anyway. So it is not believed that the FTC has changed their point of view on that kind of consolidation in this industry.

Okay, thank you.

Brad Thomas.

Thanks. First of all, I wanted to thank you as well for all the detailed information that you provided today. It certainly helps us to understand what is going on and what you are trying to do going forward.

I wanted to follow up a little bit more on the Business Solutions. It certainly sounds like there is a number of initiatives that you have in place, a lot of changes that you want to make. Could you just help us understand a little bit more how dramatic this is going to be in terms of how you currently operate the business? Maybe give us a sense for where you think headcount is going to go going forward within the Division.

As I stated, this is really back to basics. I wouldn't view necessarily the changes as overly complex. I think it is basically attacking every single aspect of the business and kind of driving it from a strategy, structure, and process standpoint.

We have identified that we must grow the small to medium-sized customer base. So we have laid out five or six key initiatives as it relates to restructuring of the selling organization between account managers and business development managers; as it relates to restructuring and revising our TAM business, which I believe you know we outsourced to third parties.

We have implemented a comprehensive set of key performance indicators, marketing metrics, as well as training and development materials for that TAM organization. It is attacking the direct business from the catalog and online to make sure we're optimizing each of those pieces.

From an organizational structure standpoint, it really is around effectiveness of our contract selling organization, which was highly focused on non-value-added activities. Those restructuring and many of these activities are actually being implemented in the fourth quarter of this year.

So the complexity of implementation really is going to be in taking the organization from where it is today to where we want it to be, to really serve our needs in 2008. We will continue to do whatever we have to and as aggressively as we can.

But I would not characterize it as overly complex. The issue is simply in a contract business where you have long-term contracts, the ability to change and move the market takes time. Then when you add on top of that the economic situation that we're facing and the percent of business that we have, as Steve has outlined, in Florida and California, as we make these changes it is going to take some time to see the -- both top-line bottom-line impact of those changes.

Okay. As we think about the changes, it sounds like a lot of them are more internal in terms of some of the administrative functions and the accountability. Can you talk a little bit more about maybe what the customer will see from these changes?

Yes. From a customer perspective, really the most critical thing which we have talked about is this new contact behavior-based model that we're putting in place. So literally I think the way to describe it would be that, if you think about every way that we contact a customer, whether it be a one-person business or a 10,000-person business; and you say that there are multiple ways to contact a customer from online to e-mail to personal to catalog; and then you basically create a behavior-based model within each segment to ensure that we are contacting each customer appropriately to maximize the value they have and see.

When it comes to our customers, there's two aspects. We absolutely must maintain our existing customers. That is an increased focus we're putting in the BSD Division. Probably we lost some focus on that as we went more to a hunter versus maintain model. So we are going to continue to focus on maintaining existing customers.

Beefing up the marketing organization will help significantly as we create new products and services that should fuel growth in the coming years, while maintaining a focus around acquiring new customers as part of that strategy. So those are the key elements that we are trying to implement at this point.

Brad, if I could just add also, I think these pendulum swing. We were really overweighted with small businesses. We were missing the boat in the large customers and missing the boat outside of -- in some of the geographies in the country.

We then added the contract sales force, hundreds people in the contract sales force to go land customers and large customers in other geographies that work. We started doing that at the same time then we had the small business slowdown.

So what the customers will see is the contact -- the level of contact now, we need to swing the pendulum back a little bit, obviously, towards the small business customer base. Because the margins are getting hit here with the slowdown in the small businesses. So it is everything Steve said, but also it is the kind of customer that we're going to be going after as well.

Then I would also add that as we look at the area of prospecting, we really were focused on, I will call it once again, the small to medium-sized sector. Our existing customers. What we were putting in place is both maintenance of existing but also an aggressive program to go out and acquire new customers through third party on the street, which we have talked about, in addition to our TAM organization going after new customers, not just our existing customer base.

Great, that's very helpful. If I could just ask one more follow-up on the Retail side things. Chuck, you mentioned that during back-to-school it seemed like customers were cherry-picking some of the promotional offers that you had. That sounds very consistent with what we saw on Black Friday last year. Could you just talk a little bit more about how you're positioned for this holiday season, and maybe what opportunities you have in that kind of an environment where a customer is cherry-picking?

Well, I think there's a few things. As I think we said in our comments that we're managing our cost, managing our inventory closely, because we're not sure how the holiday season will unfold. We have some great offers for customers. Also in my comments. We're very proud of the highest customer service scores that we have had since we started measuring that five or six years ago.

So I think that we have some great offers, we have the right product, and we have stores that are staffed with high-energy people to wait on those customers. So we are going to do our best to provide an appropriate offering to that customer and service to go along.

But I think it is important to say that we are not a holiday-driven kind of business. We are B-to-B primarily even in the stores. Black Friday, we tend to get the technology and some televisions and things like that, but nobody is coming in on Black Friday to buy more basic supplies. So it's a different kind of a deal for us.

Last year we got cherry-picked pretty heavily on the tech businesses. So we're trying to take a little bit more moderate approach to make sure that we do our best to protect our margins while continuing to drive as much traffic as possible.

All right, great. Thanks so much.

Chris Horvers.

Thank you and good morning. Stepping back and thinking about what I will describe as the investment cycle, both from a CapEx and SG&A perspective, do you think -- is '07 the peak of CapEx and the business turnaround?

Then following up on SG&A, given what you have already been spending to turn the business and the new initiatives that you're putting in place now, when do you think, let's say, on a trailing 12-month basis that the expense side of the investment cycle will peak?

I think the CapEx as we have stated, the CapEx has peaked here in 2007 as we have tried to make some investments here in dealing with our supply chain, our IT, as well as some of the new stores.

We were getting criticized in 2005 and '06 when the business was booming; we were doing upwards to 41% earnings per share growth, and we were getting criticized for not investing fast enough, so we started investing more.

I think now with the cyclicality of the business appearing here, which really hadn't appeared to this level prior to this -- remember, we are a very young company -- I think we're going to be more cautious about our investments going forward.

You know, we have to view this as a more cyclical business that is vulnerable to that. So we can't just dial up and dial down the CapEx. So I would view our CapEx -- when we start going -- get through this macro period of time, I think we can expand faster. But we simply can't go over the top on our CapEx.

The expenses, we have moderated the expenses and so forth with every intent and every hope that, when we get through this macro period of time, we will begin to leverage the expense structure and build margin again, which is what we did when we were growing in 2005 and 2006.

The critical question here is, how long is this macro slowdown going to happen? If we knew that with precision, it would be far easier to, A, predict and, B, to answer your specific questions on the investment side. But we are going to be moderate until we see a pickup here again.

So then with the new changes that you're putting in all three Divisions, is there a sequential pickup? Or is there a big expense nut related to these new initiatives?

No, we're trying to reallocate expenses within the Divisions so as not to further depress margins.

Okay, that's perfect. Then finally, as you talked about -- a follow-up question on the retail, reallocating labor to customer-facing activities and away from non-value-added activities. That is a difficult thing. Easy to say, I guess, difficult to do. Any detail on what you plan on doing there?

Yes, we have done a lot of things already. Half the chain operates on the M2 format today. That is a more consistent format. It is an easier store to operate than the traditional models that we had before. So there is -- that in itself is an opportunity.

We have reengineered all the backroom processes for the store as well. So there is another example of something that has made the operational side of the store easier to operate and allow the store manager and the team in the store to focus more on customers. There are other adjustments again in non-customer-facing activities that we have intended.

At the same time, we have also put a lot of time and effort into the customer-facing side of it. So we have a team selling program that I have talked about before that is in place; and in fact just been enhanced over the past couple of months to again stay focused on servicing the customer as best as we possibly can.

Thank you.

We're running a little short on -- well, we are way over time, but I think we're going to have to wrap it here after -- let's try to take two more questioners.

Gary Balter.

Good morning, it's actually Seth Basham for Gary. A couple quick things. First on the bonus compensation in the quarter, could you quantify how much that helps you in terms of leverage? Related to that, did you reverse any accruals for bonus compensation from earlier in the year?

Yes, it was 80 basis points in the quarter year-over-year improvement as a result of that. Then it also was $19 million in terms of the absolute reversal during the quarter.

So that $19 million was incremental or included in the 80 basis points?

Included in the 80.

Okay, great. Then secondly, can you give us a little bit more color on the issues with the telephone account management service and what you're doing to repair those?

Yes, regarding the telephone account management, we outsourced that last year to two separate organizations. What we have been doing is really working with both those organizations in terms of their hiring practices, key performance indicators, implementing a series of marketing programs, training programs, to ensure that these people are as effective as they a possibly can be.

Because as you know, it really requires a great skill set to be effective in terms of telephone account management. So we have been implementing a whole set of standards and processes over the last few months with both those organizations.

In addition to that, internally we have refocused the management that is overseeing that part of the business in terms of their key activities and what they are trying to do.

We are also exploring a number of options here in the fourth quarter in terms of rehiring some of our old TAM reps who were most effective in the organization, in addition to exploring the use of people working from home, which we all know is one of the more effective workforces in the United States today -- people who are highly educated, but want to work on variable hours.

So we are exploring all those activities. In addition to that, the contact strategy for TAM, as I said, was only focusing on existing customers. We are now doing a prospecting for new customers within that organization also. So I think we're attacking every single element.

So you're bringing some of those jobs that were moved overseas back to the US?

Well, first of all, the things that were moved offshore were really our call centers, into five separate locations. Our performance around this call centers quite frankly today is quite good.

In fact the performance metrics that we're getting from those call centers are actually slightly higher than they were when they were in-house. So at this point, we're fairly pleased with the performance of those call centers and see no need to change that direction at this time.

The TAM, Seth, was all domestic. We have had issues with the domestic performance on the TAM organization. So we're going to moderate -- with the outsourced partners. We're working with them closely to get the metrics back up.

Understood. Then lastly on the retail side, do you expect the decline in margin that we saw in the third quarter to essentially be the low point?

Difficult environment, like we said, but we believe -- we are working to be sure that that is the low point.

Okay, thank you, guys. Good luck.

Dan Binder.

Hi, good morning. A couple of questions. First, just digging into the delivery business a little bit further, I understand that the small and midsize customer has been a problem area. But I guess if I look at some of the growth in the independent dealer channel, they seem to be taking some share.

So I guess what I am wondering is it sounds like you are addressing some of the operational challenges. But on pricing, do you feel that you need to be more aggressive on price?

I guess that question goes beyond delivery to retail as well. It seems like over the last couple of years, retail prices have maybe eased up a little bit. Not quite the gap that we used to see versus Staples in terms of being below. I am wondering if you think that is potentially an issue here as well.

Not sure that we are actually seeing a share decline and that the independent -- I am not sure the independent dealers are picking it up. But, we would love to hear your analysis on that. Remember, 30% of the business on our business is in Florida and California. So I think we are doing as well as anyone in those areas.

As it relates to pricing, I will let the Division Presidents talk. But we're trying to be very careful here to test our way to things. We have cut prices in some areas through our line reviews and category management. We have pushed prices on the best and to try to have a broader range between the good, better, and best and those kinds of things.

We have no interest in chasing volume that is unprofitable and I think we have been consistent in not doing that. Steve, Chuck, any comments on that?

Yes, regarding the BSD side, first of all, I would say the softness that we are experiencing in the small and medium-size business is really not a function of price. It is a function of execution. It is a function of coverage. It is a function of people. It is a function of proper processes, marketing support, and all of those other element. So it is really not being driven by price.

The second comment I would make is that we are evaluating in the fourth quarter our entire pricing practice. We're evaluating both internally in terms of what we do by sector, by product, by category; and then in addition to understanding what our competitors do in this space, to make sure that we are doing the right things to optimize both revenue and margin.

Yes, Dan, on Retail I think you mentioned we have done a lot of work in pricing over the past couple of years. We are pleased with our prices are today. I think Steve mentioned before, we apply a category management approach, which means some things go down, some things go up.

We constantly shop our top items to ensure that we are offering the customer the appropriate price; and we back it up with a low price guarantee. So again, it was mentioned earlier, we're not interested in chasing unprofitable sales on our items.

But Chuck, I think we have seen some analyst reports that says that we're taking pricing up. That is just not the case. With the tens of thousands of items that we have in our system, there have been some price increases by manufacturers. We have moved some things here and there. But overall, our prices have not -- we're not -- we don't have a deliberate strategy to move prices up or to build margin versus pricing.

If anything, we're trying to be smarter about what items to discount, how to try to drive store traffic with those, and then build basket thereafter. So I just want to be really clear that we're not -- that this isn't a strategy to increase prices.

Okay, my comment regarding independent dealers, incidentally, was really just referencing the results that we hear coming out of the wholesale channel in terms of what they are seeing with the independent dealers. That was primarily my source of -- or point of reference.

We appreciate that, thanks.

Okay.

Okay, thank you for joining us today. I apologize again for going long. But as I hope that you understand, we have tried to share with you as much as possible of what we understand about the business and the macro situation that we're facing, and as well our detailed plans that we have to go after our business. With that, I will end the call. Thanks very much.