ODP Corp (ODP) 2007 Q4 法說會逐字稿

Good morning and welcome to the fourth-quarter 2007 earnings conference call. All lines will be on a listen-only mode for today's presentation, after which instructions will be given in order to ask a question. At the request of Office Depot, today's conference is being reported.

I would like to introduce Mr. Brian Turcotte, Vice President of Investor Relations, who will make a few opening comments. Mr. Brian Turcotte, you may begin.

Thank you, Melissa. Before we begin, I would like to remind you that our discussions this morning may include forward-looking statements which are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements reflect the Company's current expectations concerning future events and are subject to a number of factors and uncertainties that could cause actual results to differ materially. A detailed discussion of these factors and uncertainties is contained in the Company's filings with the SEC.

I would now like to introduce Office Depot's Chairman and CEO, Steve Odland.

Good morning and thank you for joining us for Office Depot's fiscal-year 2007 fourth-quarter conference call. With me today are Chuck Rubin, President of the North American Retail Division; Steve Schmidt, President of the North American Business Solutions Division; Charlie Brown, President of International; and Brian Turcotte from Investor Relations.

The press release and accompanying webcast slides for today's call are available on our website at officedepot.com; click on Company Information and then Investor Relations.

As you read in our press release this morning, Pat McKay is leaving the Company effective March 1. Charlie Brown, who was our CFO from 2001 to 2005, has agreed to assume the role of acting CFO in addition to being President of International following Pat's departure. We have begun a search for a permanent CFO and will announce a successor when the process is completed.

I would like to thank Pat for her tireless work and dedication to the Company. She made valuable contributions to Office Depot since joining the management team in 2005, and we wish her all the best in her future endeavors.

Now turning to the fourth quarter. Fourth-quarter 2007 total Company sales grew by about 1% compared to the fourth quarter last year. Net earnings on a GAAP basis were $19 million compared to earnings of $127 million in the fourth quarter of 2006.

GAAP EPS on a diluted basis were $0.07 per share for the quarter and $0.45 in the fourth quarter of 2006. The as-adjusted diluted earnings per share for the fourth quarter were $0.10 a share versus $0.51 in 2006. In addition, there was a substantial tax benefit recognized in the fourth quarter.

Total Company operating expenses as adjusted represented 26.3% of sales, an increase of 40 basis points over the fourth quarter of 2006. EBIT as adjusted was $6 million in the fourth quarter of 2007, or 0.2% as expressed as a percentage of sales compared to $201 million or 5.2% in prior-year period.

The negative impact of the US housing and credit market downturn we began experiencing in both of our North American divisions in 2007 appears to have developed into what a number of private and public sector economists have identified as a looming national recession. We're not economists, but it appears that Office Depot was a leading indicator, as we were seeing effects as early as last spring from economic slowdown that US retailers and manufacturers are now widely reporting.

The slowdown for us began in Florida and California among our small-business customers. You may recall we are overweighted in those states with nearly 30% of our North American business in those two states.

On December 12, we issued a press release indicating that the Company results were being impacted by continued economic weakness in the fourth quarter. In that release, we reminded readers of the challenges to our results in the third quarter, and that had been mitigated by certain items, and mentioned that in addition to the direct impact of the economic weakness, we anticipated a shortfall of about $70 million in vendor support in North America.

Our earnings per share results, aided by the tax rate that we're reporting today, were actually better than we expected at that point in December. Most of what we will talk about today is consistent with our press release and with the investor presentations and discussions that we had in December.

For the full year, sales increased 3% to $15.5 billion. EBIT as-adjusted decreased to $551 million. EBIT margins compressed by 180 basis points versus the prior year to 3.5%.

GAAP earnings for fiscal 2007 were $396 million compared to earnings of $503 million in the same period of 2006. GAAP earnings per share on a diluted basis were $1.43 in 2007, compared to $1.75 prior year. The as-adjusted diluted earnings per share were $1.54 in 2007 versus $1.90 in 2006.

On our previous earnings call our division presidents took you through their action plans to improve margins and drive sales in each of our three businesses for 2008. We're launching this effort now in 2008 under our banner of Taking Care of Business. Chuck, Steve, and Charlie will update you on the progress of the implementation of their action plans. I will now turn the call over to Chuck Rubin.

Thank you, Steve. Fourth-quarter sales in the North American Retail Division were down 3% to $1.7 billion. Comparable store sales in the 1,158 stores in the US and Canada that have been open for more than one year decreased 7% for the fourth quarter.

As previously reported, our results continue to be negatively impacted by difficult housing-related economic conditions in certain key markets, most notably Florida and California. Combined, these two states represented 26% of our total store sales and about 40% of our total comparable sales decrease in the fourth quarter.

As we discussed last quarter, a third-party research firm found a direct correlation between our US sales decline and the high inventory of homes on the market and the amount of time that they were on the market. We have seen this economic weakness spread to other retail markets with housing issues, creating additional pressure on sales and margins. Our econometric modeling quantified approximately 510 basis points of negative comp due to macroeconomic factors, largely related to the housing market.

Sales in the Northeast moderated slightly versus the previous quarter, but continues to be our best-performing region in North America despite having a limited retail presence. The performance of our joint venture in Mexico continues to be solid, with strong sales comps, although not included in the division's results for North American comparable sales.

Other drivers negatively impacting comparable sales included cannibalization from the new store buildout of 70 basis points; competitive intrusion of 60 basis points; and private brand penetration of 20 basis points.

Our Design, Print and Ship business continued to perform well in the fourth quarter, adding about 40 basis points of comparable sales growth.

Office Depot's unit market share as measured by the NPD Group increased in all months within the office supply market for the fourth quarter versus the same period a year ago. Furniture had positive dollar and unit share growth, with strong unit growth in seating and lighting.

Our Design, Print and Ship business, which had positive comparable sales for the quarter, also posted market share gains year-over-year in both dollars and units. Our dollar market share was down slightly in the fourth quarter driven primarily by technology, as our office supply and services competition continued to intensify their technology offerings. Market share for office supplies was down slightly on both a dollar and unit share basis in the fourth quarter versus the prior year, although we were successful in growing our ink and toner unit share.

Operating profit in the North American Retail Division was $23 million for the fourth quarter, a decline from $109 million in the same period of the prior year. Operating margins declined by 490 basis points versus the fourth quarter of 2006, despite having managed our costs actively during the fourth quarter.

The components of the operating margin decline included four key factors. Number one, lower-than-expected vendor funding due to conservative purchase volumes on our part and economic pressures on our vendors, which reduced our margins by approximately 200 basis points.

Number two, lower product margins reduced our operating margins by 140 basis points. It was a very promotional holiday season, with office supply stores, warehouse clubs, consumer electronics retailers, and department stores all taking aggressive actions to stimulate sales in a soft sales environment. Although our core shopper is generally a business customer, we did see a heavier mix of lower-margin technology influence what we believe were increased consumer sales.

We also pursued inventory clearance activities which mitigated inventory risk but further compressed our product margins.

The third factor was a deleveraging of fixed property costs, which lowered our margins by 100 basis points. And fourth, a higher shrink, which lowered margins by 75 basis points in the fourth quarter. The majority of this was a onetime expense related to our cross-docks.

We were able to offset 25 basis points of the margin decline in the fourth quarter, including 50 basis points of lower operational expense.

Regarding store labor, our strategy is to reduce operational task hours in the store but maintain the other hours focused on selling activities. Importantly, we continue to concentrate on providing the highest level of customer service. Again this order, our customer service index improved compared to last year and sequentially.

Comparable average sales per square foot in the fourth quarter decreased to $231. However, average order value was up 2.3% in the fourth quarter. So the entire comparable sales decline was due to lower store traffic.

During the fourth quarter, we opened 12 new stores and closed two stores, bringing our total store count to 1,222. We will continue to be very disciplined in evaluating both individual new store openings and our overall execution strategy, based on our 13% hurdle rate and the current business environment.

We anticipate opening approximately 75 new stores this year, about 45 of which will be in the first quarter of 2008, most delayed from 2007. We continue to believe that we have significant opportunity to expand our store count and that the stores are productive over the long term. However, we have moderated our overall rollout strategy in response to the current economic environment in order to lower expenses and to redirect operating cash flow.

During the fourth quarter, we remodeled 12 stores bringing our yearly total to 177. As of year end, more than half of our chain was operating under the M2 format. Although we also plan to moderate the pace of remodels in response to the current environment, our goal remains to have most of our North American retail stores in the M2 format over the next few years.

Turning to our full-year performance, sales for 2007 were $6.8 billion, flat to 2006. Same store sales for the year were down 5%. Operating margin, despite increases in the first and second quarters, declined for the year by 150 basis points to 5.2%. This is a result of our disappointing third- and fourth-quarter results.

A moment ago I mentioned the decrease in vendor program funding. Each year we enter into purchase arrangements with our vendors that provide for those vendors to make payments to us if and when certain conditions are met. Typically they fall into two categories -- annual purchase agreements and over-and-above agreements.

In terms of the annual purchase agreements, we did not hit some of the predetermined purchase levels tiers that would have provided additional vendor program funds due to our soft sales and disciplined inventory management practices. Although these practices did result in properly managed inventory levels, they also severely impacted fourth-quarter margin results for North American retail and North American Business Solutions divisions.

While $30 million of this impact in our North American businesses was a true-up to account for the year-to-date third-quarter impact and was recognized in the fourth quarter.

As we look do 2008, we do expect the annual vendor program rate as a percentage of sales to be approximately consistent with the 2007 annual rate. We also expect our program rates by quarter to be more consistent than what occurred in 2007. This will result in lower program rates in the first three quarters of 2008, but higher in the fourth quarter.

With respect to over-and-above agreements, many of our vendors were also experiencing the difficult sales environment, negatively impacting their participation in these discretionary marketing investments. For full-year 2008 we anticipate approximately consistent levels of those over-and-above agreements as achieved in full year 2007.

I will now update you on the action plans we discussed last quarter that comprise our Taking Care of Business strategy in North American retail. First, we are focused on improving our product value offerings for microbusiness customers, which we define as businesses having less than five employees. This means having the products in stock to meet customer demand, providing the customer service that is expected, and modifying our assortment to deliver increased value especially in our core supplies.

Second, we are continuing to grow our Worklife Rewards loyalty program which we believe is the best in the industry, providing a stronger value proposition to our microbusiness customers. We relaunched the program in the third quarter of 2007 and followed it up with a launch of our Worklife Rewards Visa card in November.

Third, we continue to enhance our service offering to complement our product assortment. During the fourth quarter our Design, Print and Ship Depot services experienced sales growth, contributing 40 basis points to our overall comparable sales growth. Additionally during the fourth quarter, our Tech Depot service became available nationally at the customers' work or home locations. We anticipate expanding our in-store offering throughout 2008.

As we look to the first quarter of 2008 we expect comp sales to continue to be below last year, partially driven by the results of the shift of Easter into the first quarter. The shift of Easter historically has had a negative impact in the office supplies and services industry.

Quarter to date, our sales comps our consistent with the fourth quarter, but may deteriorate due to this Easter shift. We expect our operating margin rate to improve 225 to 275 basis points in the first quarter compared to the fourth quarter. However, these operating margins will still be below the first quarter last year, which was a five-year high, based on continued pressure from lower product margins, deleveraging of property costs, and higher preopening store costs versus the prior year.

In closing, we're working aggressively to recapture share and improve the operating performance of our North American Retail business as we effectively did between 2004 and mid 2007. We're confident that our Taking Care of Business program is focused on the key strategies to accomplish this.

I will turn the call over now to Steve Schmidt.

Thanks, Chuck. Total sales in North American Business Solutions Division were $1.1 billion, down 4% compared to the fourth quarter of last year. Sales to our small to midsize customers were down 13%.

This decrease overshadowed solid sales growth of 5% among our large national account customers and 10% sales growth in the public sector in the fourth quarter. Growth in state government and the K-12 education sector have been driving the results in the public sector, both delivering double-digit increases for all four quarters for 2007.

The North American Business Solutions Division had an operating profit of $1 million for the fourth quarter of 2007 compared to $72 million for the same period of the prior year. Operating margins declined by 640 basis points versus the fourth-quarter 2006.

The key component to the gross margin decline included a decline of 230 basis points primarily from a reduction in our small to midsize customers, which increased the percentage of lower-margin customers and our sales mix. Next, lower vendor program funding reduced margins by 220 basis points. Next, higher inventory clearance reserves and returned product lowered margins by 160 basis points. Finally, product increases that could not be totally passed through at higher prices reduced margins by 80 basis points.

We expect our about around 380 basis points of negative margin impact not to reoccur in the first quarter.

We were able to offset 50 basis points of the margin decline in the fourth quarter, primarily by lowering operating expenses. We expect to sustain those improvements in the future quarters. In a moment, I will talk about the opportunity I see to recover the margin impact from shifting customer mix and product cost increases experienced in 2007.

Turning to our full-year performance, sales for 2007 were $4.5 billion, down 1% versus 2006. Strong double-digit sales growth in our technology products segment and with our public sector customers was offset by declines in our small to midsize customer base. Sales in the direct channel were down 11%.

Full-year operating margin for the Business Solutions Division was 4.9%, down 310 basis points from 2006.

I will now take you through the update on our action plans that are focused on Taking Care of Business in the North American Business Solutions Division. First, we're developing a detailed behavior-based customer contact strategy to ensure we're optimizing our penetration of existing customers. This program will confirm that we have the right content, catalog, online, e-mail, and overall contact strategy to optimize revenue and profit. A pilot has begun, and we're targeting a national rollout in the third quarter of this year.

Second, our direct marketing program redesign is underway. Within our telephone account management, or TAM, organization, new hiring standards, key performance metrics, revised training programs, and comprehensive marketing support are all being put into place to accelerate profitable growth.

For those unfamiliar, TAM is our outbound call effort that requires comparable selling skills to an associate who meets face-to-face with our customers.

Within catalog, we're redesigning page layout and content and revising our distribution frequency models to generate incrementality from both a profit and revenue perspective. In addition, we continue to invest in online marketing and are seeing positive gains in all key segments.

Third, we have dedicated a team to implement specific margin-enhancing initiatives; and we expect to show results in 2008. We are placing stricter controls on account level pricing decisions, where we have seen margin erosion especially with some of our larger customers. We're also testing simplified customer price plans, for which we will be prepared to report results in the second quarter.

While we are still launching our business turnaround program, we are encouraged that the rate of decline in both small and midsize customer base has slowed from our third-quarter results.

Our Internet sales on a global based continued to grow in the fourth quarter, with sales for the full year totaling $4.9 billion compared to $4.3 billion for the same period a year ago. In 2007, 80% of total BSD sales were online compared to 72% in 2006.

To summarize, we are going after a number of process-related leaky-bucket margin-erosion opportunities via process interventions that should pay dividends starting in the second half of the year. Combining this focus with the other small-customer growth initiatives, our development of higher-margin product launches like Design, Print and Ship services, and breakroom solutions, and driving private brand penetration will provide opportunities for margin growth in 2008.

In the first quarter of 2008, we will be facing some tough comparisons. The first quarter of 2007 had the highest first-quarter sales level in the division's history and the best gross margin for any quarter that year.

For the full year, we do expect low single digit sales growth; recovery from the 380 basis points of fourth-quarter items that won't reoccur; and positive operating expense reduction comparisons that we begin to realize in the second half of 2007.

I will now turn it over to Charlie Brown. Charlie?

Thanks, Steve, and good morning. The International Division reported a sales increase of 12% in the fourth quarter compared with the same period last year. Organic sales in local currency increased by 2%. This marks the eighth consecutive quarter the division has grown the top line in local currency.

In particular, the Contract Channel continued its strong performance, growing sales and local currency by 8% in the order. The Contract Channel now accounts for about 45% of the division's total sales in the quarter, which is comparable to the sales in the Direct Channel. This is a reflection of the strength of Office Depot's global brand with our increasingly global customer base. We look forward to continuing to leverage our geographic reach to grow this important part of our business.

Division operating profit was $60 million in the fourth quarter compared to $77 million in the prior year's fourth quarter. Operating profit margin declined by 230 basis points to 5.3% from 7.6% in the prior year as the UK business continued to struggle.

The components of the operating margin decline included -- a continued overall weakness in the UK business accounted for approximately $14 million of the profit decline and about 105 basis points of operating margin compression. We had 85 basis points of margin decline in the fourth quarter primarily related to the previously-discussed strategic investment spending, such as establishing regional offices in Asia and Latin America, centralizing certain support functions in Europe, starting a greenfield operation in Poland, and consolidating warehouse facilities to better support the multichannel business portfolio we have in Europe.

Outside the UK, growth in the large customer segment which has a lower margin rate than the small and medium customer segment, drove unfavorable customer mix and compressed overall operating margin by about 40 basis points.

In the UK, we're experiencing an economic slowdown which, if it persists, could provide additional challenges to our operations in that market. As you may recall from previous communications, prior to 2007 operations in the UK accounted for about one-third of the division's sales but almost half of the operating profit. Due to the weakness in the business, the UK represented 26% of the operating profit in the fourth quarter of 2007 and 42% for the full year. As such, the performance of the division is highly dependent upon a turnaround in that business.

Overall, the businesses in Europe outside of the UK continued to perform well, with revenue up 15% in the fourth quarter and 12 out of 15 countries reporting year-over-year revenue increases in local currency.

Turning to our full-year performance, sales for 2007 were $4.2 billion, up 15% versus 2006. Sales and local currency were up 6%. Full-year operating margin was 5.5%, down 130 basis points from 2006.

I will now take you through an update of the actions we discussed last quarter that are focused on Taking Care of Business in International. First, we have launched a number of service and profit improvement initiatives in the UK which we believe will upgrade the customer service experience and help counter the impact of the slowing economy. They include improvements in delivery service levels and the rollout of certain technology solutions throughout our distribution and transportation network that will better support and facilitate execution to better our on-time and complete performance.

Secondly, we're committed to improving productivity within our existing asset base. We have now successfully transitioned all back-office transaction accounting functions from the UK to our captive shared services facility in Eastern Europe. We expect to have the rest of Europe transitioned by the end of this year.

We continue to make progress on the consolidation of our call centers across Europe, completing Switzerland and Austria in 2007. In addition, we continued to consolidate our distribution center network in Europe, reducing costs and improving customer service levels.

Thirdly, we have plans in 2008 to leverage our global sourcing office in China to drive direct import and private brand penetration in Europe and in Asia. To support this effort, we have contracted with a third-party distribution company to operate a central distribution center in Antwerp that received our first containers of products directly from China in December.

As we discussed last quarter, there are certain other things we are doing to improve performance in the International Division. We're continuing to limit discretionary operating investments and capital expenditures. The focus of most of the investments we will make in the division in 2008 will be in line with the continued integration of our European supply chain and distribution operations to better support our multichannel business, removing duplicate supply chain costs and providing flexible solutions to our customers.

In addition, we continue to believe that small, strategic investments in emerging markets position Office Depot to grow global top line and deliver operating margin expansion over the long term. For example, we have been working for several years on opportunities in India and in Brazil.

As we look at our International Division for the first half of 2008, barring a further weakening in economic conditions, we expect to see improvements in the UK beginning sometime in the second quarter and then continuing to improve profitability over the balance of the year. This means that the division's profits for the first half of the year will be below the prior-year period.

The first quarter expects to be well below the near record levels of profitability reported in the same period of 2007 as the UK business works to gain traction with our action plans. The impact of prior strategic investments continue to compress margins. And we lap our best quarter of 2007 when the business delivered an operating margin of 7.6%.

That concludes my remarks on the International business. I will now review our Company's financial results. The as-adjusted effective tax rate for the full year was 15%. The effective tax rate for the full year, excluding any discreet items and the impact of a tax law change, would have been 25%. For 2008, we currently expect a full-year effective tax rate of about 30%.

Fourth-quarter charges were $15 million, bringing the total charges recorded from the inception in the third quarter of 2005 to $385 million. We anticipate charges of $62 million in 2008 and $23 million in 2009, bringing the program total to approximately $470 million. Future charges may change as plans are implemented.

Turning to cash flow, during 2007 cash provided by operating activities totaled $411 million compared to $827 million in the prior year. Cash flow was affected by a number of factors including the timing of payments, which is subject to variability quarter to quarter depending on a variety of factors. For the full year, working capital changes resulted in a substantial use of cash as sales slowed and inventory rose.

For 2007, free cash flow before share repurchases was a use of $50 million versus a source of $484 million in the prior year. Of the $534 million change, $416 million was due to lower operating cash and $118 million was due to higher capital spending.

Depreciation and amortization totaled $281 million for the year, up slightly from the $279 million in 2006. Adjusted EBITDA was $814 million.

Capital expenditures for 2007 were $461 million. Capital expenditures estimates for 2008 are expected to be around $375 million, which reflects about 75 new store openings; approximately 100 M2 remodels; and investments in our global supply chain and IT initiatives.

In 2007, we repurchased approximately 5.7 million shares of our common stock for about $200 million. Current plans are to repurchase common stock if cash flow permits. Over the past three years, we have returned to shareholders about 140% of our adjusted after-tax earnings, 106% of our operating cash flow, and 140% of our net cash flow excluding share repurchases.

Now to the balance sheet. We ended the fourth quarter with $223 million in cash and short-term investments. Our investment in inventory totaled $1.7 billion globally, up from the same period last year due to acquisitions, foreign exchange impacts, and a number of new stores.

In North American Retail, inventory per store was $960,000 as of the end of 2007, 3% higher than the same period last year. We expected that year-end levels would be higher than last year due to abnormally low inventory levels at the end of 2006, especially in computers in advance of the Microsoft Vista software launch which occurred in the first quarter of 2007. On an average basis, inventory per store was just over $1 million for the fourth quarter of 2007, flat with the same period last year.

Working capital increased by 110% as compared to the fourth quarter of the prior year. Excluding the impact of our adoption of FIN 48, working capital increased by 91%. The majority of the increase is related to higher and aging inventory resulting from the increased number of stores; higher imports; lower taxes paid; and a lower accounts payable-to-inventory ratio.

Our net debt at the end of the fourth quarter was $593 million, while adjusted debt including leases was approximately $5 billion. Return on invested capital for the trailing four quarters adjusted for charges and credits was 11.3%.

With that, I will now turn it back to Steve Odland.

Thank you, Charlie. 2007 clearly was a difficult year and we're very disappointed with our quarter four results. However, I am very proud of how our 49,000 global associates worked very hard to take care of our customers in this challenging environment, especially during the second half of the year.

The achievements during the year were noteworthy. We increased total Company sales by 3% to about $15.5 billion. In North American Retail we opened 71 new stores and remodeled 177 existing stores, and significantly improved our customer service scores.

In North American Business Solutions we posted strong double-digit sales growth in our technology products segment and with our public sector customers.

Despite the slowdown in the UK dampening the International Division's growth, we increased local currency sales 6% in 2007 and have recorded eight straight quarters of local currency growth. The division also transitioned all back-office transaction accounting functions in the UK to our captive shared service facility in Eastern Europe.

The Company opened a global sourcing office in Shenzhen; completed the acquisition of Axidata in the Canada; and we repurchased $200 million worth of outstanding shares, which contributed to a lower diluted weighted average shares outstanding by 4% versus the prior year. We have also added some talented leaders to our management ranks who will help us to drive the Company's performance over the long run.

Turning to the first quarter of 2008, our divisions are executing their Taking Care of Business plans that are focused on our customers. We also intend to tightly control spending during that time period.

Sales to date in the first quarter remain sluggish in the US and the UK. While we're doing everything we can, it will be difficult to rejuvenate growth until the macro conditions improve. Best estimates by economists as well as our customers suggest that these conditions may continue until at least the second half of 2008.

Now, operating margins in the first and second quarters should improve versus the fourth quarter by about 190 to 240 basis points for the total Company; but will still be down from the five-year high experienced in the first quarter of 2007.

Earnings per share will be down versus the prior year in the first half of 2008. But we're doing our best to cut spending and shore up margins while continuing to fund the necessary investments like labor levels in our stores to preserve our business model and take care of our valued customers for the long run.

When we emerge from this macro slowdown, we still believe that we have a business model that over the long term can deliver mid single-digit top-line growth, midteens earnings per share growth, and allow us to repurchase shares with excess cash flow. We also believe that margin expansion of up to 300 basis points are possible from our key initiatives that are in the works over the long run. Adding this expansion to a normalized margin of about 5% would achieve an operating margin of approximately 8% in the long term.

With that, operator, we are now ready to take questions.

(OPERATOR INSTRUCTIONS) Colin McGranahan.

Thank you. Good morning. Actually I have three quick questions. First, maybe you can just comment on the new store opening plan. Obviously, given the tough macro environment and some owned struggles here, it seems like being more prudent would be maybe the better part of judgment here.

Why are you continuing to open 75 stores? Understanding some of those are probably in process, especially the ones that are opening in the first quarter, but maybe if you could just comment firstly on your store opening plan and why you are sticking with that at this point.

Yes, good morning, Colin. The 75 stores that we have in the plan for this year, most of those were actually committed from 2007. So in my comments I said that we'd be opening about 45 in the first quarter of those 75; and that is what we expect to happen.

So the other 30 stores for the balance of the year are all committed. So with any real estate there is some opportunity potentially for them to move around, but we believe all 30 of them are going to happen for this year.

Then for 2009, would you go closer to something -- just a maintenance kind of store opening plan? Given the macro environment is expected to be difficult throughout 2008.

I believe that would be -- yes, it would be safe to assume.

Okay. Secondly, I guess a question now for Charlie. The working capital performance in 2007 was pretty atrocious, up 90%, you had inventories up, receivables up, payables down. Could you just comment on what you think the drivers were behind that and your plans to improve working capital in 2008?

Sure. Good morning, Colin. In terms of our receivables, you know, I think the bulk of that increase was in International as we continue to grow the International business.

In terms of inventory, a lot of that was in our new stores. The average actual inventory per store was flat. So as we open new stores, that increased our total investment.

We did lose a little ground in payables. I think that is a reflection of some of the pressure that our vendors are feeling in terms of -- as you know, we try to finance as much of our inventory as possible through our vendors. But again, as Chuck commented earlier, we saw it in vendor program and we see it in payable terms as some of our vendors are struggling as well.

I understand that, Charlie, but normally those two work in opposite directions. If you are giving your vendors better terms on payables, you should be getting lower prices. Obviously with the vendor program funding you are paying higher prices. So it seems like you kind of got the double whammy there. Not only did it impact the margins, but it hit the cash flow and the balance sheet, too.

Colin, it is Chuck. We did in the script comment on some aging of inventory. Really that is in our core supplies area.

So with the slowdown in sales, some of our inventory did age, which we are not happy about. It is not lifecycle inventory; it is just we have some additional weeks of supply, for instance, in core basic supplies, office supplies. That had an impact to the working capital as well.

Okay. I guess my final question is for Steve. Can you just maybe give us a little bit more color on the departure of both Pat and Kim Maguire, who I think was on site maybe for only about four months?

Yes, there really isn't anything more to say about Pat. She has decided to leave the organization, and we thank her for her contribution. We will have to go outside for a new CFO, and I am thankful that Charlie is able to step in.

Charlie, as you know, has been with the Company for 10 years and was our CFO for five years prior to his promotion to President of International. So I don't think we will miss a beat in this. But it is going to -- I do appreciate, Charlie, your support.

Kim Maguire started around Thanksgiving and has just decided to leave the Company. He just got started after the holidays here and has decided to leave the Company for personal reasons. It is his choice. We're disappointed in that, but we expect to be able to announce a successor as quickly as possible.

Okay, I will turn it over so others can ask questions.

Mike Baker.

Thanks, guys. Just a few quick ones here. One, so Steve, you said that things actually ended up better than you had expected relative to your December announcement. So I'm just wondering what actually did improve relative to that.

Well, I think that if you look at our third-quarter announcement, I mean our fourth-quarter December 12 announcement, we pointed to the third quarter and said normalized third-quarter results were about 50% down in EPS. So if you look at $0.51 a year ago, you divide it by 2, and then you adjust it for the $70 million worth of risk we had, it would have led you to about $0.07 a share.

We did experience better than that with about $0.10 per share due to some tax items. But we were a little bit better in vendor funding in the end than we thought; and a little better in a few of the sales areas.

So I think my point in this is that there really is nothing that has happened since the December 12 announcement significantly different between then and today. So it's been a continuation of everything we talked about in December.

Okay. So that I guess leads to my second question. Within the first quarter has the promotional activity subsided at all? You said the holidays was promotional. Is that continuing or is it backed off a little bit here?

We're seeing, I think all of the division Presidents commented that the trends in the first quarter are similar to what we experienced in the fourth quarter. We are not seeing a change in macroeconomic conditions.

However, we do expect margins to be better in the first quarter for the total Company -- and the divisions commented on their individual pieces -- because of the exceptional items that affected our margins in the fourth quarter.

So we will see sequential improvement in the margins even though the top line remains relatively consistent with the fourth-quarter performance.

Okay, okay. Fair enough. Thank you. I appreciate that.

Brad Thomas.

Thank you. Just wanted to follow up on the weakness that you saw in some of the small and medium business delivery. You know, in the Retail segment you have talked about how your geographic exposure to Florida and California has been a main cause of weakness. Are those same issues a cause of weakness in the delivery segment as well?

Yes, this is Steve Schmidt. Yes, we had basically exactly the same economic situation as we experienced in Retail. We have got about 30% of our business in our BSD division in Florida and California, and so we're being directly impacted by the macroeconomic conditions in the small to medium-sized customer segment.

That is why during my comments we talked about that impacting the business, while at the same time we have launched the new contact strategy in addition to revitalizing our TAM business, all designed to focus around growth in this small to medium-sized customer segment.

So, we are trying to do everything we can to improve the business performance in this very important growth area.

Okay. Then when we think about the 13% decline in that segment, again, can you just give us a little color in terms of how the share of wallet is working versus the total number of accounts? Are you seeing a reduction in the number of accounts?

As you can appreciate, in the business-to-business area we have hundreds of thousands of customers that we deal with every single day. As we looked at 2007, we gained tens of thousands of customers and unfortunately also lost customers. As you can appreciate, customers shop us either through the Web; they go to our stores; they purchase through our catalogs; and so we need to track customer behavior across all segments to understand exactly what is happening within this segment.

One of the things that we have done as part of our contact strategy is we have created a share of wallet model which will be essential to the launch of our contact strategy here in the third quarter, which will really identify by size of business and by sector their share of wallet. Then we will create an optimization model by which we will drive sales activity.

So it is clearly a challenge. We are focused on this important area and we will -- as I said in my comments, the rate of decline in the fourth quarter slowed versus prior quarters, and we are anticipating that trend to continue.

Okay, thanks. Just one more follow-up on BSD. I know the public sector sales has been a bright spot for that segment of your business. Do you think that growth rate can continue in 2008? How big of a piece of your business do you think it could become?

As we have talked, the public sector continues to be a very good growth area for us. We grew over double-digit in 2007. I don't think growing at that rate going into 2008 probably is realistic; but we obviously continue to see growth in this very important sector.

It is an area of strength for the Company, and so we will continue to see growth going forward. But maybe not at the double-digit rate that we saw in 2007.

Great, thanks so much and best of luck.

Oliver Wintermantel.

Yes, good morning. In regard of the North American and International supply chain initiatives, can you talk about the cost savings and potential costs there in reducing the [supplies]?

Yes, Oliver, we have reviewed the potential initiatives. Well, not the potential, but the initiatives that we're working on in Europe and North America over time.

We have currently 32 distribution facilities in North America and 22 facilities in Europe. We are moving and will move over time to combination facilities, instead of having separate supply chains for the different businesses in North America. And move from 22 to 15 distribution centers as we consolidate those centers that have been acquired from Guilbert and Viking over time. So this is a long-term effort.

Now, we have slowed it down in order to preserve and moderate the use of cash. But at the same time, they are all leased, and we are affected by lease expirations. So as they come up we are replacing them with facilities that are combination facilities.

We do believe that this will help to improve our P&L. We will post on our website later today an investor presentation with exact numbers that we are planning. But it is in the 50 to 100 basis point improvement.

We also are working on IT initiatives. We are going through phase one of the replacement of our IT system, with the finance track going in summer of this year; then in subsequent phases over the next two years in 2009 and '10, in order to have the system that is required to deliver our business. That will result in some savings as well.

But all of these are multiyear efforts that were initiated going back to 2005.

Okay. I have just one more follow-up. The $13.6 million operating charges in the fourth quarter, was that mostly in general and admin expenses?

Oliver, can you repeat that? You tailed off and we lost the last part of it.

The $13.6 million operating charges in the fourth quarter, was that mostly in general and admin expenses?

Okay, was it --.

Yes, it was. Mostly.

Mostly G&A.

Yes, it's mostly G&A. It was mostly, I think, severance related to some of our workforce reductions.

Okay, thank you.

Brian Nagel.

Good morning. I guess first somewhat of a strategic question. But Steve, as you look at the business and you are realizing the environment is probably not going to get any better, at least in intermediate term, you guys will still be pressured given your exposure to California and Florida.

What are the bigger levers you can pull nearer term, to somewhat offset what is likely to be a continued weak top line?

Yes, Brian, it's a very good question. This has been a huge disappointment to us. Given our exposure, I think I mentioned it's about 30% of the Company's sales.

North American sales, which total $11.5 billion, are in these two states, and these two states are heavily into recession. We have got housing inventories that are up to 30 months in some of these states, and high unemployment and so forth.

I don't -- I just hope everybody understands that people who don't live in those states just probably don't understand the difficulty there. We have got to be careful here to run the business for the long term; make sure that we put appropriate labor in the stores; and stock the stores adequately; and take care of the customers we have.

The reason that our store traffic is down is because our customers are hurting in these areas. These are microbusinesses that are impacted themselves by the consumer, by high gas prices, by the real estate, and so forth. We have had to learn a lot about subprime and all this kind of stuff impacting our customers.

Frankly, we have been surprised that we were at all vulnerable to the housing market. But the fact is that we are, and so we have ratcheted back as much of the discretionary spending as possible. We spread out the investments in the supply chain and IT as much as possible to try to preserve cash and moderate the use of cash.

I think in retrospect, Brian, as you look at the years 2004 through the beginning of 2007, we clearly must have benefited disproportionately from the housing boom in Florida and California. I think our average 33% per quarter earnings per share growth during that period of time suggests that.

We also, though, at the same time, aggressively took costs out of our business during the period of time when we were going up, not knowing that we were going to come back down during this impacted time over the past couple of quarters.

As a result of that, we peaked margins in the beginning of 2007, and so we don't have the margin cost, the fat, to take out of the business because we took took over $0.5 billion worth of costs out of the business while the sales were expanding. So therefore you saw record margins.

So as we come down from that period of time, in retrospect maybe we should have kept a little fat to cut during this period of time. But the net result is that we are delevering faster because we don't have the fat to cover.

So there are not a lot of things that we can do here, except to manage our grosses as it relates to the promotionality, so that we don't just give it away; but that we work directly with the customers who are coming into our stores.

But we have got to preserve our business model so that we don't destroy our brand. I'm sorry, Brian. That was sort of a long-winded answer, but strategically that is how we think about it.

That's helpful. If I could follow up with one other question with respect to new store growth. Someone asked before about the 75 stores you plan to open here in 2008. If I heard you correctly, you basically said a lot of that reflects prior real estate commitments. I guess it implies that if you didn't have these real estate commitments maybe you would not be opening as many stores in 2008.

I guess the question I have is as the environment -- as your business continues to weaken, we have seen a significant weakening over the past few quarters, does it cause you or encourage you to go back and look at your base of existing stores and maybe see if there is an area we can pull back some? Start closing some stores that are maybe disadvantaged within your existing portfolio?

Yes, the 75 stores, I think as Chuck talked about, were largely committed. If they were not, we would not be opening as many stores. Okay?

So we saved a lot from and pushed a lot from 2007 into 2008. We will push as many -- and we have pushed as many as possible. And we will slow down here.

But we also have looked at our existing store base, and I think we closed a couple of stores this quarter. That is sort of a normal kind of a thing as we relocate stores.

But we look for cash flow positive stores, and for the most part our stores are cash flow positive. So we don't see big store closures other than the sort of normal couple here, couple there, going forward through this year.

Okay, thanks a lot. Good luck in the next quarters.

We have somebody else?

Michael Keara.

Michael, are you there?

Oh, yes I am. Back in the queue, I guess. Good morning, everyone. With respect to the trends that you talked about, as things have -- the rate of decline has slowed. Is that also the case in the two states you mentioned, California and Florida?

Well, again, 40% or more of the retail slowdown were in those two states, and a significant portion of the BSD slowdown because they have 33% of their sales in those two states, happened in those two states. It was all among the very small customers.

So the declines that we have seen have been in those two states, and we are continuing to experience that, the same kind of trend, in the first quarter. So we don't see it getting dramatically worse, but we don't see an improvement at this point that we sit in the first quarter.

So it is fair to say that we're starting to see a little bit of a flattening, which is obviously important for I guess everybody in retail, given that most people have exposure in those states. So, is it sort of a flattening that we're seeing there right now?

It is not getting significantly worse. I just hesitate -- we are not economists, so I hesitate to say that it is flat. But it isn't getting worse at this point. We are hopeful.

But all the experts tell us that it is going to take until the latter part of this year before we see a substantive workoff of the inventory and workthrough of the adjustments in subprimes. So the first two quarters are going to be especially tough in these two states.

Okay. Are you talking about putting something on your website in terms of I guess -- was that some sort of operating margin driver, or from supply chain, the supply chain initiatives you talked about in terms of warehouse consolidation? Or are you guys going to be putting sort of a long-term operating margin goal that we can sort of model from?

No, we're going to just -- we have been -- we have had the practice in the past couple of quarters of updating an investor presentation that we use for discussions. In that we have got a slide that talks about the supply chain and IT improvements.

I just -- I'm sorry -- I mentioned that we were going to update that presentation and post it to our website later today. But the long-term supply chain improvement is that we expect a 60 basis points; and the IT improvement is 40 basis points; so that totals 100 of the 300 long-term projects that we are working on. So that is what I was talking about, Michael.

Okay, fair enough. Thanks for clearing that up. Good luck on the next quarter.

Okay, do we have the next question? I think we have time for one or two more.

Mitch Kaiser.

Thanks, guys. Good morning. Obviously California and Florida are weak markets. Could you just talk about where you saw slowness in the fourth quarter, other markets in particular?

Yes, I think what Chuck said is that other markets started to see the housing-related softness we followed and started to see the same thing. So you see it in the Southeast, in the Carolinas, you see in some parts of Texas, in certain areas of the Midwest like Michigan, which is having a lot of housing trouble.

It is spotty, but it is wherever you have seen published comments on the housing markets, like Las Vegas and so forth. We have seen our sales directly proportionately move downward with those housing problems.

So it appears -- we started seeing it, if you recall, in the second quarter. We have never -- it had never shown up in our modeling as being significant before. So we were really very, very surprised.

But we did some third-party econometric modeling which directly showed us that we were experiencing this thing. We didn't quite understand it; but it appears now that our customers, particularly at retail, our microbusiness customers turned out to be a bit of a leading indicator here.

Okay, that's helpful. Then, the promotional at Retail in the fourth quarter, one of your bigger competitors that reported talked about comp weakness but actually had respectable retail gross margins.

Have you dug into the differences? I recognize the vendor support probably skewed the number a little bit for you guys downward. But if you could just comment on that, that would be helpful.

Yes, I would just comment generally and then Chuck may have some specifics. But there were some extraordinary items in the fourth quarter, which was a true-up of the vendor program number, the $30 million we talked about. We did have a hit in shrink that we talked about. Extraneous legal fees and so forth that we talked about.

So there were some onetime -- not really onetime, but extraordinary kinds of charges which is why we say that the margin should improve sequentially into the first quarter.

But it was a -- realize our geographic makeup also requires a different level of promotionality. So we did have to clear inventory in those geographic areas especially.

And we had a product mix shift towards technology which is very low margin and away from core supplies during that period, which has had another impact. Chuck, do you have any other comments?

I would just add to Steve's comments. I would also look at the competitive set during the fourth quarter. You had a number of players outside of the office supply industry who were very aggressive in the technology arena. You had CompUSA starting the liquidation process and certainly others in the field of CE as well as discount who were very aggressive in the fourth quarter. Especially, to Steve's point, in Florida and California.

Okay. Then lastly, if you think about that longer-term operating margin growth from normalized 5% up to 8%, I understand that part. But this year it looks like you're going to I think roughly 3% if I had my charges right, etc.

Is the improvement from 3% to 5% predicated mostly on improved sales trends then and normalizing some of these vendor rebates? Is that the 200 basis point delta? Or are there other things on top of that that we should be thinking about?

The 2007 operating margin finished at about 3.5%. But if you look at where we were prior to that for the whole Company in beginning of 2007 we hit a 5.8% record. And we were about 5% or north of that in 2006.

So what we need to do is we need to stabilize the sales from a macro standpoint, which we hope to happen through 2008. Then we believe that we will be at a more normalized run rate of about 5%.

We are trying to do this on a -- we are trying to paint a longer-term picture here and say that 5% should be a more normalized rate through that; and then the 300 basis points for the long-term projects that we're working on, on top of that.

So, we have talked about this in terms of a five-year margin plan, and that is the 8%.

Okay, thanks, guys. Good luck.

Okay, we're out of time, so this will conclude our conference call this morning. Please check our website later in the Investor Relations section for the additional posting of the presentation. Again, it will be an update to the presentation that we have had out there over past quarters. Thanks very much for participating in today's call.

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