ODP Corp (ODP) 2009 Q4 法說會逐字稿

Good morning and welcome to the fourth-quarter 2009 earnings conference call. All lines will be on a listen-only mode for today's presentation, after which instructions will be given in order to ask a question. At the request of Office Depot today's conference is being recorded.

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

Thank you, Michelle, and good morning. 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.

In addition, during the conference call we may refer to certain non-GAAP or adjusted financial measures. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP financial measures as well as our press release and accompanying webcast slides for today's call are available on our website at www.OfficeDepot.com. Click on Investor Relations under Company Information.

Office Depot's Chairman and Chief Executive Officer Steve Odland will now summarize our fourth-quarter and full-year 2009 results. Steve?

Thank you, Brian. Good morning and thank you for joining us for Office Depot's fourth-quarter and full-year 2009 earnings conference call and webcast. 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, our President of International.

Before I [summarize our] fourth-quarter and full-year 2009 financial results this morning I will take a few moments to highlight some of Office Depot's many accomplishments in what was perhaps the most challenging economic period since the 1930s.

By executing well across the entire enterprise in 2009 we increased our liquidity by over $500 million. We improved our customer service metrics in both North America and Europe. We improved our supply chain metrics across North America and Europe to record high levels.

We worked more closely with our global vendor partners than ever before during a period when many reduced their exposure to customers or changed terms. We continued development of innovative, new private-branded products and increased our percentage of direct imported products through our global sourcing effort.

We closed 150 poorly performing retail stores in North America and Asia. We closed 12 distribution centers in North America and Europe. We rationalized underperforming businesses, remodeled 36 retail stores in North America, developed a new prototype store, began integrating our two North American supply chain systems, successfully launched a new ERP system in North America, launched a new website for North American business solutions, and engaged and retained our talented associates worldwide.

I am extremely proud of all of these accomplishments under the extraordinary circumstances that we have faced over the past year.

Turning to our fourth-quarter results, total company sales were $3.1 billion, a decrease of 6% compared to our fourth-quarter results last year. Adjusted for charges the fourth-quarter loss was $17 million or $0.06 per share versus a loss of $199 million or $0.73 per share in the same period a year ago.

The GAAP loss after preferred stock dividends of $77 million or $0.28 per share includes charges which negatively impacted earnings by $0.22 a share. You may recall that we recorded a GAAP loss of $1.54 billion in the fourth quarter of 2008. This 2008 loss consisted of a number of unusual items including a non-cash charge of $1.27 billion recorded for goodwill and tradename impairments, operational asset impairments of $89 million, and pretax charges of $167 million for actions taken as part of our restructuring.

Adjusted for charges total operating expenses in the fourth quarter of 2009 decreased by $186 million or 18% compared to the prior-year period. This decrease primarily reflects lower payroll and advertising expenses as well as reduction in reserves on private label credit cards and fixed asset impairments.

EBIT adjusted for the charges was a loss of $5 million in the fourth quarter of 2009, which is an improvement of $205 million over the $210 million loss recorded in the same period last year. I should note that we are pleased that our adjusted gross margins increased by over 150 basis points in all three of our businesses during the fourth quarter and total company gross margin was up 220 basis points versus the prior year.

Our international business in particular did a great job increasing margin this quarter and Charlie will detail his team's successful efforts later in the call.

For the full year sales decreased 16% to $12.1 billion. Adjusted for charges, the impact of tax adjustments -- and the impact of the tax adjustments that diluted loss per share for the full year was $0.26 versus a loss per share of $0.41 in 2008.

The GAAP loss after preferred stock dividends for 2009 was $627 million compared to a loss of $1.48 billion in fiscal 2008 due to the previously mentioned charges. The GAAP loss per share on a diluted basis was $2.30 in 2009 compared to a loss per share of $5.42 in 2008.

Adjusted for charges 2009 total operating expenses decreased by $681 million versus 2008 and EBIT adjusted for charges increased to $8 million compared to a loss of $51 million in 2008.

Now I will ask Chuck Rubin to talk about North American Retail's fourth-quarter and the full-year 2009 performance. Chuck?

Thanks, Steve, and good morning. Fourth-quarter 2009 sales for the North American Retail division were $1.3 billion, down 9% from the prior year due in part to having 115 fewer stores open in the quarter versus the same period one year ago. Comparable store sales in the 1,139 stores in the US and Canada that have been open for more than one year decreased 4% versus the fourth quarter of 2008, a significant improvement versus the 14% decline we reported in the third quarter.

You may recall on our third-quarter earnings call that we stated that comp sales had been trending down about 7% for most of October. We were pleased that our store sales trends actually improved sequentially each month within the fourth quarter with about a minus four in November and about a minus three in December. We also believe that we gained share in the OSS channel in the fourth quarter when we exclude the impact of the closed stores.

While transactions continued to be down in the fourth quarter compared to the same period last year, the rate of decline improved versus previous quarters. Our transactions and average order value both experienced a low single-digit percentage drop in the corner with transactions being the greater contributor to our sales decline.

Consistent with previous periods the decrease in sales was driven by macroeconomic factors as consumers and small business customers continue to hold back their spending, especially in some big ticket discretionary categories. However, we believe that the trend improvement in the fourth quarter was due in part to a short-term seasonal bump in consumer spending around the holidays versus a materially better shopping environment for small businesses.

Within each or three major product categories of supplies, technology, and furniture we experienced a sales decline compared to the prior year. The good news is that each category continued to improve sequentially over prior quarters.

We did achieve positive comparable store sales in ink and toner, storage, janitorial and sanitary products, software, and Tech Depot services. The Microsoft Windows 7 launch was very successful and helped improve our overall sales in software throughout the fourth quarter. In addition to better software sales, customers took advantage of our broad Tech Depot services offerings such as computer tune ups, data backup and protection services, and the installation of software including Windows 7.

In regard to Black Friday and the recent holiday season, we successfully employed a technology merchandising strategy that allowed us to increase our product margins due in part to better promotional planning, improved inventory management, and reduced product obsolescence.

Geographically the California and Gulf Coast markets produced the weakest comparable sales trends in the fourth quarter. The Gulf Coast market was unique this quarter as its results were compared to hurricane recovery sales that occurred in 2008. Comp store sales trends in Florida, although still negative, have improved and are running roughly at the division average.

Our best-performing sales markets were again in the Midwest and the Northeast.

In the fourth quarter of 2009 we closed eight stores, opened two, and relocated one bringing our total North American store count to 1,152 at quarter end.

Retail operating profit in the fourth quarter of 2009 was a positive $2 million, a significant increase from the $119 million loss reported in the same period of the prior year. The operating profit improvement was driven by a number of factors including last year's asset impairment charge of $78 million and $12 million in reserves for previously closed sublet assumptions and potential bad debt related to our private label credit card, which did not recur in 2009. Also, the comparative benefit from closing underperforming stores.

We also had higher gross margin, which was up about 150 basis points year over year due to improved product margins driven both by better product sales mix and lower product costs and lower levels of inventory shrink. And, finally, we reduced our operating expenses in the fourth quarter. These positive factors were partially offset by the unfavorable impact of our sales decline during the quarter.

I should note that our fourth-quarter operating profit was better than we projected in late October due to the flow-through impact of our sales improving each successive month throughout the quarter.

Turning to our full-year 2009 performance, North American Retail sales were $5.1 billion, down 16% from full year 2008. Comp sales for the year were down 14%. Our operating results improved significantly from a loss of $29 million in 2008 to a profit of $106 million in 2009. This increase was driven by an improvement in product margins and lower operating expenses and asset impairments. The improvement in product margins was driven primarily by better product sales mix as well as a lower product cost and lower levels of inventory shrinkage and valuation charges.

During 2008 we recorded fixed asset impairment charges of approximately $98 million. As a result of these 2008 fixed asset impairments we experienced lower levels of depreciation expense in 2009. Additionally, the comparative benefit from closing underperforming stores in 2009 also drove some of the increase in operating profit.

Lower operating expenses were due to a decrease in payroll and advertising expenses in 2009. These positive factors were partially offset by the unfavorable impact of our sales volume decline.

In North American Retail we continue to focus on providing innovative products, services, and solutions to both our micro-business customers and consumers while continuing to manage our costs. These initiatives will position us well as the economy recovers. I will now briefly update you on just four of those key initiatives.

First, growing service offerings like to our Copy & Print Depot and Tech Depot services. In Copy & Print Depot we completed the aggressive rollout of shredding services throughout our retail stores and added the ability for all stores to process and facilitate same-day business cards.

In the fourth quarter our Tech Depot services also performed very well with double-digit positive comps compared to last year due in part to the success of the Windows 7 launch and higher software sales. Our technology category saw the greatest sequential improvement in comp sales compared with the supplies and furniture categories in the fourth quarter.

Second, we developed and implemented a new small store format named the M2S, which is an extension of our existing M2 format. The M2S has been receiving good customer feedback and we are encouraged with its progress thus far. We have been testing this 15,000 square foot store in about a dozen locations nationally and believe it offers a number of benefits including a lower breakeven sales level than the traditional larger store. As a result, we feel this new format has potential going forward.

Third, we opened our sixth retail store in Puerto Rico during the fourth quarter. The stores in Puerto Rico have performed well and allowed Office Depot to expand in this market. We continue to see great opportunity in this region to provide office supplies to our customers at a great value.

And finally, fourth, our customer service scores remained at high levels exceeding last year's performance. In this tough economic environment we remain committed to delivering excellent service to our valued customers each and every day.

In summary, I am pleased with the progress made under challenging circumstances in both the fourth quarter and full-year 2009 thanks to the thousands of North American retail store associates that have worked hard every day to take care of business. We remain focused on improving our product assortment, reducing operating expenses, and executing our key strategic initiatives. We continue to be aggressive in seeking incremental profitable sales opportunities through our products, services, and new marketing tests.

Looking forward the first quarter is our back-to-business season and historically has been sequentially higher in both sales and margin than the fourth quarter. Thus far in the first quarter our sales comp is tracking at about minus 3% and our total revenue will be down more than our comp revenue due to the 107 stores closed during the first quarter of 2009. As a result of the lower sales, along with increased advertising, our first-quarter operating profit will be down versus the prior year.

I will now turn the call over to Steve Schmidt to review the fourth-quarter and full-year 2009 results as well as key initiatives for North American Business Solutions. Steve?

Thanks, Chuck. Fourth-quarter 2009 sales in the North American Business Solutions division were $821 million, slightly lower sequentially from the third quarter and down 11% versus the fourth quarter last year. Our BSD business was down 9% excluding the impact from our restructuring of certain non-core businesses.

As mentioned on previous earning calls, we believe that the sales decline in BSD stabilized somewhat in the second quarter of 2009 and we should begin to lap that stabilization towards the end of the second quarter of 2010.

Looking at our performance by state in the fourth quarter the sales decline in California continued to exceed the average rate of decline for the entire business, while the sales decline in both Florida and Texas were slightly less than the average. The public sector in California continued to be under extreme pressure due to lack of state revenue.

The number of customer transactions and average order value both declined in the fourth quarter versus the prior year, but customer transactions principally drove the sales decline in all channels. Our weakest product category in the fourth quarter continued to be furniture as customers delayed their purchases of some durables in favorable of consumables like paper, ink, and toner. Technology product sales were actually stronger in the fourth quarter versus the prior year. We continue to see strong demand for cleaning supplies, including sanitizing products, in both our contract and direct channels.

In contracts, the sales to our small- to medium-sized business customers, or SMB, large national accounts, and public sector accounts continue to decline in the fourth quarter on a year-over-year basis but the level of decline improved from prior quarters. The rate of decline for our SMB customers in the fourth quarter continue to improve sequentially and we begin to gain traction in growing and retaining customers.

Despite the decline in sales we grew the size of our customer file in the fourth quarter and have seen some large customers beginning to loosen their purchasing restrictions and buying products that are not on their core list.

We had a number of wins in the public sector throughout 2009. For example, we won six of our last seven state contracts up for renewal and raised our state contract total to 17. In the fourth quarter of 2009 we won or renewed about 90% of the medium-sized and large public sector account bids. For the full year we won over 85% of the medium-sized and large public sector account bids. It is important to note that we continue to win new businesses and retain our valued customers in the public sector.

In the direct business our fourth-quarter sales declined versus the prior year but at the lowest rate this year. We have taken a very disciplined approach to our direct business. Good progress has been made with our catalogs and newly upgraded websites that have driven conversion rates higher than one year ago.

North American Business Solutions operating profit was $21 million for the fourth quarter of 2009 as we had projected, up from a loss of $28 million for the same period of the prior year. The drivers of the fourth-quarter operating profit improvements were improved product margins and lower operating expenses partially offset by the flow-through impact of lower sales levels.

Our gross margin was up about 150 basis points versus last year due in part to creating a better alignment between customer rebates and their purchases. Additionally, allowances taken for bad debt and other negative items in the fourth quarter of 2008 contributed to the improvement in our operating profit comparison by about $20 million.

For the full-year 2009 performance sales in the business solutions division were $3.5 billion, down 16% versus 2008. Full-year operating profit was $98 million, down approximately $22 million from 2008. The operating profit decline was driven by lower sales and product cost increases that were not fully passed on to our customers due to timing issues.

Division operating profit for 2009 also reflects increased promotions in our direct business during the first half of the year. Reduced operating expenses helped to partially offset some of the operating profit decline.

Despite the challenging business conditions, the North American Business Solutions division continues to focus on executing initiatives that will position us well as the economy slowly recovers. I will briefly update you on four of those initiatives.

First, we announced in late September an exclusive partnership with Lil' Drug Stores enabling the distribution of office products, branded products for sale in the convenience stores throughout the country. Though this initiative is fairly new our initial results are very promising and we look forward to the full benefit this partnership will bring us. Our intent is to expand our product assortment offering and increase the number of convenient store locations carrying the Office Depot products nationwide.

Second, due to improvements in the telephone account management organization and our third-party canvassing efforts like feet on the street, we are growing our customer file and acquiring new customers. In addition we continue to focus more resources on our Copy & Print Depot services offered through 10 regional print facilities located throughout the United States.

Third, our newly revamped website that [were updated in the second] and third quarters of 2009 have continued to receive overwhelmingly positive customer feedback. Improvements such as an enhanced keyword search and customer-friendly checkout are among a few of the benefits users have been pleased with. Substantial progress has also been made in the performance of these sites.

Fourth, we launched our ink and toner recycling promotion in October of 2009. This program will help reduce the number of ink cartridges going in to landfills and supports the availability of Office Depot brand remanufactured ink and toner products. Not only will this program help promote recycling but also allows our customers to go green and become more environmentally responsible.

In the fourth quarter 84% of total BSD sales were online, up from 82% for the same period a year ago, and our global company Internet sales for the past 12 months totaled $4.1 billion.

In summary, I feel good about the progress our associates have made in North American Business Solutions Division in a very challenging business environment where the top-line results continue to be soft driven by significant spending cuts across our broad customer base. We managed our business prudently throughout the year and focused our key initiatives that will provide growth as the economy slowly recovers.

Looking forward we expect our first-quarter 2010 sales to increase sequentially and year-over-year sales decline rate to improve versus previous quarters. In addition we expect our operating profit to increase sequentially as a result of the many initiatives we have undertaken.

In closing, I would like to mention that Dave Grove joined the Business Solutions Division as Senior Vice President, Contract Sales in December. Dave is a seasoned office products veteran with over 20 years of experience and had previous roles as the Senior Vice President of Sales Marketing and Merchandising North America and President North American Furniture for Corporate Express. We are very pleased to have Dave leading the contract sales team at Office Depot.

Charlie will now discuss the fourth-quarter results and full-year 2009 results as well as key initiatives for the international business. Charlie?

Thanks, Steve. The International Division reported fourth-quarter sales of $982 million, an increase of 2% in US dollars compared to the fourth quarter of 2008. We saw a sequential improvement each month in the fourth quarter. Local currency sales decreased 6% with most of the countries in which we operate reporting a year-over-year decline.

The global markets continue to face challenging business conditions even though some countries have reported that they are technically out of recession. Like North America, concerns regarding high unemployment levels, bank lending restrictions, and reduced spending continue to affect both business investment and office supply expenditures.

Looking at our two largest foreign markets, the rates of decline for both the UK and France have improved in local currency. And although market share data is not readily available, we believe we are gaining market share in the UK.

The overall number of customer transactions declined in the fourth quarter on the back of reduced employment levels and tight expense management by our customers. However, the rate of decline has improved steadily throughout the year to low single-digit levels in the fourth quarter. In a similar fashion our average order value has also steadily improved for this year. Later I will comment further on some of our initiatives in this area.

In the direct channel we have a number of programs in place that focus on building share of wallet among our higher valued customers as well as acquiring new customers. However, sales in this channel declined single digit in local currency because of continued softness in the sales of big ticket items such as furniture and technology. Customers continue limiting their purchases to those essential consumables as unemployment remains relatively high across the region.

Sales in our contract channel also declined but at a lower rate than the decline in our direct channel. The sales decline is mostly attributable to larger businesses reducing both their workforce and discretionary spend on office products due primarily to their core list.

Our retail sales were flat versus last year after adjusting for these foreclosures in Japan and we generated positive comp sales in most of our markets.

The International Division operating profit was $64 million for the fourth quarter of 2009, an increase of $54 million from the same period of last year. Our fourth-quarter performance was better than both the prior year and what we had projected in late October. As Steve mentioned at the onset of the call, we were very successful at increasing our gross margin in the fourth quarter through better management of product costs and improved product mix. Year over year adjusted gross margin was up by nearly 300 basis points.

The positive performance in the order was also driven by lower operating expenses, particularly in distribution and G&A, that more than offset the flow-through impact of lower sales levels in local currency. Additionally, changes in foreign currency exchange rates and an intangible asst write-off in the fourth quarter of 2008 contributed to the improvement in our operating profit (inaudible) by $5 million and $11 million, respectively.

Turning to our full-year 2009 performance, sales were $3.5 billion, down 16% versus 2008. Sales from local currency were down 9%. Full-year operating profit was $120 million, down $37 million from 2008. The main drivers are the decrease in operating profit (technical difficulty) include the unfavorable flow-through impact from lower sales and the negative impact from the stronger US dollar partially offset by reduced operating expenses.

Although business conditions continue to be challenging, we remain focused on improving our service model and the overall profitability of the international business. I will briefly update you on four of our key initiatives.

First, we continued to strengthen our contact strategy and value proposition to drive sales and increase margins in Europe. Key aspects of this strategy, which is focused on leveraging our multichannel operation as one customer-centric business, includes better customer segmentation, contract remediation, and private brand substitution. This approach allows us to better service our small- and medium-sized business customers.

Second, while we ended the year with record high customer service metrics, we are leveraging our continuous improvement processes to further strengthen our value proposition. The balanced scorecard that we implemented in the UK to turn around the performance of that business is being extended to the continent and to Asia.

We are also implementing a number of technologies such as our virtual cloud [soliphany] model which will increase the service levels in our call center operations while also increasing our local productivity. Even though the economic times are challenging and we continue to tightly manage capital, we are investing in the business to build a stronger, more customer-centric business on a global scale.

Third, we remain committed to expanding our geographic footprint. For example, we opened four retail stores in Colombia during the fourth quarter through our joint venture with Gigante. Colombia is an attractive market and allows us to service growing customer demand and interest in the Office Depot brand.

We also recently signed a partnership agreement with Office Shop in Argentina. This alliance allows Office Depot private-branded products to be available to Office Shop distribution within Argentina. Additionally, both companies will cooperate on a variety of marketing, merchandising, private brand, and product assortment initiatives in the future.

Fourth, we made significant progress towards improving our Asian business through a number of key initiatives. Our Korean business is profitable and we have built a strong foundation for future growth. Further more, we had positive sales growth across Asia in the fourth quarter as we adapted the business model to the local market. Also, with almost 40% of the world's population and much of the world's future growth currently residing in China and India these two countries will be an important part of our long-term global growth strategy.

Finally we executed a comprehensive revamp of our Japanese business which involved exiting retail, relocating our distribution center, and strengthening our management team. These actions allow us to focus on more profitable direct and contract channels in that country.

In summary, our strategic initiatives are progressing well and resulting in reduced costs and overall better performance. Our focus on improving customer service is paying off and leading to better retention and reactivation of customers.

Looking forward we believe the global economic environment will remain challenged for at least the first half of 2010. Our customers are still tightly managing their spending and unemployment rates remain high. As a result, we don't anticipate demand changing significantly in the short term.

However, due to progress made with our sales growth and cost reduction initiatives, we are optimistic about our first-quarter performance and expect our revenue decline to moderate compared to last quarter. Our first-quarter operating profit should improve compared to the first quarter of 2009 but it is unlikely that we will obtain the same operating margins experienced during the fourth quarter of 2009.

I will now turn it over to Mike who will review the Company's fourth-quarter and full-year financial results in more detail. Mike?

Thanks, Charlie. At the outset of the call this morning Steve summarized a number of the Company's accomplishments during 2009 and I would like to comment on a few of them as well.

In the fourth quarter of 2009 we substantially completed the companywide restructuring effort that began with the launch of the first phase in the third quarter of 2005 and continued with the launch of the second phase in the fourth quarter of 2008. Although we don't expect to recognize new charges in future periods, adjustments to previously accrued amounts will continue to impact our results in the future.

I know that the charges taken as part of the restructuring effort during the past five years have presented some challenges to those modeling Office Depot's financial results and we are pleased to get them behind us. However, it's important to note that since the Company was built on almost 30 acquisitions and mergers over the past 20 years that we are never truly integrated at the time of acquisition. It was necessary to take the right strategic steps for the company.

A sample of the restructuring actions and benefits include the closure of 35 North American and international distribution facilities, the closure of about 180 underperforming retail stores globally including the rationalization of our underperforming retail business in Japan, the centralization of back office functions and closure of 16 sales offices and call centers in Europe, and a reduction in global headcount to centralize activities and eliminate geographic redundancies. And, finally, achieving our targeted EBIT benefit of $130 million and cash savings of $85 million in 2009 from all of these activities.

Although we are pleased with the execution of our initiatives and restructuring efforts, we recognize that the Company's current operating expenses are still higher than they were six or seven years ago at similar sales. Three of the factors contributing to higher operating expenses today include higher property costs, overhead associated with the growth of our international business over the past seven years, and the changes in accounting for share-based compensation which were adopted in the third quarter of 2005.

To address the controllable factors we have launched a new effort to reduce costs in areas such as indirect spend and other non-customer-facing functional cost areas. This is part of an ongoing continuous process improvement initiative companywide. We will be implementing this initiative over the coming three years based on lean manufacturing techniques.

Although it's too soon to quantify the potential savings, we do see significant opportunities going forward and will provide updates on this continuous process improvement initiative in the future.

Moving to cash flow. We ended 2009 with free cash flow of $166 million and cash flow before financing of $331 million. Both cash flow metrics for the full year exceeded our earlier projections due to higher than anticipated earnings in the fourth quarter. I should note that our International business did a great job of driving free cash flow results in 2009.

Although it's challenging to have a great deal of long-term visibility at this point in time, we are projecting full-year 2010 free cash flow to be in the $70 million to $100 million range. Free cash flow forecasts are down versus prior year because 2009 included benefits that won't recur in 2010 such as a significant reduction in working capital and capital spending, tax refunds, and dividends from our Mexican joint venture.

Capital spending was $131 million for the full year 2009 in line with previous estimates and for 2010 we expect capital spending to be about $200 million in order to fund ongoing maintenance and other investments needed to drive our strategic plan. Although higher than 2009, 2010 capital spending will still be under our projected full-year depreciation and amortization of about $220 million.

Moving to the balance sheet. We ended the fourth quarter of 2009 with $660 million in cash, more than $500 million higher than the same period in 2008. The fourth-quarter cash position was slightly lower than the third quarter due primarily to seasonally higher inventory levels in advance of our back-to-school season.

Inventories totaled $1.3 billion globally, down 6% from the same period last year and in line with sales. This decrease was driven primarily by better inventory management. Inventories were up 6% on a sequential basis in the fourth quarter of 2009, again in anticipation of the seasonally stronger first quarter for back to business.

You may recall that our inventories dropped 9% sequentially in (technical difficulty) quarter of 2008, due primarily to lower sales as well as improved inventory management throughout the supply chain including the elimination of redundant SKUs, a reduction in safety stock, and alternate sourcing. Working capital totaled $178 million at the end of the fourth quarter of 2009, down $355 million from the same period one year ago due in large part to better management of receivables and inventory. We still have some room for working capital improvement in 2010 but it will be modest compared to the reduction in 2009.

During the fourth quarter we recorded dividends on our convertible preferred stock of approximately $15 million which were settled by increasing the liquidation preference. You may recall last quarter that I mentioned a provision in our asset-based loan facility that does not currently permit us to pay cash dividends. We are currently analyzing market conditions and may seek an amendment to our facility to potentially allow for preferred stock dividends to be paid in cash later this year.

On the third-quarter earnings call we projected a fourth-quarter GAAP tax rate of 10% to 15% or an adjusted effective tax rate of 30% based on our visibility to earnings at that time. The actual adjusted effective tax rate was 90% and it benefited fourth-quarter earnings by approximately $16 million or $0.05 per share.

The factors that drove this increase in the tax rate included better-than-expected fourth-quarter earnings, higher-than-expected earnings from our International Division, and a tax benefit from a fourth-quarter UK pension adjustment. That said, knowing what we know today we are projecting an effective tax rate for the Company of about 28% for the full year of 2010.

Looking at the first quarter of 2010 we expect EBIT to be about flat with the first quarter of 2009. Favorable performance in our International business is expected to be offset by increased depreciation and costs related to the implementation of our enterprise resource planning system and increased advertising expenditures in North America.

Additionally, winter weather has had an unusually high impact on store and distribution facility closures in the first quarter. On a sequential basis our first-quarter G&A expenses are forecasted to be about $20 million lower than the fourth quarter of 2009 due to certain expenses that will not recur, therefore earnings per share in the first quarter should be down versus one year ago but slightly positive.

And with that I will now turn the call back over to Steve to summarize. Steve?

Thanks, Mike. In summary, I am pleased with the execution across our enterprise in 2009. What we could control we controlled well and I am also encouraged by the progress that we have made on the strategic initiatives that will provide growth as the global economy recovers.

In Retail our sales comps improved each successive month in the fourth quarter and our tracking is better sequentially to date in the first quarter. In BSD we grew the size of our customer file in the fourth quarter and we have seen some large customers beginning to loosen their purchasing restrictions and buying products that are not restricted to their core lists.

In International we saw a sequential sales improvement each month in the fourth quarter and we are achieving better retention and reactivation of our customers. So we are seeing signs of economic stabilization, but we still remain cautious about the coming year.

Having said that, I am very pleased with our associates and their great execution and I am confident that our customers will buy more as they can afford to. We remain committed to leading the Company through these challenging times and we will do everything we can to provide innovative products, services, and solutions to our valued customers.

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

(Operator Instructions) Emily Shanks.

Barclays Capital. My question is just a couple of ones around the free cash flow. You had mentioned that the tax refund that occurred this past year won't occur again. What are you assuming for cash taxes in that free cash flow guidance?

You are talking about the 2010 guidance for free cash flow?

Yes, I was just curious if there, one, was any significant tax refund that was built into there? And then two, what the run rate cash tax expectation should be?

The cash flow number for 2010 without getting into every line is the one contribution we expect from working capital is we do expect a modest tax refund in 2010. Other items related to working capital, receivables, inventory, payables, we have done a very good job on that in 2009. I do not expect a huge contribution from that going forward.

There may be some, but most of the working capital benefit will be from a modest tax refund in 2010. So that combined with earnings and the difference between D&A and CapEx, you should be able to get to the $70 million to $100 million guidance that we talked about for the year.

Great, that is very helpful. Thank you. Then in terms of the balance sheet, your cash balance is pretty hefty right now. What are your plans around that and how do you think about free cash flow use?

We will continue to invest in parts of the business. We are investing -- if you look at the year-over-year increase in capital, we are investing back into the business in things like deferred maintenance. We are putting a point-of-sale system in our retail business. We are looking at some additional rationalization of supply chain in 2010 and we also have a number of initiatives that we are using to drive our strategic business plan to increase our exposure to small businesses. Some of it's around the web.

So we will continue to invest prudently given that this is still a recovery year and some of the things that we need to do in our business to drive a long-term. So a lot of the increase from the capital number in 2009 to 2010 is driven by some maintenance items, POS, we have some supply-chain items, and then other strategic items that we are using to drive some of the sales initiatives we want to see in 2010 in each one of our business units.

Okay. So can we interpret that that the existing cash balance you, absent investment in the businesses, it sounds like you are going to run that type of cash balance going forward?

Yes, given the free cash flow guidance that we just gave and the fact that we have that amount of cash -- and keep in mind our asset-based facility as we look forward. If and when sales start to grow that facility will flex up in terms of availability. I would think that you would expect to see those cash balances consistent going forward given everything we know today.

Okay, great. And my very last question is you had mentioned the POS system. When are you rolling that out and how are you going about that? Should we see that affect all stores by year-end or what type of timeframe is that?

Emily, it's in the early stages of roll out now. It will be complete late second quarter, early third quarter. And that will be across the chain.

Okay, great. Thanks. Good luck, guys.

Kate McShane.

Kate McShane, Citi Investment Research. Good morning. Can you give us a little bit more detail on the M2S format? Besides square footage how are these stores different than your main stores in terms of product categories and mix?

Kate, it's Chuck. The mix is similar; certain businesses have been scaled down, specifically in furniture. The look and the feel of the store has a number of improvements. There are better sightlines because we reduced the height of the fixtures. We have created an expanded service area at the front of the store which really supports all the new effort that we have put in there.

The signage in the store reflects a cleaner look and it's more customer friendly. In fact, much of what we have put into the M2S we are in the process of rolling out into other stores as well. So it builds on the M2, it's just a smaller footprint with some enhancements in it.

Kate, I think you have been in the M2. I suspect if you went in to an M2S you probably wouldn't know that you were in a smaller store because of how we have designed it. And the customers don't know that. But what it does allow is to have a breakeven level that is much lower sales -- that has a much lower sales level than the old prototypes.

Okay. How long have you been testing it and how long do you expect the test to continue? And will this result in more store closures of your bigger stores?

We have been testing it for a number of months. We have about a dozen of them up and running around the country. When you say closing of bigger stores, we don't envision any large tranche of store closings.

We continue to try to reduce the average size of our stores. Today we are better than 24,000 square feet on average so we are trying to do this prudently. We would like to reduce that average size store, but some of it will be done through relocation. Some of it may be done through remodels but not through large-scale store closures.

So the M2S, Chuck, would be used for new store openings as well as potentially when we remodel (technical difficulty) we could cut it down in size and sublet some pieces, things like that, right?

Right.

Okay, that is great. Thanks so much.

Brad Thomas.

Brad Thomas with KeyBanc. Good morning. Just one last follow-up on the M2; Steve, you mentioned additional store opportunities. How long would you need to test it before you got a sense for perhaps additional expansion opportunities? At what point maybe would you reconsider opening up some more stores?

Brad, this is Chuck. We have about 20 stores that we are committed to for 2010. I think to Mike's earlier point from a retail standpoint I am encouraged by the trends that we are seeing, but it's still a recovery year. So I think that we need a little more time under our belt before we start looking at a much more aggressive store opening path.

But I think we are going to continue to read this test and use this model for remodels over the course of the year. When we are comfortable with it and when it's time to start expanding it gives us the opportunity to go into smaller niche markets with lower breakeven points. Right, Chuck?

Yes.

Thanks. Then regarding BSD, I was hoping you could talk a little bit more about contract acquisitions and losses. I know Steve referenced the strong success rate regarding public contracts. Could you talk a little bit about what you are seeing on the private side?

Sure, Chris. This is Steve. What we are seeing across the board as we talked about -- we talk about our SMB sector. We continue to grow our file and that is a combination of the strong work of our contract organization as well as our feet on the street and TAM organizations.

From a global account standpoint, when we look at fourth quarter versus third quarter we retained more customers on an average versus prior quarter and we continue to see our ability to grow share in that large customer segment on a year-over-year basis. The public sector continues to be challenging for us, particularly in California, where obviously state government businesses continue to have significant budget pressures.

But, Brad, I think there is some view out there or some question about whether we are gaining market share or losing market share. And I think -- there is no real good data source for this, but our view is that we are gaining share in the contract business. We also think we gained some share in the retail business in the past quarter.

Of course, in certain categories we gained more share and less [booked but] actually we are pleased with our competitive position.

Steve, just to follow up on that, on the retail front which categories do you think you are doing better in and which categories do you think you are losing share in?

Well, I think we saw sequential improvement across all of our businesses so it's tough to drill down at the detail. But I think that we have made good progress on all of our major businesses in supplies, in technology, as well as in furniture.

Okay, great. Thanks so much.

Chris Horvers.

Chris Horvers, JPMorgan. Thanks, good morning. Thinking about just a couple guidance clarification questions and then maybe some more strategic. 28% tax rate; so you are basically implying positive taxable income in 2010?

Yes, that is what that would imply.

Okay, just sometimes things need to be called out. Then as I think about this $70 million to $100 million of free cash flow, modest benefit on the tax rate, a net positive about -- what is that -- $20 million of net D&A. So are you backing that out, you are basically saying that net income is about $40 million to $60 million. Is that ballpark correct?

I won't comment on the net income number but unlike last year where we had a lot of working capital reductions and a lot of liquidity initiatives this year is going to be much more about net income. The D&A pickup is about $20 million, the net D&A pickup with CapEx. The balance of the guidance we are giving us between net income and working capital. And I am not going to call those numbers out because then we walk right into earnings guidance.

But we do have a tax refund that is coming in this year that is -- it's modest and the balance is net income and I will just leave it at that.

Okay, that is fair enough. Okay. In modeling the preferred dividend is the $15 million a quarter fair to think about in 2010?

Yes, the $15 million a quarter is fair. We did allude to the fact that we are in the market looking at an amendment to the ABL; we are pursuing that. There is no promises there but we did talk about the fact that this could lead to a cash dividend later in the year which obviously will change, at least the income.

The number on the face of the income statement will go from approximately $15 million to $9 million if that were to happen.

Okay. And then just curious on the BSD division, you mentioned the color saying that a bit of the off-contract buying behavior started to improve. Can you talk about how that was relative to your expectations coming in to January? Is it something that you think can gain traction here as the year progresses?

And then also, if you could maybe give us the gross margin drag for the on-contract versus off-contract behavior in 2010?

First of all -- Chris, this is Steve. For the off-contract purchase trend that we saw relative to expectations we really are in unchartered waters. When you look at the headwind that we faced from the economy and from a customer side, obviously what we are trying to do is provide the best service we can to our customers and then obviously they will purchase what they can and when they can purchase it.

And so when we look at moving away from what is called paper, ink, and toner to more broad, general supply purchasing, technology, and more perishable -- or excuse me, more items that are less off of their core list we are obviously encouraged by what we are seeing from a trend standpoint. But relative to projections, it's very difficult to project how our customers are going to purchase those products going forward.

Relative to gross margin I really can't comment on that. I don't have a specific answer to your question relative to the drag. I think you have talked about relative to our overall gross margins at this point.

Okay, thank you very much.

Joe Feldman.

Sure, it's Telsey Advisory Group. Congratulations on the results from today.

Wanted to get a deeper dive into just what you are thinking about from a macro perspective. I guess in particular on the business side are you seeing trends that give you some more confidence that small businesses are either starting to form or starting to spend again or hire? Just what you are looking at as you kind of read the tea leaves for this year.

We are not economists, but just from trying to interpret our business we are seeing a little firmness in the larger sized businesses and I think that goes to some of the pickups we have seen in the large contract business. In the fourth quarter we did have the holidays. We are not a big holiday business, as you know, but we did see some of the consumers come in, particularly around the holidays and spend a little bit. So that was good to see consumers back in the store.

We have been waiting for small business. If you recall Florida went off first a couple of years ago, followed quickly by California and those have been our two primary areas of concern. What we are seeing is some firmness in Florida relative to what we have seen in the past, but we continue to be concerned about California, particularly in the public sector of California because of their revenue situation. The state budget situation is still pretty serious out there and the business environment is tough.

So we are seeing different trends geographically. The Midwest and the Northeast, as Chuck mentioned, have been strong. But obviously in the Northeast we don't have that much business relative to Florida and California. So I think we are still waiting and hoping that the small businesses recover and I think California is the big question mark for us.

Got it. Then on the international side it seems like you certainly benefited a bit from the currency. Just I guess again what are your thoughts there about FX going forward? It seems like the operations of the business are improving but still not quite where you would want it to be?

In terms of the FX it was a benefit to us, about $5 million in the fourth quarter. When we got in to the first couple months of this year the currency was strong. But the whole issue around some of the southern European countries and their debt levels have cast a cloud of uncertainty over the past couple of weeks so we have seen that fall back a bit.

So that is about as much as we know. In terms of the economic situation, this is very, very similar to the US where businesses are affirming a bit but the unemployment levels still remain very, very high.

Got it. Are you guys also seeing that lag? It seems like -- obviously we read the same stuff I guess, but it seems like there is a lag over in Europe in terms of relative to us in terms of where they are recovery-wise. I assume you are seeing the same in business trends?

Well, to me it's actually very, very similar. Some of the countries have reported technically being out of a recession -- the French, the Germans, etc. But again, the real secret for us internationally is the same as it is in North America, it's the creation of jobs. And so as long as the unemployment remains high it's an issue for us.

Charlie, I think having said that your group has really done a remarkable job, particularly as an example the UK. Where the economy has been tough but our business has been good as we have executed well and put together some new customer programs. We believe we are gaining market share their in the tough environment, right?

That is right. Yes, that is correct. What is really happening is we have put in place processes and tools that are helping us execute better than we have ever executed in those markets. A couple of years ago the UK business fell off quite considerably and it's now back on track to margin levels that we were enjoying two or three years ago.

And that is a result, not of the economy improving, but our execution improving.

Got it. That is great. Thanks, guys, and good luck with the quarter.

Sir, I am showing no further questions.

Okay. Well, that brings us to the top of the hour anyway.

That concludes our conference call this morning. Please note that we will be updating our supplemental investor presentation in the Investor Relations section of our website. We will also be filing our proxy after close of business today, if you have any questions related to those issues.

Thanks very much for participating on today's call.

That does conclude today's conference. You may disconnect your lines at this time.