ODP Corp (ODP) 2010 Q3 法說會逐字稿

Good morning, and welcome to the third-quarter 2010 earnings conference call. All lines will be in 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 begin.

Thank you, Julie, 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 interim Chairman and Chief Executive Officer, Neil Austrian, will now make a few comments. Neil.

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

As most, if not all, of you on the call and webcast this morning are aware, Steve Odland announced his resignation from Office Depot effective November 1, 2010 by mutual agreement with the Board of Directors earlier this week. We want to thank Steve for his contributions to our Company beginning in 2005 and through one of the toughest economic climates in memory.

During his tenure, the Company grew and achieved record revenue and profits, and we have seen some improvement in margins coming out of the depths of the recession. Now that the worst of the recession is behind us and margins are improving, we believe that this is an appropriate time to seek new leadership to make the most of the platform we have in place, return to sales growth, improve financial performance and reinvigorate our franchise. We all wish Steve well.

As you may have read, we agreed to pay $1 million to settle an SEC investigation regarding communications with analysts and other matters previously disclosed. This settlement puts a definitive end to an investigation that started in 2007, and throughout which Office Depot cooperated fully with the SEC. The Company chose to settle in order to return its full focus to the business and to serving its customers.

I want to make absolutely clear that Steve Odland's resignation was not prompted in any way by the settlement with the SEC, as some have speculated.

Looking forward, we are committed to taking the time needed to find the right leader for Office Depot for the future. In the meantime, I will be very actively engaged in carrying out our strategic plan and helping the Company to deliver value for our shareholders. With that, I will ask Mike to summarize our third-quarter 2010 results. Mike?

Thanks, Neil. Office Depot's third-quarter sales totaled $2.9 billion, a decrease of 4% compared to our third-quarter results last year. Although negative, the third-core sales trend was the best since the second (technical difficulty). Additionally, I should note (technical difficulty) including impact of foreign exchange translation and business restructuring activities (technical difficulty) subsequent to this third quarter (technical difficulty) 2009, the year-over-year sales decline was only 2%.

Third-quarter earnings were $54, million or $0.18 per share, versus a loss of $413 million, or $1.51 per share, in the same period one year ago. Third-quarter 2010 earnings included significant tax and interest expense benefits related to tax settlements for open years reached during the quarter that positively impacted earnings by $0.15 per share.

Our third-quarter 2009 results included charges for deferred tax asset valuation allowances, the reversal of tax benefits and charges related to restructuring activities, which negatively impacted earnings by $1.43 per share.

Total Company operating expenses in the quarter decreased by 8% or $72 million compared to the third quarter of 2009. This decrease primarily reflects the charges taken in the third quarter of 2009, cost actions taken in the third quarter of 2010 and lower professional fees compared to the prior-year period.

EBIT of $20 million in the third quarter was $2 million higher than EBIT, adjusted for charges, reported in the prior-year period. The year-over-year improvement was driven by stronger results in North American Business Solutions and lower corporate expense.

Total Company gross profit margin increased 20 basis points in the third quarter compared to the prior year. This was the fifth consecutive quarter of year-over-year gross profit margin improvement. Our North American Retail and North American Business Solutions divisions were both successful in increasing their gross profit margins compared to the prior year in a weak sales environment, while the International division had flat gross profit margin compared to the prior-year period.

We are very pleased with the continued progress being made in these three businesses, as they continue to execute well in regard to growing margin and are very close to returning to sales growth.

I'll go into more financial detail later in the call, but I will now ask Kevin to talk about North American Retail's third-quarter performance.

Thanks, Mike and good morning. In the North American Retail division, sales for the third quarter were $1.3 billion, down 1% versus one year ago. Our comparable store sales in the US and Canada were flat versus the same period last year. This is the best comp sales performance we've had since the fourth quarter of 2006.

Comp sales across most of the US showed flat to improving trends. We saw a significant improvement in our sales performance in California, with that market achieving slightly positive comp sales for the first time in at least three years. Our best-performing sales markets were Florida, the Midwest and the Northeast, with all attaining positive sales comps.

Third-quarter customer transactions increased versus the prior year for the first time since at least 2006, due in part to our successful advertising campaign. Our average order value declined in the low single digits during the quarter versus the prior year due to increased competitive pressure during the back-to-school season.

Sales of our three major product categories of supplies, technology and furniture continued to improve versus prior quarters. Our technology category showed the largest sequential improvement with increased sales of PCs, laptops, software and accessories, as these items were on the hot list for students.

Tech Depot Services continued to gain traction with customers and achieved double-digit sales growth and a significant increase in attachment rates compared to last year.

Furniture sales were strong, as were our Copy & Print Depot services and school supply categories, all of which achieved positive comp sales.

We are pleased with our back-to-school performance this year. We offered our customers exceptional value, with a broad assortment of fashion, color and trend products. Our direct import product assortment was expanded and performed very well, with sales in the quarter doubling that of last year. The Go Back Smarter campaign effectively drove our Smart brand positioning and may have been the most successful campaign in Office Depot's history.

Also, our teacher appreciation events were a big hit with the 180,000 teachers that were celebrated, and, as a result, our star teacher program membership enrollments were up significantly compared to the prior year.

Looking at our North American store count in the third quarter, we opened three new stores and closed five stores, bringing our total to 1150 stores at quarter-end. We also relocated two stores during the third quarter.

North American Retail operating profit in the third quarter was $30 million versus $35 million a year earlier. The decrease in operating profit was primarily driven by increased advertising expense to drive improved brand awareness and the impact on product margins, due in part to a promotional and competitive back-to-school season. Despite the slight sales decline and product margin pressure, our third-quarter gross margin rate was up compared to the last year due to lower occupancy costs (technical difficulty) product clearance activity. We not only managed our back-to-school inventory and clearance items better this year, we also increased our direct import product penetration.

We continue to implement initiatives to drive sales and reduce costs and make prudent investments in both our infrastructure and customer-facing activities. I will review a few of these initiatives and investments for you.

First, in September, we rolled out the United States Postal Service offering nationally in our retail stores. The addition of this service offering now provides our customers with two choices for their shipping and mailing needs, UPS and the United States Postal Service. Our customer response so far has been very positive, as the majority of our customers find this multicarrier shipping solution very desirable. Providing this service makes Office Depot the first national retailer to implement the USPS Approved Shipper program, which we believe presents an excellent opportunity to drive additional traffic into our stores.

Second, the new state-of-the-art combination distribution facility we opened in Pennsylvania is running well and providing world-class service to both our retail stores and BSD customers in the Northeast. This investment allowed us to consolidate four facilities into one, lowering our inventory needs, improving working capital and making our supply chain more efficient.

Third, we continue to invest in our Copy & Print Depot and Tech Depot services, and these services consistently produced favorable results with positive sales growth compared to last year.

Our Copy & Print Depot service has made strong gains in key verticals, and we have also improved our Copy & Print webpage to offer additional products and enhance the customer experience.

And then fourth, we continue to focus on reducing our overall store size where appropriate. Our current average North American Retail store size is about 24,000 square feet, and we are pursuing a footprint in the 15,000 to 17,000 square foot range, based on the size of the trade area and the availability of real estate. The smaller model is our go-forward footprint, as it lowers occupancy costs and improves sales and margins.

As we reconfigure the base with about 100 of our store leases expiring each of the next three years, renewing these leases will be somewhat driven by our ability to downsize and the configuration of the remaining space. We will also continue to remodel our 400 traditional format stores remaining in the fleet. We will keep you updated on these initiatives as we move forward.

To sum up, our Retail business continues to execute well as we focus on reducing our cost of sales, improving store productivity and category management, while investing in our business. Looking at the fourth quarter, we expect the holiday season to again be very promotional and competitive this year, with consumer spending still tight and customers demanding great value. Along with our United States Postal Service and UPS shipping services, we will offer our customers an expanded product assortment that will drive incremental traffic into our stores. Part of this expanded assortment will include offering new tablet computers that provide consumers with exciting options to communicate, browse the Internet, consume media, and we think this should be very popular for the holiday season.

While we are optimistic about our fourth-quarter plans, we remain realistic about the current state of the economy. In addition, we have improved product margins in eight of the last nine quarters, and this benefit will diminish as we continue to anniversary these improvements. As a result, we anticipate our comp sales to be about flat and operating profit to be flat versus the fourth quarter of 2009 due to increased marketing expense to drive brand awareness. Steve Schmidt will now review the third-quarter results for North American Business Solutions. Steve.

Thanks, Kevin, and good morning. In the North American Business Solutions division, third-quarter sales were $842 million, down 4% versus the same period last year. The sales decline has continued to improve sequentially, with this third-quarter having the lowest rate of decline since the fourth quarter of 2007. Excluding the impact from the restructuring of certain non-core businesses in late 2009, sales were down about 2%.

We are encouraged by our sales trend in California during the third period; while still negative, was in line with the overall BSD business trend. In comparison, the California year-over-year sales decline was twice the average for the BSD business in the second quarter.

Our average order value for the third quarter was slightly higher versus the same period last year. Fewer customer transactions were the main driver of our sales decline this quarter, although the rate of decline has actually improved sequentially in each of the last six quarters.

We had strong third-quarter sales in furniture, cleaning and breakroom supplies and, of course, school supplies, where we are one of the largest suppliers to K through 12 schools in the US. Although we haven't yet seen a clear positive rebound in discretionary purchases by our customers, we do believe that this product group has stabilized.

We are pleased with our direct channel sales in the third quarter, where they were relatively flat versus one year ago. In fact, the direct year-over-year sales trends in the second and third quarters of 2010 were the best we've realized since 2005. Our success is really due to having increased effectiveness and efficiency from our direct mail, e-mail and catalog, as well as improved websites.

Contract channel sales declined in the third quarter versus last year, but the rate of decline continued to improve from prior quarters. We saw positive sales growth in national accounts, and although sales to small- to medium-sized business customers declined in the quarter, the rate of decline continued to improve from prior quarters. Sales to the federal government sector increased in the quarter, but our overall public sector business continued to decline due to budgetary cuts, albeit at a lower rate than previous quarters.

I should mention that we continued to win new business and retained existing customers in the third quarter. A few examples include an award for office and educational supplies from the latest solicitation from the state of Florida Department of Management Services, and a new contract for office supplies with the Central Kentucky Educational Cooperative. We feel good about our pipeline for acquiring new accounts.

While discussing our contract business, I should mention the efforts we are making to ensure that we continue to service customers that purchase under the US Communities Contract that expires at the end of this year. We intend to both retain our customers related to this particular business and grow the business as well through multiple offerings, such as other purchasing consortiums and other contracts that allow piggybacking capabilities. These offerings will continue excellent terms to our customers and to Office Depot, while providing much less risk to our shareholders.

For example, we recently announced that Office Depot has been awarded the contract for office supplies from The Cooperative Purchasing Network, or TCPN. TCPN is a national government purchasing cooperative that contracts on behalf of K though 12 schools, local government colleges and universities.

Taking a look at our Internet sales in the third quarter, 85% 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.

Third-quarter operating profit for BSD increased to $25 million despite the decline in sales, an increase of $4 million compared to the same period a year ago, and an $11 million increase from the second quarter of 2010.

Gross profit margins improved 90 basis points in the quarter versus last year. The year-over-year increase in operating profit was due primarily to a relatively higher sales mix from our direct channel and improved productivity in selling expense.

Even though business conditions remain challenging, the BSD sales team continues to focus on executing on its key initiatives to grow sales, reduce cost and improve margins. The sales growth initiatives within the contract channel include the following.

First, the implementation of large market business development teams. Second, a stronger focus on national account business development. Third, continue to focus on growth in the small- to medium-sized business customer space. Fourth, continued growth in the government sector. Fifth, adding sales resources in the area of cleaning and breakroom supplies. Sixth, continuing growth and increasing momentum in our Copy & Print business. And seventh, launching new marketing and loyalty programs.

In the area of margin expansion and contract, we continue to grow our margins through focus on our newly-launched customer savings plan, which incorporates savings for our customers and improved margins for the Company. We are also focusing on the expansion of our private brand and direct import programs, continued productline reviews, renegotiating low-margin contracts and reducing our supply chain cost.

In summary, we continued to be successful at winning new business and retaining existing business with large global customers in the third quarter. I am encouraged by how well the direct channel is executing, and I see many opportunities to drive profitable growth in the contract channel in the fourth quarter and into next year.

Looking forward, we expect our fourth-quarter sales to decline versus last year, but the rate of decline should improve compared to the third quarter. Additionally, we expect the fourth-quarter operating profit to be up at least $10 million compared to last year, due in part to nonrecurring legal expenses and operational improvements.

Charlie will now discuss his third-quarter 2010 results for the International business. Charlie.

Thanks, Steve, and good morning. The International division reported third-quarter sales of $778 million, down 10% in US dollars from the same period in 2009. Our local currency sales decreased only 3% versus prior year, and excluding the 2009 revenue from the shuttered Japanese retail business, the sales decline was 2%. This marks the fifth consecutive quarterly improvement in our sales performance.

While most of our markets in Europe were negative for the quarter, the sales rate of decline varied from country to country. For example, key markets, such as the UK and France, continued to improve and performed at or better than the European average. Asia performed very well, with 10% higher sales and year-over-year, excluding the closure of Japan retail. This strong perform was driven by all countries in that region, excluding Japan.

We continue to see consistent growth in this region and remain focused on improving its profitability.

In contract, sales in the third quarter were flat compared to the prior year in local currency. Asia again performed very well, with strong sales growth, but we saw mixed results in Europe. We have a large presence in the public sector in several markets which remain under pressure from the various government austerity programs launched earlier this year and negatively impacts our results. For example, sales for our contract business in the UK are up mid-single digits if we exclude public sector. In contracts, we will continue to add sales representatives to profitably grow our regional contract business.

Third-quarter sales in the direct channel were lower than a year ago. To address this negative trend, we are implementing several actions to improve the competitive position of this channel, attract more customers and increase sales. This includes sharper pricing on fast-moving SKUs and vendor-funded promotional activities.

Retail channel sales for the quarter were slightly higher compared to last year, excluding the Japanese store closures. Our retail business in France reported another solid performance, with positive comp sales driven by a successful back-to-school season. This improvement was achieved despite moving our anniversary sale into the fourth quarter this year compared to the third quarter last year.

The International division's operating profit was $30 million for the third quarter compared to $34 million reported in the same period last year. Excluding the adverse impact of foreign exchange translation, operating profit was down $1 million versus the prior year.

The operating profit decline was primarily driven by the unfavorable flow-through impact from lower sales volumes, partially offset by improved product pricing, lower occupancy costs and benefits derived from the reduced distribution and G&A costs compared with last year.

We remain focused on executing our strategic initiatives, designed to drive sales and improve the profitability of the International business. I would like to take a moment to update you on a few of these initiatives.

First, we are focused on winning new customers. For several months, we have been refining our business model to become more customer-centric, with better segmentation, refined and coordinated contacts, refreshed branding, improved pricing and more robust e-commerce tools. These activities are resulting in improving customer acquisition and (inaudible) trends in our regional and SMB customers. And, as I mentioned last quarter, we intend to continue adding sales representatives with better training and support to gain new business and market share.

Second, we are nearing completion of a project to replace analog equipment with voice-over IP Digital telephony in all our European markets. This will allow automated call distribution solutions to route incoming service requests to the first available agent with the appropriate skill set. It also features call queuing, workflow optimization and better selling tools for our agents.

In addition to reducing costs, this investment will drive a more robust customer experience to drive loyalty and retention.

And third, we remain committed to increasing our global reach and capitalizing on market opportunities. In September, our joint venture in Mexico, Office Depot de Mexico, closed a transaction with Carvajal Internacional to acquire its business-to-business office products division in Mexico, Costa Rica, El Salvador and Colombia. With this transaction, Office Depot de Mexico increases its revenues by $110 million and secures the leading office products position in Colombia, while further strengthening its leading position in Mexico and Central America.

I would like to also mention our current business in Israel. We announced two weeks ago that we are currently in negotiations to sell Office Depot Israel Limited to a large Israeli retailer for proceeds of $47 million, less outstanding debt of about $25 million at the time of closing, and expect to enter into a related agreement to license certain trade names and intellectual property rights for this business. We have executed an exclusive, nonbinding letter of intent and are currently in the middle of due diligence, and cannot add anything more at the moment.

We have been doing business in Israel since 1993 and are extremely proud of the business we've built there with our associates. There are a number of compelling reasons for executing this transaction, which will be accretive to our current division margins, and I will be happy to discuss them should the transaction close as anticipated in November.

In summary, the International division performed well again this quarter and has shown improved and sustainable results over the last several quarters. Our sales trends continue to improve, while we have also expanded our gross margins and lowered our operating expenses. We remain focused on improving our execution and reducing costs and building stronger relationships with our customers.

Looking forward, we expect our fourth-quarter sales to be slightly higher sequentially, but lower than prior years, as foreign exchange rate movements will likely continue to impact results. Fourth-quarter operating profit is also expected to be higher sequentially, but down versus the prior year because of gross margin pressure resulting from pricing actions I mentioned earlier and lower vendor rebates.

With that, I will now turn it over to Mike, who will review his third-quarter financial results in more detail.

Thanks, Charlie. As mentioned at the outset of the call, we recognized significant tax and interest benefits during the quarter, and I will try to provide some additional color now.

The third quarter was impacted by the settlement of uncertain tax positions relating to open years, as well as a catch-up benefit from the change in the estimated annual effective tax rate for 2010. These items favorably impacted third-quarter taxes by $40 million.

The settlement also resulted in lower interest costs related to these positions totaling $13 million. Combined, the tax benefit of $40 million in interest expense benefit of $13 million positively impacted earnings per share by $0.15 in the third quarter.

In addition, during the quarter, we adopted a tax accounting method change for repair and maintenance expenses which allows a faster recovery of these costs and increases near-term cash flows. This impact, combined with the tax benefit on pretax earnings, totaled $7 million, which are viewed to be operational in nature.

So in total, we recognized tax benefits of $47 million in the third quarter, reflecting an effective tax benefit rate of 295%.

Our fourth-quarter effective tax rate will be impacted by bonus depreciation rules enacted by US tax authorities after the end of our fiscal third quarter, and the accounting method change for repair and maintenance expense. These changes are expected to drive our annual effective tax rate to be a benefit of approximately 92% and our cash tax to be a benefit of about $56 million for 2010, with about $40 million having been realized September year to date.

Shifting to take look at cash flow, we ended the quarter with free cash flow of $109 million compared to $141 million in the third quarter of 2009. And although down from prior year, we are very pleased with our strong cash flow performance this quarter, which was driven by both earnings and good working capital management. We now expect full-year 2010 free cash flow to be at the higher end of the $50 million to $70 million range we gave you last quarter due to our strong third-quarter performance.

During the third quarter, we recorded dividends on our convertible preferred stock of approximately $9 million, which were paid in cash in October.

Moving to our balance sheet, we ended the third quarter with $679 million of cash on hand, slightly lower than the same period in 2009. And including availability from our asset base loan facility, our liquidity totaled about $1.4 billion at the end of the quarter, up from $1.3 billion in the second quarter of 2010.

Inventories totaled $1.2 billion globally, roughly flat with the third quarter of 2009. And receivables of $999 million were down 14% or $166 million compared to the third quarter of 2009, reflecting both operational improvements and currency impacts internationally.

Moving to the business process improvement update, on the previous two earnings calls, we discussed our efforts to reduce costs in areas such as indirect spend and other non-customer-facing functional cost areas and our new business process improvement organization. As I mentioned, we are very excited about this business process improvement initiative, but shifting the culture and building such capabilities takes time, which is why we are also driving the G&A transformation program to address our near-term financial needs. We are targeting a $100 million cost savings annual run rate by the end of 2013 and have currently identified $80 million in the areas of indirect spend reductions, financial process improvements and IT integrations. We are optimistic that the balance will be identified and delivered as we ramp up our continuous improvement strategy.

Although I'm still not in a position to provide the benefit breakdown by year, I can tell you that the benefits in 2010 are on track to more than offset any investment required this year, and I look forward to sharing the progress with you as we go forward.

Turning to look at the fourth-quarter outlook, we expect total Company sales to decline in the low single digits versus the prior year, and we expect total Company EBIT to be up year-over-year due to improved selling expenses, gross margin improvements and nonrecurring legal fees and insurance reserves. With that, I will now turn the call back over to Neil.

Thanks, Mike. I will end our prepared remarks this morning by saying that I am extremely proud of the accomplishments our associates have made this year. We have been executing very well across the entire enterprise as we focus on returning to sales growth and delivering improved profit as we go forward.

To sum up our third-quarter sales results, in North America, Retail reported flat sales comps, the best sales performance we've had since the fourth quarter of 2006. And direct sales were again flat compared to the prior year, the best year-over-year sales trends we've realized since 2005.

In local currencies, International contract sales were flat compared to the prior year, and Retail sales were slightly higher, excluding Japan. As you heard from Steve and Charlie, we've identified opportunities and initiatives to grow profitable sales in our two remaining businesses, North American Contract and International Direct.

We believe that we are pulling all the right levers and controlling what we can control well. These efforts will enable us to better position Office Depot for the economic recovery when our customers resume their normal buying habits for office supplies and services. However, we will need some tailwind from a recovering global economy and some relief from high unemployment to return to more normalized levels of profitability with EBIT margins in the mid-single digit range.

Before I ask the operator to open the call to Q&A, I would like to note that Newsweek Magazine released its 2010 green rankings report for the top 500 US publicly-traded companies last week, and we were pleased to learn that Office Depot was listed as the number one green company in the retail category and 18th out of 500 overall. This is a true testimony to Office Depot's commitment to the environment and leadership in the green space. This is extremely important to both our public and private sector BSD customers.

Operator, we are now ready to take questions.

(Operator Instructions) Matt Fassler.

Goldman Sachs. I've got one strategic question for Neil, and then a financial question for Mike. Neil, good morning. And my question to you would be, if you could talk about the timing of the Board's decision -- why now? I know you said that the SEC settlement did not factor into your thinking, but to the extent that this was a mutual call by you and by Steve, what did the Board see that drove the timing on its end?

Hi, Matt. Good morning. I think there is basically never a good time to make a change. And I think in this situation, we were starting to see a return to some of the economic positives that we had experienced in the past. We were beginning to see margin improvement. We were beginning to see the situation from a total economy standpoint bottom out.

Yet at the same time, no one was 100% pleased with the results, and basically, we both concluded that now was as good a time as any. And I want to reiterate, it didn't have anything to do with the SEC issue. If you use a sports analogy, at some time you make a quarterback change. And there's never a good time to do that and you're never 100% certain if it's going to work. But on the field there is an emotion, there is a spark, there is an energy level that the whole team gets from that kind of change, and I think both of us at this point felt that was probably necessary.

Got it. That's helpful. And then secondly, for Mike, when you look at the inventory dynamic, your inventory growth was a bit unfavorable to your sales trend. And that was, I believe, a reversal of trends that we had seen leading up to certainly versus where we were last quarter. If you could give us a sense as to what contributed to that, kind of where inventories stand and where the inventory lives right now.

Actually, when we talk about flow in the quarter and the contribution to cash flow, we are actually really pleased with the inventory levels. If you look at what is driving flow for the quarter, it is mostly driven by increases in accounts payable from last year.

But what didn't happen with that increase in Accounts Payable was an increase in inventory. We had great sell-through on back-to-school inventory. We had great sell-through on overstock and clearance items in inventory. And we also had some operational changes in the way that we are managing the supply chain on ink and toner that we think are going to be permanent. So I'm actually very pleased from a flow perspective with the payable and inventory numbers for the quarter, principally for those reasons.

Got it. Thank you so much.

Colin McGranahan.

Sanford Bernstein. First question for Neil, just following up on Matt's question. As you think about getting that, I guess, spark back on the field, what kind of quarterback are you looking for? What are the characteristics and qualities in new leadership that you are pursuing at this point?

We want a Hall of Fame guy. I think basically -- right? I mean, I think the specs are pretty obvious, Colin. I think that you want someone that is an absolute proven leader, somebody who has run a major business, somebody who in the past has not only demonstrated their ability to control costs and innovate, but someone that can build revenue. We are not going to cost-cut our way out of the problem here going forward for the next decade. We've got to build revenues.

We would like to find somebody that has had both retail and what I will call BSD experience. It is a very tough position to fill. I think we've hired the right search firm in Heidrick & Struggles. They've already gotten started. And our expectations are that, given the liquidity we have in the Company, given the management team that we have in place and given the starting change in the economy, we are going to find a superior CEO to come in and take the Company to the next level.

And how important is it that person has any familiarity with office products?

I can't answer that today. All I can say is, as an analogy, I was on the search team at DIRECTV when Chase Carey went back to News Corp, and our initial specs to get a CEO were to find somebody that knew the media, entertainment or television business. And an out-of-the-box candidate, Mike White, who had been vice-chairman of Pepsi and a former CFO of Pepsi, came in and he is doing an extraordinary job. So I don't want to rule out anybody at this point.

Okay, fair enough. Then a question for Mike. Of the $80 million you've identified in OpEx (technical difficulty) and cost reductions, where are you today? And how much of the G&A reduction that we saw in the third quarter -- I think it was down more than $20 million year-over-year -- how much of that was from efforts that are already underway on the process improvement?

Yes, the decrease the last year was more due to -- it was more due to the things that are already been in place, plus some non-recurring things from last year. Of the $80 million, we are not -- as I mentioned in the script, I really don't want to get into a year-by-year update, but we are making a lot of strong progress. I feel as good as I could feel sitting here looking at 2011, and looking at us making considerable traction towards delivering that $80 million in three years. Our teams are working hard. We've got a lot of buy-in from the organization. We've got a lot of great process workshops going, that my folks are running. And I really feel as if this thing is getting a lot of traction. I don't want to give specifics, but I feel like we are well on our way to delivering that $80 million, given where we are today.

Okay. And then if I can sneak one more follow-up in. Just on gross margin, there is still an improvement, fifth quarter in a row, but the least improvement we've seen in a while. But gross margins are still more than 200 basis points below historical levels, in the 31 to 31.5 range. I know there are probably 100 bps there on rent deleverage. But what needs to happen to get the rest of that 100 to 150 basis points back?

I think on the retail -- I think it is general leverage across the Company. I think rent is a key piece. We are talking about a number of programs that take the level of rent down.

But it is leveraged across the Company. It is also our contract business, and we are working hard at looking at improving profitability there. Steve has talked about the customer savings programs and some initiatives there.

But those are the pieces I would highlight as why we are short, based on your question.

Okay, thank you. Good luck.

Chris Horvers.

JPMorgan. I wanted to follow up on the timing question, Neil. And reflecting back a few months ago -- I guess it would have been February/March timeframe -- re-upped Steve's contract and added a three-year retention package, which, frankly, was just kind of exchanging value for his option to leave around this time of year, given the change of control clause. So I just wanted to follow up and really understand the timing and what has really changed versus six or seven months ago.

I think, as I said, it is really a coincidence. The contract discussions got started a while back, given the BC Partners investment and the change of control issue. They only got signed in the first quarter. So you're really looking at a time period there where we've had almost nine to 10 months, from the time the discussion started about changing the contract or renewing the contract with the effective event that we had this week.

So it was just one of these things where, as I said earlier, there is never a good time to make a change. Both sides decided it was appropriate at this point, and I again want to say it had nothing to do with the SEC issue. It was unfortunate that has come out that way, but that is not the facts.

As a follow-up, as you compare it to when you brought Steve in in 2005, and he did a great job early on and the recession has been a really tough. But how maybe is the lens that you are looking through for the search different today versus what it was in late 2004?

I think it is going to be in some ways more difficult to find a good new CEO; in other ways, it's going to be easier. It is going to be easier because from my perspective -- and that's my lens -- there is a far more solid and more in-depth management team here at the Company today than when I was here in 2004. And I think that is a huge positive.

I also think that the reason it may well take a little bit longer is because of the economy and because of the fact that we've had two changes in the last 10 years, and somebody on the outside may wonder if this is an appropriate time to make a change.

Fair enough. I'd completely agree.

Mike, as a follow-up on the expense side, on advertising, you drove sales, you drove gross margin dollars here in the third quarter with back-to-school. It sounds like in the fourth quarter, you are looking at advertising again and really causing your operating profit rate to be flat.

Could you maybe quantify what the step-up in advertising was in the third or fourth quarter, and how you are thinking about advertising, I guess, more holistically? Is this now a part of building the brand so there is some upfront costs, and you assume it to pay off later? Or do you expect a more immediate term payoff?

I'll let Kevin Peters answer that.

I think maybe the place to begin is our customers have choices, not only in the OSS space, but across the broader retail chain. We have underspent in marketing and advertising as a Company, really since the depths of the economic recession hit Office Depot.

During that time, though, I think what would be important to point out is we've made significant investments in our business. We have improved our private brand penetration. We significantly improved the products that we domestically -- or globally source and bring in to provide great value for our customers in the store. We've invested in Copy & Print Depot. We've invested in Tech Depot services. We've priced our assortment so that we are competitive not only within the OSS channel, but across retail in general for highly visible items. And we've reduced our supply chain from 33 facilities down to 16.

So given the fact our customers have choices, and we've got a great story to tell our customers about the changes that have taken place at Office Depot, not only to drive brand awareness, but also to drive traffic and customer loyalty, we felt it is time to tell that message. And one of the marketing levers that we have to tell it is through broadcast media. And typically ,that is the broadest lever that we have.

Over time, we may change the mix of how we choose to market, but I think the one thing that we won't change is the recognition that we need to do a better job of creating brand awareness, we need to do a better job of marketing our Company.

To the point earlier, I would say our issue, at least within North American Retail, is less about marketing. It's -- from an operating margin standpoint, it is our store base. We have an aging store base, and we have a store base that is larger than it needs to be, on average. We have a plan to address both. By addressing that over the next three years, we think we can right-size our store base. We will continue to advertise our Company. And we should talk less about advertising expense at that point and talk more about how we are growing the business. That is certainly our plan.

Thanks, guys.

Steve Chick.

FBR. I guess the first question is for Kevin. And the comps for the quarter being flat, obviously relative to your history that is a good trend. And I think through to date in August, you had said, helped by back-to-school, that your comp trends were slightly positive at that point. So did they slip a little bit, I guess, once you kind of moved away from that back-to-school period? And if you could give us a sense kind of how they are trending maybe now. And to get back to flat for the fourth quarter, do they need to accelerate from the trend we are looking at here today?

We talked in August about the comp trends in North American Retail, and we said they were slightly positive at the time. As we continued to progress through the quarter, there really wasn't a material change in the comp trends. They were, if it's possible to say, less positive, and so we didn't have enough of the positive inertia to allow us to round to a positive comp. But there was not a significant drop-off in the comp trends. It's just there wasn't enough tailwind behind us to allow us to round up to a positive one. So I think that is probably the best way to characterize it.

Okay. And so as we look -- as we come into the fourth quarter here, I guess if you look at year-over-year comparisons, they sequentially get a little tougher. It sounds like you are on a trend right now to achieve what your guidance is, which would be flat for the period. I mean, nothing has really changed much post-quarter-end.

I think that is certainly what we've communicated. I think many of us in the retail space will have to comp over the Windows 7 launch. So we've got plans in place to address that. But that is obviously going to be some headwind that we are going to have to work through in the fourth quarter.

Okay, that's helpful. And then second, if I could, I know it's small, and this may be for Charlie or maybe even Neil as well. But the sale of Israel, as I recall, if I got it right, that you had just maybe closed out or exercised a put option against your Dubai, the minority stake of that, in 2008. So was that an asset that you were proactively, I guess, out approaching people for a sale, or were you approached? And is it a sign of other things you might be looking at or entertaining, as you look at other assets and their strategic relevance to you?

Charlie, do you want to answer that?

Sure, Neil. Well, Steve, I think the International business, as I frequently say, is different than our domestic divisions because it is a portfolio of businesses. And we look at this on a regular basis, this portfolio. Our long-term goal is to move up to a high-single-digit operating margin, and we've still got a ways to go.

So we look at those businesses that will be accretive to that move and those that won't. So that was part of the -- this is an overall strategy that we've had in place for some time.

Now regarding Israel itself, we were not actively marketing that. We were actually approached several months ago. And as we worked through our discussions with this particular company, it became clear that we could create a win-win situation for both us and this large Israeli retailer. So I think that pretty much covers it.

Yes, that is helpful.

The only thing I might add is at this point in time, we are not looking at selling any other of the assets that we own.

That's where I was going, so great. Thank you. And if I could sneak another one in here for Steve Schmidt. On the direct segment of BSD, obviously, flat has been an improvement from where it had been. It was kind of the same as last quarter, and I was thinking that direct would have gotten sequentially a little better.

I don't know if you're kind of looking that way as well. But just given the investments that you've been making there, can you talk about what is happening competitively within direct? And just remind me, is that about a third of the BSD business?

Steve, yes, about a third would be a good estimate. When we look at the direct business, it's a combination of obviously our activity on the web, catalog, direct mail, e-mail; and when we look at that space, it is a highly competitive space. When you look at page search, you look at what's happening through the different search engines, we see competition increasing significantly. The number of companies who are actually competing with us from a paid search standpoint to acquire key words has increased significantly. We see increased activity around catalog. And obviously, our focus around the web.

I would say generally we are pleased with the overall performance of our direct business. Obviously, we were involved in the whole back-to-school process, also highly competitive. So just to see that business kind of trending flat, it is our intention to obviously return to positive growth hopefully in the near future. So no, I was not displeased in any way with our performance. And I think we are doing a good job overall managing the mix of both products and promotion relative to our direct business.

Okay, thank you.

Michael Lasser.

Barclays Capital. Thanks a lot for taking my question. Neil, how long can we expect that the process to find a permanent CEO will take place, and what will be your priorities and day-to-day involvement in the business as you are in the interim CEO role?

My wife said if we had somebody by Thanksgiving, she would be thrilled. We both know that's not going to happen. I don't think we want to set a timetable, because I think we want to find the best person we can. If you look at the last search, it took somewhere six plus months, plus or minus. I think that is probably as good an estimate as you can make at this point in time, to do the search right.

In terms of priorities, I think what my plan really is is to sit with the team and find the ways we can implement the strategic plan which I think is the right plan. At the same time, spend more time trying to find revenue-building opportunities, as opposed to just cost-cutting, which has to continue. And I really plan for the next several months just to listen, to spend as much time as I can in the organization, to get a sense from the people as to what we are doing right and where we can make improvements. I think we've got a very good team in place at this point, which gives me a lot of encouragement that I think we are moving in the right direction.

And then a quick follow-up for Steve Schmidt. I think your guidance implies that the operating margin in the fourth quarter will be up maybe 100, 150 basis points. A, is that appropriate; is that correct? And B, what is driving that and can we expect that to continue into next year?

Well, what we stated was in Q4 versus Q3 that our operating profit would be up $10 million versus prior year. So that is continued growth. We mentioned that we see, from a sequential, basis Q4 versus Q3, while we will still see the revenue down, it should continue to improve. And we are pleased with the progress we are making from a bottom-line standpoint.

The focus really has been around creating effectiveness and efficiency across every area of the organization. We've streamlined our overall cost structure from a selling standpoint. We are continuing to focus around supply chain. Our mix of products and services, particularly on the direct business, continue to trend favorably. So obviously, our commitment, as I have publicly stated, over time is to get these margins back into the mid-single digits, and we are making progress on that trek.

Okay. Is there anything unique above the fourth quarter that there will be a disproportionate amount of benefit?

Nothing that I would want to call out.

Okay, thanks. Best of luck for the rest of the year.

Thanks.

Brad Thomas.

KeyBanc. Neil, just one last follow-up on the CEO search. Will you be considering internal candidates or is this external only?

We are considering everybody, and obviously, internal candidates will always be included.

Okay, thank you. Charlie, I wanted to just follow up on some of the International trends. You obviously alluded to some of the changes in the political and economic backdrop over there. But could you just share some more insight in terms of what you are seeing?

I think what we are seeing is a strong improvement in our contract business. I think we actually mentioned the fact that our UK business was up mid-single digits in the third quarter, if we took out the public sector. And we are seeing those trends continue. So, getting good growth in the regional accounts, getting good growth also in some of our strategic accounts.

It is just that a big portion of our business in our major markets, UK, France, Germany, Netherlands, depends upon the government. And as you know also, the government is a bigger part of the economy in Europe than it is in North America. So it is kind of a double hit.

Retail is looking very, very strong right now for us. The French business has actually never been stronger from a retail perspective, and we've got good growth going in Sweden as well.

So, as I think Neil pointed out in his closing remarks, the issue that we have is really in the direct business, where we have a lot more competitive pressure than we've had in the past. We have plans to address that. And you will see those start to kick in in the fourth quarter.

Charlie, what I forgot when that question was asked, are we selling other assets, in my mind, I had already assumed that the situation in Japan had closed and had been announced, and it hasn't. You might want to say something about that.

Well, I think I would leave my remarks kind of where they are. We are consciously looking at (multiple speakers).

Okay, fine.

Just a quick follow-up on the business solutions. This is the first quarter that operating margin has increased year-over-year in several years. Obviously, the revenue backdrop is getting better. Do you think we are at that tipping point where we should continue to see margins improve in the division, or do we really need to get sales back into positive territory?

I would prefer not to really give any guidance relative to the future, just because of the uncertainty around the economy. What I would say, though, is when you look at the first half of the year, we did invest. We had anticipated an economic turnaround. We invested in sales costs. We added additional resources. We invested behind marketing. We invested behind a number of areas.

And at the end of the day, given the lack of an economic turnaround, obviously that impacted our margins in the first half of the year.

What we have done in the second half is really focused around cost reduction, mix, pricing, and really driving the fundamentals of the business, and that is why you are seeing the improvement in the overall margin structure.

Obviously, what happens from a competitive standpoint, what happens from the economy, are things that we can't predict. So obviously, again, my commitment -- and we believe it is attainable -- is to return this business to the mid-single-digit margin range over time, and we will obviously be committed to delivering that. But how fast and at what rate, yet to be determined.

Thanks. And if I could squeeze in just one last housekeeping item. Mike, could you give us an update on what you're thinking for CapEx for this year and perhaps an early sense for 2011?

Yes, we've guided -- probably the lower end of the previous range that we've given on CapEx, 170 to 180. As we go forward, we're looking probably -- we have just finished our strategic plan -- we have been looking at CapEx probably consistent with D&A, in the 210 to 220 range. We talked earlier in the discussion about touching our old format stores. We want to take 400 old format stores and put them in the new M format. That will be a significant CapEx driver going forward.

And we are also looking at a common systems platform for Europe going forward. So those will be two things that we are looking at that will drive the business. And given where we are with liquidity, cash flow, I'm particularly pleased with the third quarter cash flow -- those are the -- that is probably the long and short of CapEx guidance from where we sit today.

Great. Thank you, Mike.

Dan Binder.

Dan Binder, Jefferies. Neil, you mentioned earlier that you thought the strategy was right. I am curious, though, is there anything that you would say -- where there were philosophical differences that needed to be addressed more immediately? For example, store closures beyond your sort of typical maintenance of closing and opening in a new location?

And then secondly, is there any visibility on sort of this period after the US Communities contract was awarded to independent stationers, is there any visibility on the level of retention you think you can achieve with the various accounts that fell under that? In other words, are you getting signals from those accounts as to whether or not they plan on staying with you?

I'll answer the first part. I don't see any significant change in the strategic plan at this point at all. I think it is an executional issue, and I think it gets back just to the blocking and tackling and doing what we do best.

On the US Communities, let me ask Steve to talk about that.

Dan, from a US Communities standpoint, just to remind everyone, we are committed to our existing US Communities contract through January 1 of 2011. Obviously, we are prepared and have prepared to retain as many of those customers as we possibly can. We haven't given any guidance relative to the percent of customers that we will retain, but we do expect to retain the majority of them.

I mean, these are our customers. We have been servicing these customers. We've been selling to these customers, and we have the relationship with these customers. And we have all of the options that our customers will need to stay with the Office Depot Corporation.

But again, that process will take place as we move into the latter part of this year and early 2011. And we can give indications at that time.

In the most recent quarter, did your account wins offset your account losses? Was it a net positive or negative number?

As we stated, particularly in kind of our medium to large public sector -- excuse me -- private and public sector business, we are having very good success from the standpoint of acquiring new customers. And we are actually running at the highest retention rate that we have since I've been here. So clearly in our large segment, we are growing share.

Okay. And then, Mike, just one question for you. On the G&A cuts, the $100 million, I think you said you wanted to achieve by the end of 2013, is that a net number, or is that before investments that are needed to achieve those cost savings?

That's a net number.

Net. Okay, great. Thank you.

Mitch Kaiser.

Piper Jaffray. You talked a little bit about the Windows 7 launch. Could you just talk about what your thoughts are on the tablet and E-reader impact on the computing category, and maybe what your strategy is on a go-forward basis? And then I have a quick follow-up, too, if you don't mind.

I will take the question on the tablet. I think the tablet is certainly here to stay, with the launch of the iPad earlier this year. There are several million iPad tablets in the market. I think data that is published from a number of sources would suggest that it certainly impacted not only the netbook market, but has also impacted the laptop, and in some respects even in the smart phone market.

So I think it is a choice that both consumers and small businesses will make in terms of their computing needs. So therefore, for us, having a presence in the tablet category we think is important. We have picked a couple of tablets that we plan to have as part of our offer in the fourth quarter, specifically for our small and medium business customers. We've also enhanced our offering of accessories, both for Apple products, as well as other makers of not only tablets and smart phones.

So short answer is I think tablets are here to stay. I think there will be an evolution. It seems as though every week, somebody is getting in the tablet market. So we will try to stay at least on pace or ahead of that curve.

So is the expectation that you will have those in the fourth quarter here, in a meaningful way?

Yes.

Okay, and then just on Florida and California, I think California was the big turn. Could you just talk a little bit more about what you are seeing in California from the delivery side and also the retail side that suggested the sequential improvement relative to Q2? Thanks.

I'll take the retail piece and then let Steve address BSD. I still think if you look at California and Florida for the retail business, it is roughly 25% of our fleet of stores. If you look at unemployment in California and Florida, it is still running about 24% or more higher than the national average. I think the stores in California are well-known. There is still a furlough that I think is in place in public government there. So I don't think California is out of the woods.

That being said, for retail in the third quarter, students and parents still need to do back-to-school shopping. They still need the supplies to allow their student to go back to school equipped. And we did, I think, a good job, not only advertising the products that we had available for sale, we had attractive price points. And we were fortunate that when shoppers came in our stores, we were able to convert them to buyers.

So we are pleased with the results in California. I think we said they were slightly positive for the quarter. I don't know that is necessarily a telltale sign of what to expect in the future. I think they've got a lot of headwind that they are going to have to navigate through.

On the BSD side of the fence, I think Kevin articulated most of the key points that are consistent between retail and the BSD organization. As we look at our state business within the state of California, we have seen some leveling off versus prior negative trends. Obviously, we still remain concerned specifically regarding the furlough process, where most of the workers are off on Friday. But as we kind of look at our business overall relative to Florida, Texas and other key states, we have seen stabilization, primarily driven by the key trends that Kevin articulated.

Okay, thanks, guys. Good luck.

Kate McShane.

Citi Investment Research. Can you talk a little bit about what you are seeing in your furniture business? I think you highlighted it comped positively during the quarter. There is some thought out there that it is temporary, as landlords are incentivizing businesses to move to smaller spaces. Do you have any read on the sustainability of this trend?

We are very pleased with our furniture business. Office Depot for a period of time was in the furniture business. We lost our way. Our customers have told us over time that furniture is an important category for them. I don't think we were as relevant as we could have been.

So we've made a big investment in getting back into the furniture business, and it started really a couple of years ago. We've got an exciting private brand assortment, as well as national brands, a real focus on seating and modular furniture, and very, very attractive price points, not only within the OSS space, but perhaps more importantly, even within the broader retail space.

So I think we are increasingly becoming a destination for furniture. Data from NPD, which is a [private source] that provides market share, would probably confirm that. And at this point, we don't see any softness on the near-term horizon for the furniture category.

From a BSD standpoint, what we've seen is really kind of a pent-up demand. As you know, the furniture category over the last two or three years was in severe decline. So one, there is just a need out there for furniture. Two, what we've done is really focused on the basics -- core accessories, chairs, cabinets, the things that our customers need. And we have also, working with our merchants, have really created, I think, a line of product that meets the overall needs of our customer base.

So we've really seen an increase in demand relative to the furniture category. With that said, we do understand this is more of a discretionary purchase and so it is something that we need to continue to watch, versus what I will call core supplies, which is more of a day-to-day basic need.

Okay, great. That's really helpful. My second question is on private label. It sounded like it contributed positively to gross margins, both in retail and delivery. Did you have a notable increase in penetration of private label? Did that increase as a percentage of sales, or is it mix and what customers are trading to?

Probably more the latter than the former.

Okay, thank you.

Anthony Chukumba.

Anthony Chukumba, BB&T Capital Markets. Not to sort of beat a dead horse here, but I was interested in Steve's departure, just in respect of what role did BC Partners play, I guess, in the mutual decision? And then just as a follow-up, what role will BC Partners play in the selection of the new CEO?

BC Partners is on the Board. They had the same votes, if I want to call it votes, because we never voted as such, as all the other Board members. So they did not play any role other than as a Board member. And they are good Board members. This was not a BC Partners issue at all.

In terms of the search process, there are five Board members on the search committee, and Jamie Rubin of BC Partners will be one of the five.

Okay. Thank you.

Joscelyn MacKay.

Joscelyn MacKay from Morningstar. I just had a really quick question for International. With regards to the annual sale, I believe you said it was moved to the fourth quarter of this year versus last year it was in the third quarter. Would you be able to quantify the impact of that?

No, I can't quantify the impact. This is -- every year, we have our anniversary sale, and it is a three-day event. It tends to drive -- it tends to be very promotional, so the margins are not at the level that they normally are in our retail stores. But it does tend to drive a lot of top-line sales; it drives a lot of foot traffic through the stores.

So I think the main callout was that we were actually positive, despite not having that -- it was positive from a sales perspective without that sale, and we will not have those sales in the fourth quarter.

Okay, thank you.

I would now like to turn the call back over to Steve Turcotte.

It's Brian.

This concludes our call this morning. Please note that we updated our supplemental investor presentation that provides information on the Company and placed it on the Investor Relations website this morning. Thank you very much for participating in the call. I'll speak to you soon.

That concludes today's conference. Thank you all for joining. You may disconnect your lines at this time.