ODP Corp (ODP) 2010 Q1 法說會逐字稿

Good morning, and welcome to the first-quarter 2010 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 make a few comments and then summarize our first-quarter 2010 results. Steve?

Good morning, and thank you for joining us for Office Depot's first-quarter 2010 earnings conference call and webcast. With me today are Mike Newman, Chief Financial Officer; Steve Schmidt, President of North American Business Solutions; Charlie Brown, President of International; and Kevin Peters, President of North American Retail.

I am very pleased to have Kevin assume this new leadership role at Office Depot. Not only is he very qualified, having run supply chain, merchandising and store operations at his previous company, he is also very experienced at Office Depot, having been here for about three years. Kevin has worked side-by-side with Chuck Rubin and Steve Schmidt as a member of our executive committee, and he has been my direct report. He has been involved in most of the Company's major decisions and has spent considerable time in our retail stores, working closely with our executive vice presidents of merchandising and store operations. So I'm sure Kevin won't miss a beat in his new role, and Kevin, welcome to the organization.

It goes without saying that we regret losing Chuck. Chuck made significant contributions to the retail organization and has been instrumental in building a strong team and driving the strategic vision for that business. We thank him for his hard work and dedication and certainly wish him well in his new role at Alta.

Before I cover our first-quarter 2010 results, I'll provide an overview of the economic and business environment in the US and globally from our perspective. Although fourth-quarter GDP data showed improvement and we assume the first quarter will be positive as well, the business environment remains challenging in the US, especially for our small-business customers. Most notably, unemployment in the US is still hovering around 10%, with mixed job creation data and cash-strapped small businesses continuing to tightly manage their discretionary spending, with limited access to capital.

The other issue facing US businesses is the projected costs related to various reform legislation that has been passed and is still pending.

Our small-business customers are uncertain of the future cost of adding employees and are hesitant to do so. We especially see softness continuing in California, with some improvement in Florida.

Internationally, things are improving, but weaker pockets remain in key markets like the UK. Unemployment levels are high across Europe and small-business owners are facing liquidity challenges similar to their US counterparts. The US dollar has weakened against the pound sterling and euro compared to 2009, but recent trends in the currency market show that that trend is reversing.

This economic environment continued to challenge our customers in the first quarter of 2010. Total Company sales were $3.1 billion, a decrease of 5% compared to our first-quarter results last year. This is the best sales trend we've had in seven quarters.

First-quarter earnings were $20 million, or $0.07 a share, versus a loss of $55 million, or $0.20 per share, in the same period last year. I should note that the first-quarter 2009 results include charges related to our restructuring activities, which negatively impacted earnings per share by $0.30.

Total operating expenses in the first quarter of 2010 decreased by 12% or $112 million from the first quarter of last year. This decrease primarily reflects charges related to restructurings taken in the first quarter of 2009 and lower distribution costs in the first quarter of 2010. You may recall that we reduced operating expenses by over $190 million in the first quarter of 2009 versus the prior year, and we've reduced operating expenses by about $600 million in the past year.

EBIT was $62 million in the first quarter of 2010, which is a 9% improvement over the EBIT adjusted for charges reported in the same period last year.

So we are pleased that our total Company profit margin has increased by 120 basis points in the first quarter versus last year. This is the third consecutive quarter of year-over-year gross profit margin improvement, and our international business again did a great job increasing their margins.

I will now ask Kevin to talk about the North American Retail's first-quarter performance. Kevin?

Thanks, Steve, and good morning. Let me start by saying that it is a pleasure to be leading the North American Retail business, and I look forward to building on the strong platform Chuck and his team have created.

In the North American Retail division, sales for the first quarter were $1.3 billion, down 6% from the first quarter of 2009, mostly due to having fewer stores open in the quarter versus the same period last year. You may recall that we closed 120 stores during 2009 as part of our restructuring.

Same-store sales in the 1133 stores in the US and Canada that have been open for more than one year decreased 1% versus the first quarter of 2009, a 300 basis point sequential improvement from the fourth quarter of 2009.

Looking at the two-year sales comp trend, we experienced a 500 basis point improvement sequentially. We were pleased that store sales trends actually improved each month within the first quarter, with about minus 5% in January, flat in February and positive 1% in March. Since then, April to date comps are down 2%.

The number of customer transaction counts were down in the low single digits in the first quarter compared to the same period last year, with the rate of decline improving sequentially over previous quarters. Our average order value turned positive for the first time in nine quarters, although we still believe that consumers and small-business customers are holding back spending on office supplies.

We continued to see strengthening across our three major product categories of supplies, technology and furniture, with the largest comparable sales improvement occurring in furniture, which turned positive for the first time in 13 quarters. This improvement was due to changes in the seating and ready-to-assemble furniture assortments and comping on a lower sales base.

Technology products, such as notebooks, software and office machines, achieved positive comp store sales, as well as Tech Depot Services, which continued to perform well. Storage items and breakroom products are among other supplies that did well through increased awareness.

The moderate comp sales decline in the first quarter was due to mixed results across the US. Our best-performing sales markets were again the Midwest and Northeast, which comped positively, with Florida and the Southeast region achieving flat comp store sales this quarter. California continued to experience economic challenges and weak sales trends, and the Gulf Coast region also produced weak sales, mostly due to hurricane recovery sales extending into the first quarter from last year.

We continued to increase our Worklife Rewards loyalty members in the first quarter and have seen some increases in member purchases versus the prior year. Customers appreciate the valuable benefits received from being a Worklife Rewards member, such as receiving 10% back on ink, toner, paper and copy and print purchases and 1% back on almost everything else. We also offer customers $3.00 back in rewards for recycling old ink and toner cartridges, and have also launched our new trade-in, trade-up event promotion that gives customers extra savings when trading in shredders, cameras, notebooks and printers.

We remain committed to helping customers and our small-business customers get back on track, and believe loyalty program rewards like these are important to get there.

In the first quarter of 2010, we closed seven stores and opened four, bringing our total North American store count to 1149 at quarter-end.

Operating profit in the first quarter of 2010 for the North American Retail division was $73 million versus $81 million a year earlier. These results are in line with the outlook we provided in February on the fourth-quarter earnings call.

Our operating profit margin was 5.4%, down slightly from the first quarter of 2009. The decline in operating profit was driven by the negative impact of lower sales and increased advertising expenses to drive brand awareness, somewhat offset by expense reduction. Similar to 2009, we experienced positive impacts to inventory shrinkage in the first quarter of 2010. We believe that our control initiatives in this area have led to achieving a lower sustainable rate for shrink expense.

We had a good response to some of our recent promotions and will continue focusing on our strategic initiatives. Just to give you an update on one of these, we continue to be very encouraged with the ongoing test of our M2S store format. We believe the new format offers us a lower sales threshold required for profitability for potential new stores, along with potential downsized models. We will keep you updated on this initiative as we move forward.

In summary, we are very pleased with how the North American Retail division performed in the first quarter. Our back-to-business season historically has been our strongest sales period, and I feel we executed well this quarter, as we achieved similar margin performance compared to the first quarter of last year, but with a lower sales level. Our retail associates have diligently focused on improving our product assortment, reducing operating expenses and executing on our key strategic initiatives. We want to thank all of them for their hard work, especially as we achieved higher customer service scores compared to last year while balancing our labor needs.

As we look forward, we will continue to be aggressive in seeking incremental profitable sales opportunities through our products, services and new marketing tests. The second quarter has traditionally been our weakest sales period, and our comps may be flat to down slightly. However, we are optimistic that our sales comps will continue to improve in the second half. Due to the second quarter's seasonally low sales, we will likely have an operating loss.

Steve Schmidt will now review the first-quarter results for the North American Business Solutions Division. Steve.

Thanks, Kevin. In the North American Business Solutions Division, sales for the first quarter were $831 million, down 9% versus the first quarter of last year, though slightly higher than the fourth quarter. Excluding the impact from restructuring certain non-core businesses and adverse winter weather conditions in the quarter, sales were down 7%.

We continue to see our rate of sales decline improving, though slowly, with customers keeping a watchful eye on their spending, as unemployment remains at high levels and economic uncertainty remains. April to date, our sales are down 5% versus the prior-year period.

Our average order value and number of customer transaction counts for the first quarter continued to be down versus the same period last year. While transactions were the main driver of our sales decline, the rate of decline has actually improved sequentially over the last four quarters to single digits. Nevertheless, customers continue to keep a tight rein on discretionary spending for office supplies.

If we look at our business geographically in the first quarter, California remains a major concern, with the double-digit sales decline exceeding the average rate of decline for the entire BSD business. With the budget deficit and government-mandated three day per month furloughs for state employees in place, it looks like our business in California could be affected for an extended period. The furloughing not only impacts our public-sector business, it also has a negative trickle-down effect on small-business customers as well.

Inversely, business in Florida continues to recover, with single-digit sales declines that were better than the average for the division. Our Florida business has also had their rate of sales decline sequentially improve over the last four quarters.

Our strongest product category in the first quarter versus the same period last year was technology, as our customers continue purchasing notebooks, electronic perishables and services. Copy & Print Depot and cleaning and breakroom supplies performed well, both of which are areas of focus for our business. Furniture sales remained somewhat depressed as customers delayed their purchases of some durables in favor of consumables.

Sales in our contract channel continued to decline in the first quarter versus last year, but we did see the decline improve from prior quarters and sequentially each month within the first quarter. Winning with our small- to medium-sized customers remains a top priority for BSD, and that customer group experienced improvement in the sales decline within the first quarter.

The competitive landscape continues to evolve and we understand that some of our competitors are going after large accounts with selective aggressive low- to no-margin bidding. We remain committed to winning new customers and being smart about what business that we go after. As such, we have not deviated from our account strategy to go after profitable business and walk away from business that does not meet our standards.

In regard to our public sector, our win and renewal success rate remains very high, as discussed on last quarter's earnings call, and we recently renewed the State of Washington account. Accordingly, we continue to win or renew large corporate business as well, with a focus on improving the quality of our customer portfolio.

I assume that many of you are aware of the press release issued by U.S. Communities on April 1 announcing that Los Angeles County will resolicit their office supply contract and award a new contract later this year for five years, beginning in 2011. Our current contract with U.S. Communities has been in place for five years and extends through the end of 2010. This was expected, and we plan to vigorously pursue the contract for renewal.

I would like to note that Office Depot was recently awarded a national contract for school supplies from Fairfax County Public Schools. The contract will be part of the U.S. Communities program and available to public agencies across the United States for school supplies. The contract, which contains a five-year term, took effect on April 13, 2010 and allows Office Depot to deliver school, classroom and educational supplies at significant discounts to thousands of eligible public agency customers.

In the Direct business, our first-quarter sales declined less than our contract business and at the lowest rate since the third quarter of 2008. This is a result of our very disciplined approach to our Direct business and the success we have had with our updated website. This business, however, is hypercompetitive. The companies bidding for key search words on the web has increased about 50% over the past year, driving our cost up significantly.

In the first quarter, 89% 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 $4.2 billion.

First-quarter 2010 operating profit for the North American Business Solutions Division was $20 million, relatively flat with the fourth quarter and down from $33 million reported in the first quarter last year. Operating profit margin was 2.4%, which is on par with the average margin over the previous three quarters. The operating profit decline from the first quarter of 2009 reflects the flow-through impact of lower sales and the adverse impact of the extreme winter weather that occurred in the northeast and southeast in the first quarter, as heavy snow forced us to close some distribution facilities and miss deliveries during the quarter.

These factors were offset partially by both price increases that were passed on to customers and a positive impact in shrink from added control procedures established in recent quarters.

Even though business conditions remain challenging, the North American Business Solutions Division continued to focus on executing on our key initiatives. These initiatives include our customer profitability optimization efforts, small- to medium-sized business customer acquisition and retention, penetrating new business verticals and growing our Copy & Print Depot business.

In summary, although not pleased with our results, I feel good about how the North American Business Solutions Division has performed and how our many associates are focused on driving us through this difficult time. Even though sales continue to be soft, we have reduced spending and have managed our business to position us for growth as the economy slowly recovers.

Looking forward, we expect our second-quarter 2010 sales decline rate to improve somewhat compared to the first quarter and operating profit to increase, both sequentially and versus the same period last year.

Charlie will now discuss the first-quarter 2010 results for the International business. Charlie?

Thanks, Steve. The International division reported first-quarter 2010 sales of $894 million, up 2% in US dollars for the same period in 2009. Local currency sales decreased 5%. The decline was 3.5% after excluding the Japanese retail business we exited from last year's revenues. All regions showed improvement compared to last quarter in the same period last year.

The sales decline rate in the first quarter improved for many of the countries in which we operate, especially in France, where revenues were flat to last year in local currency. The sales decline in the UK has stabilized, and we believe we are gaining market share in the UK, France and other countries as well.

Our Asian region performed very well compared to last year, with all countries reporting positive sales growth, excluding the retail closures in Japan.

The number of customer transaction counts declined in the mid-single digits in the first quarter and was the main driver of our sales decline in local currency.

Our average order value has sequentially improved and was up this quarter because of improved pricing and product mix.

In the Direct channel, sales declined at a mid-single-digit rate in local currency. The sales decline resulted from a lower-than-expected level of account activity and reduced catalog circulation. Our customers are purchasing consumable items at a much higher rate than discretionary items, although we have noticed some sales increased activity in technology.

Sales in our contract channel also are stabilizing. The sales rate decline has steadily improved over the last three quarters, with our largest contract region achieving flat sales versus the same period last year.

The decline in sales occurred within all our major product categories, primarily as a result of large existing customers limiting their purchases to core lists and new customer accounts not yet being fully implemented.

Workforce reductions at several large companies and reduced government expenditures have had the largest impact on this channel's performance.

Our retail sales were flat versus last year, after adjusting for the store closures in Japan, and we continued comping positively in most of our markets.

The International division's operating profit was $42 million for the first quarter of 2010, up significantly from the $19 million reported in the same period of last year. Operating profit margin was 4.7%, or 260 basis points better than prior-year and consistent with the outlook we provided in February. The operating profit increase this quarter was driven by a number of factors, including better pricing management, which improved our gross profit percentage versus last year by over 150 basis points, and offset the negative flow-through impact from lower revenue.

Reduced distribution costs, mainly from further rationalizing our supply chain, reduced advertising expenses, and exiting the retail business in Japan last year also drove the operating profit increase.

Lastly, the change in exchange rates, driven by a weaker US dollar, also favorably impacted operating profit in the quarter.

We remain focused on improving our service model and the overall profitability of the International business. I would like to update you on three of our main initiatives. First, for the last few quarters, we have talked about our key initiative to strengthen our contract strategy and value proposition. We continue to make great progress in modifying our multichannel approach in Europe to better focus on small- and medium-sized business customers. This has been demonstrated over the last several quarters through our improved performance and margins.

We continue to focus on deploying the right tools and training to better service our customers and move closer to a customer-centric business.

The second initiative relates to driving improved operating performance in our Asian business. We have strengthened our Japanese business by restructuring our operations, reducing expenses and adapting our business model to the local market. The remaining markets are growing at high single to low double-digit rates. This had led to steadily improving operating results over the last several quarters. We have made significant progress in building a strong foundation for future growth and substantially reducing our operating losses in this emerging region.

Finally, I am particularly pleased with our efforts to reduce our operating costs while at the same time investing in our selling resources. We are adding sales reps in all regions, launching new websites, upgrading existing websites and further expanding our geographic footprint.

In the first quarter, our Middle Eastern franchisee opened its first store in Dubai.

So in summary, the International division performed well thanks to the hard work and focus of our associates. Our strategic initiatives are progressing and we are leveraging our best practices to other regions. We've also been very successful in reducing and managing our costs, while at the same time keeping our service scores at historically high levels.

Looking forward, we believe that the global economic environment will remain challenged. With high unemployment levels and strained budgets in both the private and public sectors, we believe customers will continue controlling their expenses very tightly. Therefore, we don't anticipate demand changing significantly in the short-term.

Thus far in the quarter, local currency sales are trending at about the same level as quarter one. For the second quarter, we expect our revenue decline compared to last year to moderate, although the absolute level of sales will decline as we enter our seasonally slowest quarter of the year. We expect our operating profit to improve over last year, but to be sequentially lower based on the reduced sales volume.

I will now turn the call over to Mike, who will review the Company's first-quarter financial results in more detail. Mike?

Thanks, Charlie. To echo Steve's earlier comments, I, too, am pleased with the progress our business has made in the first quarter. Despite softer sales, we grew both EBIT and gross profit margins versus the first quarter last year. We also maintained our strong cash and total liquidity positions and sustained the significant improvements we achieved in 2009 in accounts receivable, days of sales and inventory turns.

We ended the first quarter of 2010 with free cash flow of $11 million. First-quarter 2009 free cash flow of $67 million was considerably higher compared with 2010, mostly driven by significant reductions in inventory receivables in 2009, as we were at that time responding aggressively to rapidly declining demand for our products. We continue to expect full-year 2010 free cash flow to be in the $70 million to $100 million range, with depreciation and amortization of approximately $220 million and capital spending of around $200 million. Capital spending was $41 million in the first quarter.

During the first quarter, we recorded dividends on our convertible preferred stock of approximately $9 million, which were paid in cash in April. We obtained an amendment to our credit facility in late March that allows for preferred stock dividends to be paid in cash in 2010 and beyond. While it is not our desire to flip back and forth between payment in kind and cash dividends each quarter, it remains a quarterly decision that we will review with our Board and will be based on the competing needs for cash by our business.

Moving to slide 14, on the balance sheet, we ended the first quarter with $663 million in cash, almost $500 million higher than the same period in 2009 and up slightly from year-end 2009. Inventories totaled $1.1 billion globally, up slightly from a very lean first-quarter 2009 number, and total Company inventory turns of 6.4 were almost flat versus fourth-quarter 2009. We continued to hold inventory turns at these levels despite seeing North American direct import as a percent of sales increase to almost 8% versus 6% one year ago.

Receivables of $1 billion in the first quarter were down $112 million versus prior year-end 2009.

On the fourth-quarter earnings call in February, we projected an effective tax rate for the Company of about 28% for the full year 2010. The first-quarter actual rate was 34%, and our expected effective tax rate for 2010 has increased to about 36%, primarily due to certain book-to-tax timing differences, primarily related to fixed assets. Typically, temporary timing differences would not impact the annual effective tax rate calculation. However, as we have previously reported, we recorded a full valuation allowance against all of our US deferred tax assets during the third quarter of 2009. Therefore, for the foreseeable future, book-to-tax temporary differences will create volatility in our annual effective tax rate.

I also mentioned in February that we launched the 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, Companywide, continuous process improvement initiative. We have received numerous questions on this effort, including the projected savings and timing. It is still too soon to quantify the potential savings, but we do see significant opportunities going forward and will provide updates on the initiative as soon as we are able.

Looking at the second quarter of 2010, I would remind you that it is our weakest sales quarter of the year, and that our second quarter 2009 EBIT loss, adjusted for charges, was $62 million. We expect to improve upon our EBIT loss last year by $10 million to $20 million.

With that, I will now turn the call back over to Steve.

Thanks, Mike. I would like to mention that since 2006, Office Depot has had an industry-leading environmental strategy with continuous improvement goal. Today, we are proud to cement our leadership by announcing three new quantitative goals in each area of this strategy.

Over the next three years, we plan to increasingly buy green, be green and sell green, the summary of our strategy. First, buy green. We'll buy green by sourcing third-party-certified green products in each major category we sell, where there is a credible eco-label, and ensuring that 40% of our marketing papers come from FSC-certified forests.

We intend to be green by recycling over 80% of end-of-life materials that we manage and earning more from recycling that we spend on waste, and by reducing our carbon footprint from facilities by 25%.

Finally, sell green by exceeding $600 million in contract sales of items with green attributes, enabling key word searches for green attributes on our website and launching new product takeback solutions every year for the next three years.

Again, we are very proud of our efforts to be leaders in this extremely important area and believe that it is the right thing to do for the environment and for our shareholders.

To sum up, I am pleased with the continued execution across our enterprise early in 2010. I remain encouraged by the progress we've made on the strategic initiatives that will provide growth as the global economy slowly recovers. We are positioned to benefit from white-collar employment growth recovery and better economic conditions in key markets like California. So we are seeing signs of economic stabilization, but we remain cautious about the year. I am very pleased with our associates, their great execution and we are confident that our customers will buy more office supplies and services as they can afford it.

Operator, we are now ready to take questions.

(Operator Instructions) Chris Horvers.

Chris Horvers, JPMorgan. I wanted to -- a few questions. First on the North American Retail, you said April comps were down 2 and you are guiding flat to down 2. Is that a comparison issue for the second quarter, or something that is going on in the business that you are seeing?

I think it is, Chris, mostly timing around the Easter shift and so forth. I don't think that it is anything material. But we are cautious around the second quarter in total. This is our weakest quarter of the year.

We did have a good back-to-business season in the first quarter. You never know how that's going to carry over into the second quarter. Remember, we have to have people at work and kids in school in order for our business to do well, and in the second quarter that all drops off. So we are just looking at the second quarter cautiously.

So then for NAR, is it -- are you basically saying maybe the Easter timing shift was -- what -- 300 basis points from March to April?

No -- well, I'm not saying that. It was the same -- it was in April last year as well. What I'm saying is that March finished strong. We've had some shifting within April and weather and those kinds of things. I just don't know if the minus 2 is going to hold or -- but we just wanted to update you on what has happened so far.

Okay, fair enough. And could you -- on the U.S. Communities contract, could you maybe explain how that works? It's a little confusing, with the Fairfax announcement versus the Los Angeles announcement. How exactly does the process work, and what does Fairfax really say about the outlook for that contract?

Yes, Chris, Steve Schmidt. We've had the U.S. Communities contract for five years, just like all of our contracts, three- to five-year contracts with our large customers. They come due and they have to be rebid out, and that is the process we are doing with LA County as part of the U.S. Communities agreement.

What we did recently was the school supplies piece was part of the U.S. Communities contract. They had asked us to take that out of the contract because it wasn't something that they specifically wanted to focus on. And so we moved that business to Fairfax County. Fairfax County went through a complete competitive bid process with ourselves and our competitors, and we won that bid, which we thought we would. So we continue to have a very strong relationship with U.S. Communities and with all the different agencies that we provide as part of that contract.

So, Steve, you know, U.S. Communities is a buying group, but they have to have a lead public agency, and LA County has been the lead on all of the business. Now Fairfax County Public Schools will be the lead on part of that business, which is the school supply business. So that's good because it is sort of breaks up some of the risk and splits it into two pieces.

So then you mention in the Q that U.S. Communities in total was about 5%, I think, of BSD. How much does the -- is that inclusive of the school supply business or exclusive?

That was inclusive, so that number declines as a result of the school supply business going out. And then the other point I would make is we did mention it was 5% of revenue. It is now less than that. But it is also significantly less related to our overall profitability as a percent of our total profits.

Okay. And then finally, could you perhaps quantify exactly what the snowstorms was? Was that 100 basis points in the first quarter? And would you also quantify how much the California business is dragging down BSD overall? Thank you.

Sure. On the BSD business, we estimated that we lost somewhere around $5 million to $6 million of revenue as a result of the snowstorms that occurred in the Northeast and across the southern part of the US.

The state of California, as we've stated before, Florida and California are our two single largest businesses -- or states in which we do business. And we've talked before that those represent about a third of our total business. And California is declining at probably double-digit what our other states are declining right now. And we just don't see much optimism for the future at this point, given the furloughs that I talked about and the continued economic issues that the State of California has before them.

Mike Baker.

From Deutsche Bank. Can you talk about within the delivery business what you are seeing in terms of new customers versus old customers, and what you are seeing in the different segments, like small, mid versus large customers? And then I guess related to that, in the past you've talked about customers buying more on-contract type of product. Has that trend changed at all? Thanks.

First of all, regarding our large customers, during the first quarter of 2010, we saw very positive results relative to both retention of customers, that went up sequentially by a month, in addition to winning new business during the first quarter with our large customers. And so we made good progress during the first quarter relative to gaining share in that segment, in addition to increased retention levels.

On the small- to medium-sized business segment, this is the most competitive segment by far, and we have a great deal of customers, both within Office Depot and all of our competitors, who are aggressively price-shopping, and so we continue to see switching going on in the small- to medium-size business sector.

We are working very hard on a number of loyalty programs to create continuity with our customer base, but we have seen significant movement in and out. We did a great job acquiring a large number of new customers during the first quarter, but at the same time, a number of customers left -- partly what we talk about the leaky bucket going out the bottom end. And so it remains a real challenge in that area.

Your third question relative to core and non-core purchasing, we had seen some optimism in the fourth quarter, where we were seeing purchasing off of core. I would say in Q1 we saw somewhat of a reversal, meaning, again, more purchasing coming off of the core business. And right now, we just don't know how to call the remaining part of the year. So the trend has continued and we really are not seeing at this point any reason for optimism relative to off-core purchasing.

The good news is we are winning a high percentage of our bids, which is terrific. So even though our existing customers cannot afford to buy as much, particularly in the SMB space, I think we are well-positioned from a customer file perspective, Steve. Don't you agree?

Yes, the customer file, particularly on the large-, medium-sized customer base, we feel good about. Again, we've got millions of small- to medium-sized customers and we have significant movement in and out in that space.

Okay, thanks. If I could ask one more, just on the SG&A, it seems like the -- I guess when you adjust for the charges last year, your total expenses including corporate G&A were about flat, I think, if I got my charges right. So should we expect to see -- until you sort of make some inroads in this indirect SG&A initiative that Mike Newman talked about, should we expect the expenses to be sort of flat year-over-year until you make progress in those initiatives?

Yes, I think adjusted year-over-year, we are seeing a little bit of an increase to last year, mostly as a result of depreciation on our global ERP system. I would expect to see that continue going forward, in the absence of any traction that we get on the indirect spend or on the benchmarking of the non-customer facing entities -- or (multiple speakers) I should say.

Yes. Thanks very much for the color.

Matt Fassler.

Goldman Sachs. Two questions. First of all, you talked about some interesting contrasting trends in furniture, where in Retail, furniture seems to be gaining some ground, and in BSD, it remained kind of chunky -- or difficult, that is. And I know that furniture tends to be one of the early movers in a recovery. So what does that tell you, if at all, about the relative health of your different channels, of the overall backdrop?

I think it is more, Matt, a difference of what we are selling in each and what we typically sell. So in Retail, we are seeing a little bit of a rebound in seating. I think chairs wear out and you can only defer chairs for so long. Whereas I think in the BSD business, that business skews more towards larger collections and office, big office settings. And I think what we are seeing is that market still has not recovered. I don't know, Steve, if you want to comment.

Matt, this is Steve. Furniture has always been much higher from a development standpoint in our Retail business than in our BSD business. Within the BSD business, obviously, with our large corporate customers, they really have put off furniture purchasing as part of discretionary spending. And we typically have not sold a great deal of furniture through our Direct business. And so it has been less of a focus for us on the BSD side; much more so on the Retail side, and that is partly why the difference.

Got it. Second question, if I could. On the U.S. Communities contracts and the business that you do there, is the geographic distribution of that business fairly broad? In other words, if you were to lose some of those contracts, is the impact felt disproportionately in a number of different warehouses and locales, or is it really kind of a truly national book of business for you?

Matt, it is a national book of business for us. We have customers and agencies in all states. It is like any other business; it can be focused more heavily in our key developed states around Florida and California. But it is a national business, with agencies located everywhere.

And in terms of the outcome of the rebidding process, will the remaining parts of that contract be rebid out in their entirety, or is it possible that it could be broken up further among competing bidders?

We don't know at this time. The actual bid -- this is the way to process works for us and our competitors -- the actual bid will come out sometime in June, July, with an awarding later in the year. So we will have to wait to see what the structure of the document is. That is really totally up to LA County, which is the lead agency on the bid process.

Got it. Thank you very much.

Kate McShane.

Citi Investment Research. Can you remind us at what comp store sales number you need to leverage fixed costs? And has this threshold changed as you've closed doors and reduced fixed costs in your cost structure?

We haven't really given that number out. The thing I always point to when we talk about leverage going forward is given the depressed sales levels we've been at, we continue to improve EBIT year-over-year. We think the business is positioned well with the restructuring actions it has taken in all three businesses, really.

I am not going to give you a number, because I think it will depend on the mix of products that we have in a recovery. Is it going to be more tech, is it going to be more discretionary, is it going to be more supplies? That will have a big impact on how we leverage.

So I'd prefer to stay away from that, but we obviously like the position the business is in, given the restructuring actions we've taken. And I think we are positioned well when we finally see some recovery come in the top line.

Yes, and I think after you've seen the declines that we've had, and we were down 1, which is much improved, but we are still profitable on this business. So it suggests that we have taken the right decisions and adjusted the cost structure of the business so that we can be profitable going forward.

Okay. And if I could just follow up with another question on inventory. How should we think about your inventory ballots for the rest of the year, with potential continued sequential improvement, specifically in the Retail side? I think we saw from both 3M and Avery Dennison an uptick in their office supply and stationery orders this morning.

I think we are on the front end of our back-to-school build, so certainly as we enter into the tail end of the second quarter, we will begin to build inventories for back-to-school to support the demand that will come in for back-to-school.

But I think beyond that, I wouldn't anticipate much further inventory building. I think we've reached a point with our inventory levels where we get a nice return on the asset, as well as we've also driven the highest service levels that we've seen in the business probably in the last two or three years. So we will build for back-to-school, but essentially keep our inventories flat and turns consistent with about where we were last year.

Thank you.

Dan Binder.

Jefferies. A couple questions. First, on the -- just going back to this U.S. Communities contract for a minute -- I guess they had indicated on their site that they had a one-year extension that they weren't taking advantage of. So that sort of suggests that maybe they are going to look for more aggressive bids on that business. And you did indicate, I think, in your comments that some of the competitors were starting to get more aggressive on the -- I think it was the larger account bidding process. I was just curious how recent that is and what do you think there is offsets to that, so that your overall gross margin is not impacted on the year.

First of all, the aggressive pricing that I mentioned during the call this morning, we really saw that during the second half of 2009 and continuing through the first quarter. But despite -- as I had mentioned, despite some of that aggressive pricing, we were able to be able to both retain a higher percentage of our customers and also grow our business. And we are just being selective with, obviously, certain customers, where we just don't think it makes sense to be aggressive and to put ourselves in a position where we are basically negative on a cash flow basis. But we have been able to manage that process.

Second, regarding U.S. Communities, it is really their decision. The contract was ending here at the end of December, and given the economic situation the State of California is in, they are doing everything they humanly can do to reduce their cost base, and they are re-looking at every piece of their business across every agency across California, and no different with LA County.

So they want to put it out to bid, and time will tell relative to our ability to retain it, which we feel very optimistic about. But second of all, regarding the margins, we will just have to see how the bid process works its way through.

But, Steve, I think part of what we can offer U.S. Communities and all these big customers is the chance to move to more private brand purchasing. And we have, I think, one of the broadest ranges of private brand, which can save them money. And as we move that mix, that can actually help us save them money, but also manage our margins in the process.

Look, I think this -- I just want to be clear, because there are a lot of questions here on U.S. Communities -- this has been in the works since we won it five years ago. The economic times suggest that they have to competitively bid it; it is just -- it is part of the deal in the public sector today.

Every competitor has -- virtually every competitor has these buying co-ops. It is not easy to switch, either for our competitors or for our customers. And even though our customers are currently buying underneath U.S. Communities, they are not necessarily interested in switching.

So there are a lot of reasons why I think Steve feels optimistic. And we feel optimistic, although we are going to be very aggressive and make sure that we take care of this customer through the bids.

One other point I would like to just make is that the customers that are part of the U.S. Communities contract are our customers. These are Office Depot customers. So the 10,000 plus agencies that are part of the contract are our customers.

And so through the bid process, we feel very optimistic going forward. But for some reason that turn a different direction, we will still be able to aggressively obtain and keep a high percentage of those customers as part of our overall strategy.

Okay, great. And then the second question was on cash flow. Mike, I think on the last call, you gave us similar color on D&A, CapEx, and I think you also added that maybe working capital would probably not be a big contributor on that.

And I was wondering if you could just update us on your view on working capital, cash flow for the year, and then whether or not that includes this other line item that you have, which is charges for losses on inventories and receivables.

Yes, let me start out with the -- let me start out with that line. First of all, yes, it does include that line that is called out as charges for losses on inventory receivables. If you look at our cash flow statement this quarter, it is $12 million versus $21 million last year. This is basically shrinking bad debt write-downs that we take on an income statement as a charge and we add back on the cash flow statement. So when I make a reference to that working capital number, it will include those impacts. And if you look at that line year-over-year, we are about $21 million better. That is basically lower shrink of about $6 million and roughly the same amount on bad debt research. So yes, that is included in the working capital number.

Our guidance for the year remains in the $70 million to $100 million range. Our D&A stays in the $220 million range. We are still looking at CapEx of around $200 million. So towards a $70 million to $100 million number, you are looking at a D&A and CapEx pickup of about $20 million net there.

And I'll say no more than I said last time. The balance of the free cash flow estimate will come from working capital improvements, and it will come from net income, without calling out what that net income number is. We still feel comfortable about that as we go forward and look at our first-quarter results.

Great. Thanks.

Michael Lasser.

Barclays Capital. Thanks a lot for taking my question. How does the composition of customer base for the BSD segment compare in California versus Florida? Is there a greater exposure to the public sector and a trickle-down effect in one or the other state?

Michael, we have a higher development index in our public sector in California than we do in Florida as a percent of our total business.

So that will contribute a lot of the differential performance for those locations, or is there something more than that?

Obviously, the decline in the public sector in California is a significant drag on our business, as we stated during the call this morning. But it is also, as we stated, having a trickle-down effect basically to all of our customers. Because of the budget cutbacks, it is trickling down to our small- to medium-sized business customers also in the State of California. So we remain very concerned about California, and it is a very large state for us, and a very large percentage of our overall business.

Michael, let me just give you a little more color on what Steve is saying. We were out visiting our stores in California, and when they have these furloughs on Fridays, they have a lot of state agencies and office buildings scattered around the state. And what we see is that the small businesses that have serviced those government employees on those Fridays have begun to close on Fridays, too. So the dry cleaners and the local restaurants and that type of thing.

And so we see significant hit not only in our BSD business that day, in other words no orders, but we also see a big hit on our stores that are around those state agency offices, too. And so this is why we say we are concerned about California. We think it is a unique situation in the country, and something they are going to have to work through.

That is really helpful. And it sounds like you are not necessarily seeing a similar impact in other geographies.

No, and as we said, things are actually improving a little bit in Florida, which is good news. Retail comps, I think were flat in Florida versus still down, and the BSD trends were much better versus the double-digit negatives in California. So, you know, if we could get California to go in the right direction here, we would be a lot happier about our business.

Sounds good. Good luck.

Alan Rifkin.

Bank of America. Charlie, you mentioned that the impact after Japan on revenues were down 3.5%. I was wondering would you be able to quantify the impact on last year's EBIT of $19 million, how much was impacted by Japan?

I don't think we released that number. But, obviously, we closed that business because it had a pretty -- we couldn't see a way to make that business profitable, and it was a real drag on the overall business for us in Asia.

Okay.

(Multiple speakers) was 3.5%.

Thank you. I know that it was mentioned that California and Florida combined on the BSD side are about a third of the business. Would you be able to just break that down? With so much uncertainty surrounding California, how much is California in and of itself?

That is not something that we have disclosed, and so we continue to just talk about those two states as being obviously our two largest markets.

Okay. And then maybe a question for Steve Odland. Steve, could you just kind of give us an update on where you are in the renegotiation process on the Retail side with your attempt to renegotiate some of your leases to smaller stores?

Yes, you know, we have about 10% of our leases up every single year. That tends to be a 10-year lease with multiple renewals. And so it is roughly that.

We've had pretty good success renegotiating the leases, either to TI, tenant improvements, or sometimes the landlords are agreeing to pay for remodels. And then we are getting rent concessions. But remember, those rent concessions then are spread over the life of the lease, rather than seeing them hit in any one given year. So in this environment, we've been very aggressive and the landlords have been very responsive, Alan.

Okay. About how far through that program would you say you are right now?

Well, 10% a year, so we've been at it a couple of years, so 20%, 25%, round numbers.

Okay. Thank you, Steve.

Joe Feldman.

Telsey Advisory Group. I wanted to ask a little more on International. If you could talk a little bit about maybe some market share you are gaining there. It sounds like the business has been pretty good and profitability has been good. Also wanted to ask about the profitability a little, and how sustainable is some of the profit improvements that you've been making.

First of all, in terms of market share, unfortunately, we don't have the same type of tracking mechanisms internationally that we have here in the US. So what we do is we look at product categories. So we look at the basic -- paper, ink and toner, and those sorts of -- writing instruments. And what we see is that our share of those markets have tended to be up in the UK for pretty much most of last year, continue in the first quarter. We are now seeing the same kind of trends in France as well.

So that is where we are getting our information.

Regarding the sustainability of our profit improvement, last year we took a lot of initiatives. We closed some warehouses, we exited the Japanese retail business, we put in place some better pricing and mix management tools with our sales force. And so all of these things, I think, are foundational to our business, and therefore, they are not kind of one-shot deals. So I think we should be able to sustain our profitability going forward.

That's great. Thanks, guys. Good luck.

Okay, Joe. Thanks very much. I just want to wrap up by saying that we are very pleased with the results in the first quarter. This has been the best trend that we've had since, I think, about the last seven or eight quarters. We are making good progress.

We are trying to be a little cautious in the second quarter because it is our weakest quarter. So that is a little bit why we've been cautious. But we are more confident in our second half, as we get back into the fall season, back to school and so forth.

This is Mike Newman. I have one more comment to make, and I want to make sure everybody is clear, so we get it out in a full disclosure area.

Our effective tax rate for the quarter, as you know, was higher than what we anticipated, in the 34% range. A lot of that had to do with timing differences, that because of the deferred tax asset valuation reserve we put up a few months ago affected the tax rate.

Our cash tax rate continues to be in the 15% range. And while we may have volatility in the reported effective tax rate, that cash tax number will remain in the 15% range. That had an impact of about $0.015 to $0.02 on our first-quarter results from where we guided to. And I wanted to make that statement so you had that thinking in your models for both Q1 and going forward.

Okay. Thank you, Mike. Well, this concludes our conference call this morning. Please note that we've updated our supplemental investor presentation that provides additional information on the Company and placed it on the Investor Relations section of our website. Thanks very much for participating on today's call.

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