ODP Corp (ODP) 2008 Q3 法說會逐字稿

Good morning and welcome to the third-quarter 2008 earnings conference call. All lines will be 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 now like to introduce Mr. Brian Turcotte, Vice President of Investor Relations, who will make a few opening comments. Mr. Turcotte, you may begin.

Thank you, Shirley. Before we begin, I would like to remind you that our discussion 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. The press release and accompanying webcast slides for today's call are available on our website at www.officedepot.com. Click on Investor Relations under Company Information. I would now like to introduce Office Depot's Chairman and Chief Executive Officer, Steve Odland. Steve?

Good morning and thank you for joining us for Office Depot's third-quarter 2008 conference call. With me today are Mike Newman, Chief Financial Officer; Chuck Rubin, President of North American Retail; Steve Schmidt, President of North American Business Solutions; and Charlie Brown, the President of International.

Before I review our third-quarter results, I would like to welcome Mike Newman to our executive team. For those of you who don't know Mike, he has 30 years of financial experience, including CFO positions at RadioShack, Intimate Brands and Hussman International. He also spent 17 years at GE in a variety of management roles in the US and in Europe. Mike brings strong financial skills and a wealth of operating experience to Office Depot and we are very pleased that he has joined the Company.

In addition, I would like to thank Charlie Brown for serving as the acting CFO during the six-month search process, in addition to his duties as President of International. Charlie did a great job managing the finance organization during the transition and we can now let him go back to focusing all his efforts on running the international business.

Looking at the third quarter, our performance was representative of the unprecedented time in which we live. The global liquidity crisis has created an environment in which small and large businesses, as well as consumers, have reduced their spending for products and services. In the case of Office Depot, our sales were below expectations, particularly late in the quarter as our customers were significantly impacted by the global liquidity crisis and cutbacks. As we go through the call today, the Division Presidents, Mike and I, will share our strategies on how we plan to successfully manage the Company through this challenging period.

Third-quarter 2008 total company sales were $3.7 billion, a decrease of 7% compared to the third-quarter results last year. Our net loss on a GAAP basis was $7 million compared to earnings of $117 million in the third quarter of 2007. The GAAP loss per share, on a diluted basis, was $0.02 for the quarter versus diluted earnings per share of $0.43 a year ago. Adjusted for charges, the diluted loss per share for the third quarter of 2008 was $0.01 versus earnings of $0.43 a year ago.

Now I should note that the retroactive UK tax law change that we referred to last quarter had an $8 million or $0.03 per share negative impact on our third-quarter 2008 results. In addition, within North American Retail, the store impairment and closer costs had a $21 million pretax impact or a $0.05 per share negative impact on the quarter.

Total operating expenses as a percentage of sales for the third quarter of 2008 were 27.7% compared to 25.2% for the same quarter of the prior year. Third-quarter 2008 operating expenses included lower bonus accrual reversals versus a year ago, resulting in comparably higher compensation costs in the third quarter of 2008. The increase in operating expenses also reflects approximately a $21 million charge for North American Retail store impairment and closure costs I mentioned earlier, as well as higher corporate charges for professional and legal fees and deleveraging of costs against the lower sales levels. EBIT, adjusted for charges, was $15 million in the third quarter of 2008 or 0.4% of sales compared to $128 million or 3.3% in the same period last year.

Although we are extremely disappointed in our third-quarter results during these challenging times, I assure you that the management team and associates at Office Depot have and will continue to do everything we can to manage the top line, cut costs, reduce our capital spending and improve our cash flow. This focus on cash flow is paying off. In the third quarter, our cash flow from operating activities was $261 million and we generated $190 million in free cash flow despite our earnings. Now I will turn over the call to Chuck Rubin to talk about North American Retail.

Thanks, Steve. Good morning. Third-quarter sales in the North American Retail division were down 11% to $1.6 billion. Comparable store sales in the 1203 stores in the US and Canada that have been open for more than one year decreased 14% versus the third quarter of last year. It is worth noting that our sales comps in the first six weeks of the quarter actually improved versus the second-quarter average of minus 10, but then fell significantly in the back half of the quarter, especially in the last couple of weeks, due to the worsening economic crisis, which limited liquidity for our small business customers.

North American Retail experienced sales declines in our three major product categories of furniture, supplies and technology in the quarter. Sales of laptops and business machines in particular were down as our small-business customers reduced their spend on big-ticket and discretionary items and focused their purchases on our core supplies. Our best-performing productlines were ink and toner, paper and design print and ship services.

We continue to be negatively impacted by weakening business conditions in North America. Although it appears that the rate of sales decline in California has been consistent over the past few quarters, Florida, our largest and most profitable market and the other markets in which we operate, experienced a steeper decline in demand. The sales comp decline was driven by both a reduction in the number of store transactions and increased softness in average order values versus the same period one year ago.

Although most of the decline can be attributed to macroeconomic factors, a conscious effort to reduce our marketing efforts for low-margin technology items in the third quarter also negatively impacted the top line, but improved our product margins. Additionally, Hurricanes Gustav and Ike had a 40 basis point negative impact on sales comps.

In the third quarter, we opened six new stores, closed three and relocated two, bringing our total store count to 1275. We also remodeled two stores in the third quarter.

We continue to be very pleased with the progress made with our service levels in store. Mystery shop scores were 95% in the third quarter, up 2% versus last year and our in-stock levels were also quite good.

Operating profit for the North American Retail division was $12 million in the third quarter of 2008. This includes a charge of approximately $21 million for store impairment and closure costs. While we typically have some level of store impairment charges, this is about $17 million above the amount we recognized in the third quarter of last year. In the fourth quarter, we will evaluate our store base for potential closures. We cannot predict today the extent or magnitude of those potential closures and related charges, but they may include asset impairments, severance costs and provisions for future lease commitments.

Including the store impairment charge, operating profit as a percentage of sales decreased 370 basis points to 0.8% versus 4.5% in the third quarter of 2007. The key components of operating margin change versus a year ago include the following. On the positive side, our product margins were higher than last year by approximately 170 basis points due primarily to improved product mix and less inventory clearancing, offset partially by increased costs associated with mail-in rebates. On the negative side, lower sales levels caused fixed costs and operating expense deleveraging, which reduced margins by approximately 300 basis points compared to last year. About 60% of that deleveraging relates to property costs and the remainder from base operations such as payroll.

Second, based on the results of the store impairment testing, we recognized an impairment charge of approximately $20 million in the third quarter of 2008 compared to approximately $3 million in the third quarter of 2007. Additionally, we incurred $1 million related to store closure costs, higher than the third quarter of 2007. The charges for impairment and closure costs resulted in a decrease in operating margin of approximately 110 basis points.

Third, shrink and higher supply chain costs driven by fuel costs and deleveraging reduced margins by about 60 basis points. Fourth, we experienced a negative impact of approximately 30 basis points due to the hurricanes in Houston and the Gulf Coast region and fifth, lower bonus accrual reversals versus a year ago and other items combined decreased operating margin by approximately 40 basis points.

Last quarter, I outlined the actions we are taking to improve our operating margins going forward and I will summarize them for you, as well as any progress made. First, we accelerated our product assortment reviews to reduce our overall SKU count. We continue to complete additional line reviews resulting in significant cost savings on our future purchases, which will certainly improve our future margins.

Second, we are microassorting our key technology departments to better match our offerings to the individual store sales volume and customer profile. This action reduced end-of-quarter clearancing in the third quarter. Third, we have implemented stringent inventory controls to support our more conservative sales forecast. Our end-of-quarter per store inventory in the third quarter was $777,000, down 15% from the same period one year ago. These controls should reduce end-of-life clearancing and improve margins and cash flow.

Fourth, we have significantly reduced our new store opening plans with only three planned for the balance of the year. These three stores have committed leases, which would cost us more to break than to actually open the stores. Fifth, we are slowing our remodeling efforts. For the balance of this year, we anticipate remodeling seven more stores and they will be landlord-funded. And sixth, we continue to manage our in-store costs while protecting our commitment to high service levels.

I would also like to update you on a few of the Taking Care of Business key actions to improve our sales going forward. First, we continue to address our customers' increasing need for low prices and high value. For example, in the third quarter, we continued to expand our small and pack-sized offering and leveraged high-traffic areas for entry price point products.

Second, we continued to target our Worklife Reward loyalty members, building our file in the third quarter by double digits versus a year ago. Third, to fulfill the unmet needs of micro-business customers, we rolled out our Tech Depot service offering to all stores during the third quarter and we are pleased with the performance to date.

In summary, although not happy with our results, we do believe the actions we are taking in the current economic environment will provide significant leverage when sales do improve. Now I'd like to turn the call over to Steve Schmidt to review North American Business Solutions.

Thanks, Chuck. Total sales in the North American Business Solutions division were $1.1 billion, down 10% versus the third quarter of last year. This decline was driven by further deterioration in our small to medium-sized customer base, a significant reversal in the sales growth trend among our large national account customers and public sector and declining growth in our technology and furniture businesses as customers have focused their spending on core office supplies.

Business Solutions sales in Florida and California continue to be challenged due to state mandates to reduce expenditures and budgetary issues, as well as reduce liquidity among companies as a result of the banking crisis. We have also seen business declines outside of Florida and California as the economic woes are spread across the nation.

The North American Business Solutions division had an operating profit of $39 million for the third quarter of 2008 compared to $69 million for the same period prior year. The operating margin was 3.7% in the third quarter of 2008, down from 5.9% in the same period in 2007. On a sequential basis, operating margins were down 90 basis points due to the unfavorable product and customer mix, higher advertising expending and deleveraging of fixed costs driven by the revenue decline.

The components of the operating margin decline versus one year ago included the following key factors. First, approximately 90 basis points of this decline relates to product margin, including increased promotional activity and customer rebates. Second, an increase in advertising spend, primarily in the direct business, reduced operating margin by about 90 basis points. And third, operating margin declined 40 basis points due to lower bonus accrual reversals versus a year ago and the deleveraging of costs against lower sales levels, partially offset by an increase in vendor program support.

I would now like to update you on the action plans that are focused on Taking Care of Business in the North American Business Solutions area. First, we implemented our contact strategy in the third quarter and it has had a positive impact on our sales organization. This strategy allows us to continue to aggressively pursue small to medium-sized business customer using the tools and processes of this initiative. Unfortunately, many of these small to medium-sized businesses have increasingly pulled back on office supply purchases in the midst of worsening economic conditions. In addition, our contract customers are spending less on discretionary items as they have come under increasing pressure to reduce their budgets. As a result, we do not believe the improvements that we have made are truly reflected in our third-quarter results.

Second, we continue to make progress with our telephone account management or TAM organization. We have improved the management of the third-party firms who handle this business and have made progress on the key performance indicators that we have put in place. We have also added third-party sales representatives to increase our focus on customer prospecting.

Third, our direct business also continues to make progress as we are implementing catalog analytics and increased catalog distribution. We continue to test through a number of marketing strategies and will incorporate the lessons learned from each of these tests. And fourth, we continue to execute our website optimization plan where we look to improve the usability of the site, as well as make customer-focused enhancements.

While our customer conversion rates rank among the best in the industry, we will continue to make improvements to the website in order to make the site more user-friendly for the end-user. Our Internet sales on a global basis continue to grow in 2008 with sales for the previous 12 months totaling $4.9 billion compared to $4.8 billion for the same period a year ago. In the third quarter, 81% of total BSD sales were online, up from 79% in the same period a year ago.

We continue to aggressively defend our state contract businesses while at the same time make progress with existing state bids. For example, we were recently awarded a sole-source supply contract in the state of Nebraska and a portion of a multisource contract in the state of New York following competitive bid processes.

In summary, we will continue to focus on executing our key initiatives in managing our expenses during these challenging market conditions. Charlie will now discuss the results of our International business.

Thanks, Steve. The International division reported sales of $1 billion in the third quarter, an increase of 3% compared to the same period a year ago. In local currency, sales decreased 2% with nearly all European countries reporting year-over-year revenue declines. Sales in the direct channel were down 7% in local currencies as a result of a growing number of value-seeking customers and increased competitiveness within the channel. The contract channel continued to outperform direct, increasing sales by 3% in local currencies. However, sales weakened during the quarter as many of our large accounts came under pressure to reduce spending wherever possible.

As I have mentioned on previous calls, the economic downturn in Europe originated in the UK last fall and has steadily worsened. Earlier this year, the downturn spread to the continent with France, Ireland and Denmark having officially declared recessions. The economists are also predicting that the UK, Germany and Spain are at substantial risk of falling into a recession. As a result of the weakening economies and growing liquidity concerns, businesses, both small and large, are finding it more difficult to finance and grow their businesses. This has a direct impact on their purchases of office supplies and services.

Division operating profit was $36 million in the third quarter compared to $47 million in the third quarter a year ago. Operating margin was 3.5%, down from the 4.7% last year. The components of the operating margin decline versus a year ago include -- lower bonus accrual reversals versus a year ago accounted for about 70 basis points of the decline. Second, lower sales volume deleveraged our fixed expenses, which accounted also for 70 basis points of the margin decline. And third, unfavorable foreign exchange, acquisitions and other small items negatively impacted margin by 40 basis points. Partially offsetting the overall decline was an improvement in the UK's operating performance, which contributed 60 basis points of positive improvement.

While business conditions continue to be very challenging, we are moving forward with our previously announced action plans. I would now like to update you on our progress. First, in the UK, we have substantially improved our performance with our supply chain and customer service metrics dramatically better than at this time last year. These improvements are reflected in the improved financial performance of this important market.

Second, our Tech Depot business has been rolled out to the UK and the Netherlands with France and Germany scheduled to roll out over the next few months. The performance of this asset-light model are meeting our expectations. Third, we expect to test Tech Services next year in France. This is the same offering that has been fully deployed in our North American Retail business.

Fourth, we continue to transition the back-office transactional accounting functions to our shared service facility in Eastern Europe. To date, the UK, France and Germany have been completed. And we are now in the process of transitioning Spain and Italy. We remain on track to have the balance of Europe completed by year-end. And fifth, we continue to leverage our global sourcing office and have seen increases in private brand sourcing penetration rates and volume as a result. While we are still in the early stages of this initiative, we view direct sourcing as an enormous margin-enhancing opportunity for our business across the globe.

I will now provide an update on the unsolicited, nonbinding proposal from our partner in our Mexican joint venture. We have not moved forward with selling our investment in the Mexican joint venture, but continue to engage in discussions with our partner regarding strategic alternatives for the business that will add to cash flow and increased shareholder value. Decisions regarding alternatives for this business would need to consider, among other things, the share repurchase restrictions in our asset-based loan facility, which currently prohibits share repurchases. In addition, the proceeds received from a potential sale would be reduced by about 40% due to taxes.

As I discussed last quarter, the Mexican business is very profitable and we expect it to contribute between $35 million and $40 million in net income this year to Office Depot. If we had taken our partner's original offer, we would have given up our rights to participate in the development of the South American market and the transaction would have been dilutive to earnings, even if the proceeds had been used to buy back shares.

In summary, as we look forward, we will continue to focus on executing our key initiatives in the International business, reducing our capital expenditures and managing our cash flows during these difficult times. In addition, we are pleased with the results of the small emerging acquisitions we have employed and we will set it aside until we see market conditions improve. I will now turn it over to Mike who will review the Company's financial results for the quarter.

Thanks, Charlie. Before I review the financial results for the quarter, I would like to say that I am extremely excited to be part of the executive team. Although I have joined Office Depot during a challenging time for both the Company and the global economy, I believe that we have many opportunities to improve our financial performance, size our cost structure, reduce capital expenditures and be positioned to capture profitable growth when the economy recovers.

My focus as CFO in the coming months will be to first assure the Company has the liquidity it needs to operate in this difficult environment; second, to increase the Company's free cash flow by improving working capital and reducing CapEx to a level that is appropriate for the current environment; and third, review all of our business processes to see what activities we can do without.

Also in the fourth quarter, we will be conducting a strategic review of our asset base in addition to our normal annual assessment of goodwill. Examples of what will be included in the strategic review include potential sale and leaseback arrangements, potentially exiting businesses with negative cash flows and possibly closing a number of North American retail stores. We will determine in the coming months how best to change our business to succeed in the current and future anticipated economic environment. We will likely begin taking charges in the fourth quarter. We will also continue to make adjustments in our global workforce, including both corporate and field as our business needs dictate.

During the third quarter, we recognized approximately $5 million of charges as part of the plan we announced back in 2005, bringing the total charges from inception in the third quarter of 2005 to $417 million. This quarter's charges primarily were for severance related to international projects. We anticipate charges of $8 million for the balance of 2008 and $46 million in 2009 for a program total of $471 million. However, future charges may change as plans are implemented.

In the third quarter, we had $190 million in free cash flow. For our definition of free cash flow and a reconciliation to a GAAP financial measure, please go to our website under Investor Relations. The principal third-quarter free cash flow driver was $187 million in lower inventory versus the end of the second quarter as a result of the initiatives mentioned by Chuck Rubin.

Third-quarter capital expenditures of $71 million were close to the $62 million of depreciation and amortization we recorded and we also realized nearly $50 million in proceeds from the sale and leaseback of eight North American retail stores during the quarter. Overall and in light of our business performance, we are very pleased with our cash flow performance in the third quarter. For the nine months ended September, net cash provided by operating activities was $398 million and free cash flow was $120 million.

Next, I would like to take a moment to respond to questions we received in regard to two issues -- our new asset-based credit facility and also our capital expenditure plans. As most of you are aware, we successfully closed on a new five-year, $1.25 billion asset-based credit facility at the end of the third quarter. The agreement is similar to other asset-based facilities, yet different in several ways from our previous revolver.

Most importantly, this agreement does not contain a maintenance financial covenant. If you remember, our prior revolver contained both a fixed charge coverage and total leverage ratio that needed to be maintained at all points in time. Under the new agreement, the only time we would be required to comply with the fixed cost coverage ratio would be if liquidity on the facility fell below $187.5 million or if we wanted to make certain investments or restricted payments such as dividend or share repurchases. For example, we are prohibited from repurchasing shares when our fixed cost coverage ratio falls below one and at the end of the third quarter, our fixed cost coverage ratio was approximately 0.9.

At the end of September, we had drawn $365 million on the asset-based facility and had $135 million in outstanding letters of credit against the facility, leaving us with $750 million of availability. Given this availability and the $395 million in cash we had on hand at the end of September, we ended the quarter with $1.15 billion in available liquidity.

In addition, since the new asset-based facility does not contain any type of a leverage test, we could go out and raise additional liquidity if necessary. Specifically, we have the ability to raise another $750 million in secured debt and $650 million in unsecured or subordinated debt. And in addition to that, we will also review other internal sources of liquidity, such as our owned store and distribution center properties for potential sale-leaseback arrangements in the fourth quarter.

In regards to capital spending, we have increased our focus on CapEx and are currently reviewing our fourth-quarter 2008 and full-year 2009 spend. Our CapEx has been tracking nearly 20% below last year for the first nine months of 2008 and is on track to come in around $350 million for the full-year 2008. In order to increase our cash flow in 2009 and to provide additional liquidity, we are planning on reducing our CapEx to about $225 million, which is $50 million below our expected 2009 depreciation and amortization of $275 million. To achieve this, we will decelerate the implementation of our IT and supply chain initiatives, as well as limit new retail store growth.

In regard to our balance sheet, we ended the third quarter with $395 million in cash and cash equivalents. Our investment in inventory totaled $1.5 billion globally, down 9% from the same period last year and this decrease was driven primarily by lower inventory in North American Retail with inventory per store at quarter-end at $777,000 per store, down 15% from the same period a year ago. This inventory reduction was the result of improved inventory management, as well as mitigation of inventory risk through clearance activities.

Our net debt at the end of the third quarter was $546 million, including $519 million in long-term debt. With the new asset-based credit facility in place and our $400 million in long-term bonds not maturing until 2013, I feel comfortable that we have a capital structure in place to take us through this business cycle. And with that, I'll turn the call back over to Steve Odland.

Thanks, Mike. Clearly, we are disappointed in our third-quarter earnings and the steep decline in our share price. Given the world that we are operating in today, given that world, our liquidity, of course, then is paramount and as Mike mentioned, we are focusing on our cash flow and have the asset-based loan facility in place if needed. As a result, even though we don't know the depth and duration of this global crisis, we believe that our liquidity positions us well for the long term.

As Mike mentioned, we will be conducting a strategic review of our asset base in the fourth quarter, including potential sale-leaseback arrangements, potentially exiting businesses with negative cash flows and potentially closing a number of North American stores.

I would like to reiterate that we are committed to managing the Company through these challenging times and we will continue to do everything we can to manage the top line, cut costs, reduce our capital expenditures and improve our cash flow. With that, I would like to open up the call for questions.

(Operator Instructions). Matthew Fassler.

Thanks a lot, Goldman Sachs and good morning to you. A couple of questions here. First of all, as you think about what you are going to do with Mexico, why are share repurchases, I guess, part of the dialogue right now? What is that limitation? It seemed to be perhaps an influence on what you're looking to do. To the extent that the market is concerned about liquidity, you might think they are overdoing it and hence, a share repurchase is appropriate here. But just talk about the way you might deploy any capital that you raised from that and why that seems to be a consideration in that thought process.

Thanks for that question, Matt. No, I think that all we were pointing out is that there was a lot of talk about, gee, we should monetize that asset in order to buy back our shares and all we were pointing out is that there are limitations underneath the current asset-backed facility on share repurchase, so we were pointing out that the fixed charge coverage ratio needs to be above one in order for that to be the case. Nevertheless, we do believe that that is an important asset and we have engaged in our discussions with our partners and continue those discussions quite frankly. The offer changed from the initial offer. We have worked through that with them and continue to keep the negotiations alive.

But we also are pointing out that that business is a good business. You'd lose 40% of the proceeds to taxes, so whatever the gross proceeds would be, however amended, you would have to take 40% off of that. So it is not an efficient return of capital and then whatever the use would be.

The issue of liquidity, Matt, is that if we felt we needed liquidity, there are a lot of places we could turn. And what we've pointed out is that we have got $1.150 billion in liquidity at the end of the quarter. We have nearly $400 million of cash on our balance sheet. We have got sale-leaseback arrangements we can do, but after all of that, of course, the Mexican business and any other business that we have is able to be monetized for cash if we wanted to do that. Hopefully that clarifies --

It does. One quick follow-up on that and then one other question. You said the offer has changed. Is it different from the dollar value that you discussed on the second-quarter call?

Hi, Matt. This is Charlie. No, the transaction has changed. Originally, it was $430 million and what they talked about doing was splitting it into $400 million and $30 million, $30 million being a fully paid-up value for South America. We lose all that future potential. Plus, their own financial situation has changed. At the time they made the offer, they had $1.3 billion in cash on their balance sheet. Last we saw, it was down to just around $400 million. So obviously they would need to secure financing to complete the transaction.

Got you. A follow-up question. As you think about some of the larger strategic steps you want to take and you talked about strategic review at year-end, how extensive of a restructuring could you imagine? And does your balance sheet or your concern about perceptions of your balance sheet limit the kinds of store closings or other asset write-downs or removals that you might contemplate?

Well, we are just in the process of beginning that review and I think that nothing that we have conceived of so far is limited by our balance sheet or our liquidity situation. We have got to look at everything and our business is smaller today. We're caught up in a global crisis. We have got to look at cash flow negative businesses. We have got to look at stores and we will do that. We are just simply starting that now and we will continue this and we expect to take these actions either during or towards the end of the fourth quarter and will announce any potential charges, cash or non-cash, probably with our fourth-quarter earnings.

And then finally, the $21 million impairment charge, it seems like most of that -- impairment and closing charge I should say -- it sounds like most of that was non-cash. Where does the add-back show up on the cash flow statement, if you could just help us there?

Well, it was non-cash. It was a FAS 144. Our annual third-quarter FAS 144 assessment of our stores and so it was a non-cash -- it was a non-cash charge and it was in the North American Retail operating income.

Got you. Just to the extent that it was added back to net income on cash flow, do you know which item, Charlie or Mike?

That was right. It would be -- Matt, it would be treated the same way as depreciation and amortization.

Got you.

It would be cash flow from operations.

But that is an interesting point. Chuck, you may want to -- Matt, those numbers for FAS 144 impairment charges are in the division numbers that we reported.

We reported 0.8% operating profit for Retail. The impairment charges are included in that. So if you take that non-cash out and some other issues that were unique, like the hurricane impact, the operating margin for Retail in the third quarter was in the mid to upper 2% range.

Understood. Thanks so much.

Hey, Matt this is Mike Newman. If you look at the 39-week statement of cash flow, it is in that changes in working capital and other line --

So it's in working capital. Got you. That what I was looking for. Thank you so much.

Chris Horvers.

Thank you and good morning. Can you maybe frame out, from the liquidity perspective, some of the things you are talking about here? Can you frame out on the sale-leaseback side how many stores you own where you have the opportunity and also on the DC side and perhaps geographically where that is just so we can get an estimate of what the potential cash flow opportunity is?

And also from the store perspective, it seems like you have changed your tone over the past -- just over the past two months on that. Prior to this, you had talked about saying, well, we don't want to exit just some stores because it is important that we have stores in the BSD division in those regions. So are you planning more of a regional exit?

Chris, let me take the second half of the question first. I think we have said all along that we believe in our store model long term. What we have talked about on this call is that we are going through the process of evaluating all of our stores given the current economic situation. We haven't made any decision. We are not finished with the analysis that we are doing, but I don't think that our strategy has changed radically, other than just a recognition that we are dealing in a unique time and we have to, as we do every year, visit our store profitabilities and cash flow.

So we will keep you up-to-date as this thing evolves, but your comment about the synergies between BSD and Retail are still there. Steve Schmidt and I see that in both of our businesses, that the closer we work together the better the results are.

Mike, you may want to just talk about the sale-leaseback opportunities.

Yes, there is another -- on the sale-leaseback in addition to the eight that we did in the third quarter, there is another 40 to 50 that we are looking at and we want to make sure they are smart, economic deals. We also have some warehouses and facilities internationally that we are looking at as well. And at this point, I would prefer not to size it, but it could be at least as large as the opportunity we reported in the third quarter.

Okay. Just two follow-ups on that. First, on the store closure side, does then the BSD synergy, in order of magnitude, try to help frame it, does the BSD synergy then suggest, well, we could close 20 to 30 stores, not 100 to 200 stores and then also on the store exit side, how much is it typically to exit a lease for the stores now?

We are not at the point, Chris, where we're able to say how many stores could potentially be affected here. I know people would like to have that number, but we simply are going through the analysis today and we are taking every aspect of that into consideration, including the BSD synergy and the location of the stores, the long-term future of the stores. We don't want to just make short-term decisions based on this quarter's operating environment and damage our long-term business, but we do want to be responsive to the business situation. We don't know how long this crisis will last. We don't know how long the business downturn will last.

I just would remind everybody, all of our sales are office supplies. These are G&A expenses for our customers and therefore, they are discretionary expenses for all our customers. And our business model relies on the health of the economy and spending by our small, medium and large business customers and especially on the small side, we started to see the impact a year ago and that has been hit dramatically particularly in the last two weeks of the third quarter as we saw the global liquidity crisis hit.

So we are in unprecedented times where people just simply have cut back severely on their spending. I think every company that is on this call has cut back on their G&A expenditures. So that is the time we live in. So we don't know how long that is going to last. What we are saying is we have got to adjust to that and be responsive to that and that is what we are looking to do here. In terms of the cost -- potential cost per store, Mike, you may want to mention that.

I think, at this point, I would wait until we did further analysis before I threw that out.

Okay, it is variable by store, so it depends on the lease length and the expenses and how much we have into the store, Chris.

Okay and just one more quick one. How do you -- as you think about inventory and accounts payable into year-end, do you think you can maintain that 93%-ish AP to inventory ratio and down 10% to down 12% inventory growth?

Yes, we do. Obviously, with inventory where it is, the idea that there is additional opportunity off that, it is a little tight, but we think we actually have some opportunity in payables and yes, we think we can maintain that relationship.

Understand the inventory declines. We have been able to take a lot of inventory out in this period of time while at the same time improving our store in-stock conditions and that is paramount to us. Our customer-facing in-stock and conditions in inventory are very important both for the BSD division, as well as in Retail.

The place we have been able to affect inventory is through supply chain changes. We have implemented some creative opportunities in alternate sourcing between our facilities so that we don't have to carry the safety stock in every single one of our DCs. We are alternating and moving product between stores more to try to balance out inventories. Chuck has done a great job with the merchants of micro-sorting, especially big-ticket items in stores so that we don't just peanut butter all of our inventory across every store regardless of customer demand in those stores.

So these are some very creative and aggressive techniques that we have used that have actually improved our customer-facing conditions. So we continue to believe that we can do more of that in the fourth quarter and take inventory out, improve our cash flows while not negatively impacting our customer situation.

Thank you.

Mike Baker.

Thanks, guys. Just a few quick ones here. You spoke about some money-losing businesses. I am wondering if you can give us an example of what you might be talking about and I guess does that include -- when you talk about a business, is that a geographic segment perhaps, count as sort of a money-losing or standalone business? I am just trying to understand what you mean by that comment.

Mike, this is Charlie. Probably the best example would be the business that we have in Japan. We have been in Japan for about 12 years, first as a joint venture and more recently as a standalone operation and that business doesn't make money. The Japanese market is a very tough market to begin with for American companies and as a matter of fact, the economy and the office products industry itself in Japan is actually shrinking. So we are in the process, as part of the strategic review, we don't want to specifically exit the market, but we want to find alternatives in that market that would move us closer to profitability.

And did you disclose the size of that -- sorry. I was going to ask if you disclosed the size, but I didn't mean to cut you off.

No, no, we would rather not disclose the size of it, but, at any rate, it is important for us to look at. It's meaningful.

Okay.

But Mike, that is just an example and so any geography where we are not making money, any store where we are not making money, any customer, BSD customer where we are not making money, we are just simply slicing and dicing the business and saying, hey, look, we have got to reflect the realities in today's business and we've got to go through and make sure that we understand that we have got to have positive cash flow in every element of our business. And then we will take whatever actions we think are required here in the fourth quarter in order to maintain our long-term business prospects while adjusting the business to the short-term reality.

Understood. One more question, just a clarification. On your charges, you took a -- you have a charge with a capital C I think you referred to it of $5 million. That gets you to the loss of $0.01, but that minus $0.01 includes you keep in the $21 million of impairment charges and then the $0.03 on the tax thing, is that right?

On a GAAP basis, we recorded $0.02. The charge of $5 million that is additional $0.01, that relates to the restructuring we started in 2005, which gets you to minus $0.01. And then you would add back $0.05 for the FAS 144 store impairment, and you would add $0.03 back for UK.

So if you want to exclude, if one were wanting to exclude all those charges, then it would be more like $0.07?

Bingo.

Okay. Thank you for that clarification.

Thank you for that question.

Kate McShane.

Hi, good morning. I just have a question about your real estate commitment so far for 2009. Are you committed to any real estate so far?

Yes, Kate. It's Chuck. We have talked before that we have worked aggressively to reduce our store opening plans over the next couple of years. We are still sitting at about 40 planned openings next year. Those are all committed leases. We have done the analysis of the financials on trying to get out of the lease versus opening it, and right now they all come back to that it is more financially astute to open those sites. Now we continue to work on those sites. We would like to reduce that further, but today we are sitting at about 40.

Yes, you know, these are signed leases, but we will also look at whether it makes sense to keep them dark even though they are signed, and pay the rent for some period of time until the economy picks back up. So we are going to look at every aspect of this. We are not rushing to open stores in this environment.

Okay, thank you. Can you comment at all what you have seen so far the first couple of weeks of the fourth quarter? Has the deterioration you saw at the end of the quarter worsened?

Kate, it's Chuck. Our business continues to track in a similar fashion to what we saw at the end of the third quarter.

Okay. And then my final question is about international markets, where you saw more intense competition. I assume you are talking about price competition, and can you give us a little bit more detail behind that?

Well, I think it is -- the situation internationally is really very much similar to here in the US. Everyone is scrambling for business as the economy has slowed down. And some of the large customers, you know, have specifically instructed their employees to reduce not indirect spend. So in that environment, it has been more aggressive as to maintain our business.

Okay, thank you.

Oliver Wintermantel.

Good morning. You mentioned a further deterioration in your small and medium-sized customer base. Could you tell us if that was all macro driven or if you lost market share in that segment?

Yes, this is Steve Schmidt. As we look at the SMB sector, the majority of the decline is macro related. The state of Florida and the state of California continue to [degregate] in performance, but as we said that macroeconomic pressure is obviously being seen across the country in most of our state business as well as our contract business. So the majority of it is macro driven.

From a market share standpoint within BSD, we really don't have specific market share data. But from a gut standpoint and based on what we think is happening in the marketplace, we are trying to hold in grow share. We think we are holding and growing share in the education sector, government sector, our large corporate customer base, and obviously challenged in the SMB sector.

Okay. I have just one follow-up. What are the specific levers that you can pull in the fourth quarter to reduce SG&A dollars, or is that pretty much fixed at this point?

Well, as part of our restructuring we are looking at our SG&A as well, Oliver. We continue to scale the size of our business and the size of our employment base throughout North American retail and our field operations and our selling organizations, and then globally by country where the economies are not good. So we will continue to do the best we can.

Obviously, especially in Retail, SG&A levels reach a bit of fixed levels. You simply have to keep the lights on in the stores and a certain base of staffing in the stores in order to be customer-facing. So at some point, they act a little more fixed than they do variable, but we will continue to work very hard on our SG&A to right-size that for the business that we have today.

Thanks very much.

Colin McGranahan.

Good morning. Thank you. I have three questions. First, the easy one. Just back on the G&A, the growth of the third quarter, looked like about 20% growth in dollars. How much of that was the reversal of bonus accruals and if you could just comment on that growth otherwise?

Yes, this is Mike. G&A bonus accruals was probably over $15 million. We had some advertising increases and then we also had the impact from international acquisitions. Those are the big pieces.

Okay. And then secondly, I know you typically don't provide a whole lot of guidance, but given the current situation, the level of uncertainty, the stock price, could you tell us what you think your cash flow outlook would be for the year and how much you think you will be drawing on the credit facility at year-end?

We currently -- at the end of the third quarter, we were drawn on the credit facility, as I mentioned in my script, to the tune of about $500 million. Based on the projections we see going forward, we see a draw to the tune of $500 million to $600 million for the next four to five quarters, which, of course, indicates that we see a likelihood that, with the CapEx reductions and the working capital management, that we can generate free cash flow next year even in this down environment. I don't really want to dimensionalize that just because of the uncertainty of the top line, but the pieces that we can control we feel comfortable with, particularly the CapEx to depreciation relationship I alluded to.

And in that draw, remember that we have got about $395 million of cash on the balance sheet right now.

And that's a great point. We probably drew $150 million plus of excess cash that we had at the end of the third quarter to get ourselves comfortable with the liquidity crisis. We did not need to draw that much.

So the cash on the balance sheet alone is $1.44 a share.

Right. I got you. Okay and then, finally, Steve, a final question for you. Just in terms of thinking about the business, where you are today, the liquidity situation, obviously, thinking about assets and then the stock price, how seriously will you think about something more significant -- and let me throw something out at you. Your International business looks like -- if I allocate G&A to that business, it looks like it will generate, I don't know, something around $62 million in EBIT this year. I would assume it probably has about a third of depreciation, so we can call it something like $150 million in EBITDA for that division.

Staples bought Corporate Express at something close to 10 times EBITDA. So it seems like maybe you could sell that division for something like $1.5 billion. Your stock price is $500 million. You can sell the division, pay off your ABL and buy the whole company and have a total North American business for free. Is that something you would consider and I know you have talked about a total strategic review, but given where the stock price is, how seriously are you going to think about something more transformational?

Look, the stock price makes no sense to us whatsoever. If you look just ex-charges, EPS we are largely consistent with expectations. Ex-charges, North American operating margins were in the mid 2 to 3 range. Free cash flow was $195 million or $0.71 a share. The cash on the balance sheet is $1.44, available liquidity is $1.150 billion. The stock price doesn't make any sense. We could monetize any part of our business. We could sell the North American Retail business. We could sell the North American Business Solutions. We could sell country by country. We could package the whole thing. All of these things clearly have been discussed at least at our level and have not gone unnoticed.

What we are setting out to try to do is to assure and inform everybody of our liquidity situation. You would have to believe that in order to justify the stock price that we have today, you would have to believe that we were at the end of our liquidity, which is simply untrue and I think we have dimensionalized that this morning.

So all of these things are a possibility, even the things that you have outlined. But we want to make sure that we make people understand that our business is discretionary spend for everybody else. We are in a global crisis right now and the question is how long is it going to last? We simply don't know the answer to that. We want to make the right short-term decisions for the business. We also want to make the right long-term decisions.

So all of these kinds of things certainly have been considered, but at the end of the day, it still is a great franchise with great cash flow production possibilities, even in these downtimes. I think Mike just dimensionalized that and the question is how extreme should our actions be in the face of a short-term situation when six months, a year from now, we could find ourselves with a great growth business all over again. And those are really good questions, Colin, and we will evaluate all of it.

Okay. Thank you.

Dan Binder.

Good morning. I had a couple of questions as well. When you look back to your comments last quarter about not expecting to close a significant number of stores, obviously, some time has passed, things have gotten a little bit tougher. What is sort of the driving decision behind now doing this review and potentially closing more than just a few stores? And maybe in that commentary, could you include how many of the stores are cash flow negative at this point?

Yes, we don't have specifics at this point, Dan, because we are just starting the process. Now I think part of it is an annual process that we go through. When we do it in the fourth quarter every year, we looked at it. We have done it in the fourth quarter the last three or four years and we have talked about it. So part of it is that.

Part of it though is simply looking at the business more directly and trying to take more dramatic action to improve our cash flow and improve our shareholder value. I think that if there were normal economic times, we probably would be closing no stores because those stores would be cash flow positive and growing nicely and so forth. In this economic time and with an uncertain future, the economists are projecting that this kind of a situation is going to last through 2009 and it is going to take until the beginning of 2010. We don't know whether that is reality or not, but we have to assume that 2009 is going to look a lot like the back part of 2008 here. If that is the case, then simply it does make sense to close stores and maybe shrinken our size a little bit before we start growing again.

So that is the view that we have on this thing and we hope that people understand that we are being very responsive to the current situation while at the same time being very cautious not to damage our long-term strategic situation because we do believe that this company will take off again once the economic conditions change.

We think that we are overexposed to Florida and California. We have known that for some time, which is why we have tried to diversify and I think we have done a good job of diversifying through our acquisitions in our emerging markets. We are very pleased with China and India, Eastern Europe. So this is not a situation where we are trying to move too dramatically, but we are just simply trying to adjust to the projections of the business today and what we are hearing the economic projections will be for 2009.

Could you put some bookends on the potential range of stores that you are looking at that are at least under consideration for closure?

No, I know everybody would like that, Dan and we just simply haven't done it yet. So we will let you know as soon as we can.

The other comment that you made in your formal remarks that struck me as interesting was the -- I think you said somewhere along the lines that vendors -- that you had some increased vendor support and in light of the significant inventory declines and the liquidity concerns out there, warranted or not, it was interesting to hear that vendors were perhaps even incrementally more supportive. I was wondering if you could speak to that a little bit.

Yes, Dan, it's Chuck. In terms of liquidity, our vendors have not expressed any concern. We are getting shipped product without any interruption, any hesitation. As we have talked about before, vendor support is an ongoing negotiation that we have with our vendors to support all of our businesses, whether it is Retail, BSD or International. It is a tough time for the Office Depot sales; it is also a tough time for our vendors. So in the third quarter, we were able to do some incremental opportunities to help out both BSD especially, as well as Retail. So it is both -- it is us sitting down with our vendors and really trying to work as aggressively as we can to try to create transactions and traffic and sales opportunities.

Vendor program support as a percent of sales year-over-year, it is almost identical and it has not appreciably changed in the quarter. It is the same.

Was there any kind of inflationary buy-in activity that helped the margins? If so, how much?

Buy-in on product you mean?

Yes, ahead of price increases.

Not anything material. We had a little bit of -- odds and ends, nothing material. Again, our inventory was down significantly from a retail standpoint where, North America, most of our inventory is. Per store inventories were done 15%. So that indicates there wasn't a lot of load-in of any inventory. We are managing that inventory really closely to be sure that we are not stuck with lots of problems going forward.

Okay. And then one last question. On the delivery business, what is your exposure to the financial institutions? Is it 10% of your delivery business, 20% or more?

Dan, we haven't talked specific figures, but I would characterize it this way. It is one of the areas that we have been fortunate from the standpoint that our customer base has been the majority of those that are surviving the current process. It will have some minimal impact, but we don't believe any impact at this point will be material in any fashion.

Great. Thanks.

Okay, we have one more question, Brian or not? Okay, it looks like we are out of time. Let me just wrap up by thanking everybody for attendance this morning. Clearly, again, we are disappointed with our share price and we hope that through our comments this morning, we have reassured people on our liquidity situation. Free cash flow was $195 million this quarter or $0.71 a share, cash on the balance sheet is $1.44 a share. We have got $1.150 billion in liquidity and the ability to add debt beyond that if we needed to. We are looking at sale-leaseback opportunities and other things to be cautious. We will go through this asset review in the quarter. We are, obviously, very disappointed in our sales and our issue is our sales. Our sales are dependent on our customers' financial health and their business health and we will do everything we can to do the right thing in terms of trying to generate profitable sales while not chasing unprofitable sales during this period of time, but we are focused on liquidity. We believe our liquidity is strong and will very much enable us to weather this economic storm. Thanks very much for joining us today.

Thank you. This does conclude today's conference. We thank you for your participation. At this time, you may disconnect your lines.