ODP Corp (ODP) 2010 Q4 法說會逐字稿

Good morning and welcome to the fourth-quarter 2010 earnings conference call. All lines will be on listen-only mode for today's presentation, after which instructions will be given in order to ask a question. At the request of Office Depot, today's conference is being recorded.

I would 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 and good morning. On the call today are Neil Austrian, interim Chairman and Chief Executive Officer; Mike Newman, Chief Financial Officer; Kevin Peters, President of North American Retail; Steve Schmidt, President of North American Business Solutions; and Charlie Brown, President of International.

Before we begin, I would like to remind you that our discussion this morning includes 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 refer to certain non-GAAP or adjusted financial measures. A reconciliation of these non-GAAP financial measures to the directly comparable GAAP financial measures as well as our press release and accompanying webcast slides for today's call are available on our website, www.OfficeDepot.com. Click on investor relations under Company information.

Neil will now summarize Office Depot's fourth-quarter and full-year 2010 earnings results. Neil?

Thanks, Brian, and good morning. Before I review our results, I would like to update you on our CEO search. As I told you in late October, we had begun the process of identifying candidates with the assistance of our executive search firm, Heidrick & Struggles. The search committee, which includes five Board members, has met with a number of candidates over the past four months. Although we hope to conclude the process within a reasonable timeframe, we will take as much time as we need to find the right leader for the Company and our shareholders. All I can say at this point in time is to stay tuned.

With that, I will review our results. Office Depot's fourth-quarter 2010 sales totaled $3 billion, a decrease of 3% compared to our fourth-quarter results in 2009. The Company reported a net loss after preferred stock dividends of $58 million or $0.21 a share in the fourth quarter of 2010 versus a loss of $77 million or $0.28 a share in the same period one year ago.

Fourth-quarter 2009 results included charges related to restructuring actions which negatively impacted earnings by $0.22 a share.

The reported results for the fourth quarter of 2010 included actions to improve future operating performance, change the ownership structure of certain international investments, and eliminate nonproductive corporate assets. Excluding these actions and certain costs related to executive severance and retention, fourth-quarter 2010 net earnings after preferred stock dividends were $24 million or $0.09 a share. These results were favorable to the outlook we provided in October due to stronger than anticipated operating results and significant tax benefits from carrying back 2010 tax losses to an earlier tax period that positively impacted earnings in the fourth quarter.

Total company gross profit margin increased about 60 basis points in the fourth quarter compared to the prior year. This was our sixth consecutive quarter of year-over-year gross profit margin improvement. Our North American Retail and Business Solutions divisions were both successful in increasing their gross profit margins compared to the prior year in a weak sales environment.

Total Company operating expenses adjusted for charges in the quarter decreased by $41 million compared to the fourth quarter of 2009. This year-over-year decrease primarily reflects lower G&A expenses due to lower payroll and legal fees, an insurance settlement reached during the quarter, and the effect of accelerated vesting of certain employee stock grants in 2009, partially offset by higher advertising expenses.

EBIT adjusted for charges with $26 million in the fourth quarter of 2010 compared to an EBIT loss adjusted for charges of $5 million in the prior year period. This year-over-year improvement was driven by lower operating expenses.

For the full year, sales decreased 4% to $11.6 billion. The reported net loss after preferred stock dividends for fiscal 2010 was $2 million compared to a loss of $627 million in fiscal 2009. The loss per share on a diluted basis was $0.01 in 2010 compared to a loss per share of $2.30 in 2009.

Adjusted for charges and certain tax benefits, net earnings after preferred stock dividends for the full year 2010 were $30 million and the diluted earnings per share were $0.11 per share. We recognized additional tax benefits from carrying back 2010 tax losses to an earlier tax period, which positively impacted earnings for the full year 2010. Adjusted for charges and the impact of tax adjustments, the net loss for the full year 2009 was $71 million and the diluted loss per share was $0.26.

Adjusted for charges, 2010 total Company operating expenses decreased by $109 million versus 2009. For the full year 2010, EBIT adjusted for charges was $86 million compared to an EBIT adjusted for charges of only $8 million in 2009.

Mike will go into more financial details later in the call. I will now ask Kevin to review North American Retail's fourth-quarter and full-year performance.

Thanks, Neil, and good morning. In the North American Retail division, fourth-quarter sales were $1.2 billion, down 2% versus one year ago. Same-store sales were down 1% versus the prior year period.

Consumer transaction counts in the fourth quarter were slightly positive versus the prior year for the second consecutive quarter and our average order value declined in the low single digits during the quarter versus the prior year. This AOB decline was not surprising as the sales of big ticket items were down due to reduction in our television offering and the anniversary of the Microsoft Windows 7 launch in 2009 which drove software and computer purchases for the prior-year period.

Overall, however, the technology category continued to post strong results in the fourth quarter. We were pleased with our performance and strategy to provide customers an expanded Black Friday and holiday season product offering. Notebooks and printers sold well and exciting new products such as tablet computers and Apple accessories were popular items among all of our customers.

Furniture comp sales were positive in the fourth quarter, a testament to our merchandising efforts and the success of our private brand direct sourcing program. In fact, the direct import penetration in retail increased as a percent of sales to double digits in the fourth quarter.

Growing sales of our high margin service offerings continues to be a great opportunity for Office Depot. I am pleased that our Tech Depot services reported double-digit sales gains for the second consecutive quarter and Copy and Print Depot comped positively for the fourth consecutive order. We are encouraged that these value-added services continue to gain awareness and traction with our customers and we believe they have a great deal of upside.

Our North American store count at the end of the fourth quarter was 1147 stores. During the quarter, we opened three new stores, closed six, and relocated four stores. We also remodeled 12 stores during the quarter. Of the 12 remodels and four relocations, we successfully reduced the space in those locations by about 20% on average. Although we are pleased with the success of our space reductions in the fourth quarter, this rate may not be indicative of future opportunities.

North American Retail operating profit in the fourth quarter was $16 million, up $14 million from the prior year period despite lower revenue. This performance was driven primarily by better management of promotional activity during the holidays, reduced occupancy costs, and an adjustment to variable base pay in the quarter. These benefits were somewhat offset by increased advertising expense and the negative flowthrough impact from lower sales.

Turning to our full-year 2010 performance, North American Retail sales were $5 billion, down 3% from the prior year. About half of this decline was driven by having fewer stores open versus last year. You may recall that we closed 120 stores during 2009 as part of our restructuring efforts. Same-store sales for the one-year were down 1%, which is a significant improvement versus the 14% decline in 2009.

Our full-year operating profit increased from $106 million in 2009 to $128 million in 2010, driven by higher product margins, lower occupancy costs, and adjustments to variable base pay. Partially offsetting this increase was higher advertising expense and the negative flowthrough impact from lower sales.

In terms of the initiatives in North American Retail to drive sales and reduce costs, I've spent a significant amount of my time over the last several months visiting stores, speaking with customers, assessing the customer shopping experience, and taking a hard look at our product assortment and pricing actions. My take away is that while we run a good retail operation, it's clear to me that we can get better.

To raise the bar, we are targeting our efforts and resources in 2011 on a more narrowly defined set of initiatives that will improve the customer shopping experience and enhance our profitability. Areas of focus will include the following.

First, we will improve our in-store shopping experience. We will look at our labor model and work schedules, eliminate non-value-added activities, invest in training, and improve our visual merchandising. Second, we will invest in Copy and Print Depot as well as Tech Depot services. These two businesses consistently produce favorable results with positive sales growth and we are in the process of piloting a few significant enhancements to both models as well as a set of actions to improve awareness, trial, and retention.

Third, we are focused on improving the productivity of our stores. This includes remodeling traditional stores into our M2 format and reducing our average store size wherever possible. We are also piloting a new urban concept store with a lower breakeven, improved sightlines, more appealing visual merchandising, and stronger shopping adjacencies. As we've mentioned before, about 10% of our store base comes up each year for renewal and we will continue to pursue rent reductions and downsizing opportunities as part of this process. We've had some success with this initiative in the past year and it remains a key part of our real estate strategy.

Fourth, improving the balance between private brands and global sourcing will be an important ingredient for continued margin growth and enhancing customer loyalties. Our progress with global sourcing has been very good but we will re-energize our private branding efforts in 2011 as part of our ongoing rationalization of the product assortment.

In summary, our North American Retail business remains focused on delivering its key initiatives to improve sales, reduce costs, and enhance our customer shopping experience. Although the reallocation of some marketing spend to drive these initiatives could negatively impact sales growth in the short term, our profitability should improve over the long term as investments mature.

Looking forward, the first quarter is our back to business season. Even though some of the areas of economy are showing signs of improvement, we have not seen a significant change in consumer and small-business spending habits to date and the winter storms in January and February have negatively impacted our business. As a result of these factors and lapping shrink improvements in the first quarter of 2010, we anticipate that our first-quarter same-store sales and operating profit will be down versus last year.

Steve Schmidt will now review the fourth-quarter and full-year 2010 results for the North American Business Solutions division. Steve?

Thanks, Kevin, and good morning. In the North American Business Solutions division, fourth-quarter sales were $798 million, down 3% versus the same period last year. The negative sales impact from the restructuring of a non-core business in early 2010 on a year-over-year comparison was about 100 basis points in the quarter. Although still negative, it was the best year-over-year sales comparison we have experienced in over three years.

If we look at our product categories, we did see solid sales in writing instruments, break room supplies, and seating in the fourth quarter compared to the prior year as well as improving trends in the paper category. Although some months have been better than others, we have yet to see any meaningful favorable trends around discretionary spending by our customers.

Geographically, fourth-quarter sales in California were again in line with the overall BSD business and seemed to have stabilized. We are encouraged by the significant region sales trend over the last two quarters and look forward to continued recovery.

Although the division's fourth-quarter average order value was slightly lower versus the same period last year, lower customer transaction counts continue to be a main driver of our sales decline in this quarter. The good news is that the rate of decline has improved sequentially over the last seven quarters.

Turning to the direct channel, we are pleased that our sales in the fourth quarter were up versus one year ago. This is the third consecutive quarter of improved sales results and demonstrates the effectiveness of our marketing efforts and online web enhancements to drive traffic and conversion at our website. In an effort to stay current with the changes in technology and consumer buying habits, we recently added an Office Depot iPhone application that can be used by our customers to locate stores, browse the product catalog, and purchase products directly from their smartphones.

If we look our contract channel, sales declined in the fourth quarter versus last year but the rate of decline continued to improve. We continue to see weakness in the state and government area of our business but are focused on winning new business and retaining existing customers remains a priority.

For example, federal government sales grew double-digit in the fourth quarter. Additionally, sales to our small to medium-sized business customers performed better than the division average and we enter 2011 trending flat year-over-year. Overall, we won or retained over 85% of our contract bids of $75,000 or greater in the fourth quarter and third-party industry data indicates that we gained unit and dollar share in contract among the OSS players.

With regard to our public sector business previously associated with US Communities Contract, we began transitioning our customers to The Cooperative Purchasing Network or TCPN, and National IPA purchasing consortiums effective January 1. To date, we are pleased to report that we are retaining revenue at around this 85% rate.

In addition, some customers that we initially did not retain have recently begun switching back to Office Depot as their office product supplier. These early results confirm our belief that our long history of providing quality products and great service to our thousands of value customers nationwide would help us retain a significant amount of this business.

Global Company Internet sales for the past 12 months totaled $4.1 billion with 86% of total BSD sales online, up from 84% for the same period a year ago.

Fourth-quarter operating profit for BSD was $37 million, an increase of $16 million compared to the same period a year ago. The year-over-year increase in operating profit was driven by gross profit margin improvement of about 150 basis points, the execution of initiatives to reduce the division's cost structure, and an adjustment to variable base pay in the quarter.

For the full year 2010 performance, BSD sales were $3.3 billion, down 6% versus 2009. Full-year operating profit was $96 million, down approximately $2 million from 2009. The slight operating profit decline was driven by the flowthrough effect of lower revenue and incremental marketing expense in the first half of the year partially offset by moderate margin improvement and reduced operating expenses.

In North American BSD, we are focusing on three key initiatives to drive sales and improve margins in an environment that remains difficult. And I will now review these with you.

First, we are determined to increase our customer mix of small to medium-sized business customers. This initiative has been a priority over the last several quarters and we feel that we are gaining traction as evidenced by our fourth-quarter performance in this group. We are also implementing new marketing and reward programs to drive customer loyalty and retention within this customer group.

Second, we are continuing to grow our Copy and Print business. We have a great opportunity to expand this service with our contract customers using Office Depot's 10 regional print facilities and will continue to invest to grow in this business.

Then third, we continue to look at new business verticals that could increase sales and margin. Some of these new business platforms utilize asset light models to build partnerships and provide compelling service and solutions.

We have a number of projects in the pipeline but an example of past successes include cobranding a set of office supplies with little drug stores. Little drug is the largest supplier of products to the convenience store industry. Our relationship will enable Office Depot to be sold in more than 80,000 convenience stores when fully ramped.

While I won't go into specifics at this time for competitive reasons, we are also fully engaged in developing a suite of services and solutions for our business customers which will begin delivering revenue and profit contributions in the second half of this year.

In summary, our direct channel is executing very well and we expect greater returns from this area in 2011. We have work to do in contract but we continue to win and retain new business in the fourth quarter and believe that we have a more efficient cost structure entering 2011.

Looking forward, we expect our first-quarter sales to decline at a similar pace to the fourth quarter but we will depend totally on the impact of continued bad weather throughout the US. Additionally, we expect the first-quarter operating profit to be slightly lower compared to last year due to a slow start for back to business season this year, winter weather disruptions, and the transition of the public sector consortium business.

Charlie will now discuss the fourth-quarter and full-year 2010 results for the International business. Charlie?

Thanks, Steve, and good morning. The International division reported fourth-quarter sales of $930 million, a decrease of 5% in US dollars compared to the prior year.

Our constant currency sales were about flat versus a year ago and excluding the negative revenue impact of our divested businesses in Japan and Israel on a year-over-year basis, constant currency sales growth was positive for the first time since the second quarter of 2008.

Most countries in Europe showed sequential sales improvement in the fourth quarter. The UK reported positive sales growth compared to the prior year ending a protracted sales decline. Asia continued to perform externally well, with double-digit sales growth in the fourth quarter.

We had a solid sales performance in our Contract channel during the quarter growing mid-single digits in constant currency compared to the prior year. Sales to our small to medium-sized businesses and large national account customers continued to grow and more than offset softness in the public sector which was attributable to the various government austerity programs enacted last year.

Geographically, our contract sales results improved sequentially substantially in most of our larger markets. For example, the UK contract business increased about 10% in the fourth quarter. In addition, our Contract business in Asia also performed very well with double-digit sales growth in the quarter.

Fourth-quarter sales in the direct channel were lower than the year ago but the rate of decline actually improved sequentially. We are currently executing on initiatives to increase our customer base and sales in order to drive our competitive position in the direct channel.

Retail sales in the fourth quarter grew mid-single digits compared to prior-year in constant currency excluding the 2009 store closures in Japan and the sale of our business in Israel in the fourth quarter of 2010.

Our Retail business in France had another successful quarter improving sales sequentially from the third quarter. The International division's operating profit was $21 million for the fourth quarter compared to $64 million reported in the same period last year. The reported operating profit of $21 million includes $23 million of charges associated with the business restructuring and costs related to our portfolio optimization actions in the fourth quarter of 2010. The portfolio optimization costs include a large amount of non-cash currency translation adjustments.

The year-over-year operating profit decline was primarily driven by a reduction in gross profit margin because of product cost increases that were not fully passed along to customers, lower vendor rebates of promotional activity in the current year related to the holidays. Foreign currency translation in the fourth quarter negatively impacted results by $3 million. These items were partially offset by lower occupancy costs, benefits derived from reduced G&A costs compared with last year and an adjustment to our variable base pay in the quarter.

Turning to our full-year 2010 performance, sales were $3.4 billion, down 5% in US dollars and down 2% in constant currency including a 100 basis point impact from the divested businesses in Japan and Israel.

Full-year reported operating profit was $111 million compared to $120 million in 2009, including the $23 million of fourth-quarter charges. The main drivers of this increase in the operating profit excluding charges included better pricing management for the year and reduced distribution in G&A expenses compared to the prior year. These benefits were partially offset by the unfavorable flowthrough impact from lower sales and foreign exchange translation.

We continue to focus on advancing our strategic initiatives that will position the international business to increase sales and deliver improved profitability.

I would like to take a moment to update the three that we are focused on currently. First, following several months of negotiations, we executed several changes in our portfolio of operations during the fourth quarter. This strategy will be an ongoing process to optimize our international portfolio of businesses and increase shareholder returns.

As I mentioned, we sold our businesses in Japan and Israel and converted them into licensees. Both of these transactions will be accretive to the Company and the proceeds will be applied to the acquisition of Svanstroms in Sweden. We have been successful in this market and see continued growth and high potential in the region.

This acquisition combines the global resources of Office Depot with local talent, market knowledge, and resources of Svanstroms who provide both our Nordic and European business customers an integrated solution for all their office supply needs. We believe that expanding our global footprint remains an important vehicle for the Company's long-term growth.

Second, during the quarter, we have launched a business restructuring and continuous improvement initiative in Europe. This initiative will reduce costs as a result of implementing a common IP platform, improving the productivity of our supply chain, reducing indirect procurement costs, and fostering a culture of continuous improvement throughout all our markets. We believe we can enhance our current processes and leverage our resources, enabling us to continue reducing our overall cost structure.

And then third, as mentioned last quarter, we are focused on winning new customers and increasing the loyalty of existing SMB customers. We have been refining our business model to become more customer-centric with better segmentation and coordinated contacts, refreshed branding, and better e-commerce tools. These actions are driving growth in our overall small to medium-sized business customer base in Europe.

In summary, the International Business Division performed well again this quarter as we improved our sales trends and lowered operating expenses.

Looking forward, we will continue to focus on executing our strategic initiatives and managing our cost structure. While our sales improved throughout 2010, the situation remains volatile in Europe and our forward visibility remains somewhat muted as we move through the quarter.

Similar to the situation in North America, a number of weather-related events have specifically impacted our revenues. As a result, we expect our first-quarter sales in constant currency to be flat to slightly lower than the prior year and operating profit to be slightly down.

I will now turn the call over to Mike, who will review the Company's financial results and restructuring actions in more detail.

Thanks, Charlie. I'd like to give additional details on our announced restructuring actions and benefits for the fourth quarter of 2010 and going forward. We initiated this round of restructuring actions in the fourth quarter to both respond to the continued soft top line we experienced throughout 2010 and to better position our business competitively by addressing cost opportunities globally.

Let's first discuss the restructuring. In the fourth quarter, we reported $87 million of charges, of which $51 million related to write-offs of certain software applications and $11 million related to costs associated with the sale of our businesses in Japan and Israel. I should note that the $51 million software write-off has no present or future cash impact.

Of the remaining $25 million in charges, $12 million was for international restructuring actions that Charlie discussed earlier relating to European process improvements and about $13 million related to with CEO severance and retention arrangements with certain executives.

If we look at 2011, we anticipate an additional $70 million to $80 million in charges primarily related to global process improvements and cost reductions. The negative cash impact from these charges could be in the $65 million to $70 million range in 2011 and relates mostly to severance and facility closure costs.

In total, we anticipate incurring $170 million to $180 million in charges for the actions I just mentioned over the three-year period through 2013. This range includes the $87 million of charges taken in the fourth quarter, the $70 million to $80 million of charges anticipated for 2011, and any additional charges left be taken in 2012 and 2013.

Let's now discuss the benefits from both the restructuring actions and our previously announced business process improvement or BPI program.

In 2010, we realized $6 million in benefits mostly from indirect spend cost savings. We anticipate the combined 2011 P&L benefits to be about $80 up to $90 million, most of which will have a positive cash impact. The benefits will come principally from headcount reductions, process improvements in both our domestic and international businesses, the elimination of losses as a result of divesting our businesses in Japan, and indirect spend cost savings.

It's important to note that we will be reinvesting $40 million to $50 million of the $80 million to $90 million in 2011 restructuring benefits in three key areas.

First, we will invest in additional resources to drive process improvement in key areas of the business such as improving the customer shopping experience in our retail stores. Second, we will also invest in the growth of our service offerings globally, which we feel are under penetrated and have great upside potential. It's too early to articulate the benefits from these investments, but we will be updating you with more detail as we go forward. We do expect these investments to generate some benefits in 2011 and 2012.

Third, we will return benefits to our associates that had been withdrawn as part of a cost-cutting initiative in 2009, including annual merit increases and 401(k) matching.

In total, we anticipate realizing an annual benefit run rate of $180 million to $190 million by 2013 from these actions. Again, this range includes both restructuring benefits and our anticipated bpi savings of $100 million from indirect spend cost savings and financial process improvements that we have announced earlier.

Turning to our results, the fourth quarter and full year 2010 tax rates on a reported basis were a benefit of 37% and 159% respectively. The tax benefits were primarily driven by tax settlements and the Company's ability to carry back the 2010 tax loss to an earlier period. Because the Company continues to carry a full valuation against deferred tax assets in the US, the carry back of the 2010 tax loss and the resulting cash tax refunds are taken to operations and therefore impacted 2010 effective tax rate.

With the completion of the 2010 tax year, the Company has exhausted its ability to carry back tax losses at the US federal level. This combined with the full valuation allowance against deferred tax assets in the US jurisdiction will likely adversely impact future effective tax rates.

We are currently estimating an effective tax rate of approximately 30% for 2011. However, any changes in the geographic mix of earnings will possibly also have a significant impact on the rate.

Taking a look at cash flow, we ended 2010 with free cash flow of $30 million compared to $166 million at the end of 2009. This free cash flow performance fell below our expectations due to higher inventory investment and working capital timing issues in Europe.

We invested $169 million in capital expenditures during 2010, including investments in IT, supply chain infrastructure, and the remodeling of our retail stores. 2011 capital spending is estimated to increase to approximately $180 million in order to fund ongoing maintenance and other investments needed to drive the Company's strategic plan.

During the fourth quarter, we recorded a dividend on our convertible preferred stock of approximately $9 million which was paid in cash on January 3 of 2011.

Moving to our balance sheet, we ended the fourth quarter with $627 million of cash on hand, slightly lower than the same period in 2009 and including availability from our assess-based loan facility of $674 million, our liquidity totaled about $1.3 billion at the end of the quarter. We did have borrowings of about $52 million in Europe on our assess-based credit facility at the end of the fourth quarter and this related to our acquisition of Svanstroms in Sweden and tax planning in Europe.

Inventories totaled $1.2 billion globally, slightly down from the fourth quarter of 2009, and receivables of $1 billion were down 8% or $95 million compared to the fourth quarter of 2009, reflecting both operational improvements and currency impacts internationally.

Looking at the first quarter of 2011, we expect total Company sales to be down about 3% versus the prior year including the unfavorable impact on sales of both foreign currency and the divestiture of our businesses in Japan and Israel.

First-quarter EBIT is anticipated to be down compared to last year as a result of higher marketing costs, winter weather disruptions experienced to date, spending to drive growth of our service offerings, and investments in business process improvement opportunities across the enterprise. Although we are two months into the first quarter, March is typically the month that makes the first quarter for us and results could swing up or down at quarter end.

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

Thanks, Mike. Before we open the call to Q&A, I would like to share a few of my observations after almost four months as interim Chairman and CEO. I've spent a great deal of my time reviewing the three businesses and talking to everyone from our associates and vendors to our sales team and customers. My take away is we've got great associates who are smart, work hard, have great ideas, and want to win as much as I do. Trust me, I want to win, but to do so we will need to change the way things are done going forward.

First, as you've heard from the Company's leadership this morning, we are limiting the number of things we do and we are reallocating our resources to do them well.

Second, we will improve the customer experience in every channel. Third, we will market and sell our products, services, and solutions as never before. And fourth, we will invest in our most valuable resource, our people. We will hire, train, develop, and retain enabled, empowered associates to lead the Company into the future.

I am really excited about the opportunities we have to get Office Depot back on track and look forward to sharing our successes with you.

Operator, we are now ready to take questions.

(Operator Instructions) Chris Hofers.

Good morning, it's Aaron for Chris at JP Morgan. Just on the 85% retention rate, do you see any risk to that number? Have you signed these people to longer-term deals? And was any of that expensive margin?

Aaron, this is Steve Schmidt. We feel very good about the retention rate at the 85%. We have signed up the majority of these customers to longer-term agreements. As I said during the presentation, we have actually won back already three or four customers who had switched have now come back to us because of the service levels they were receiving. And we are also continually working with the customers that have left us and come back to Office Depot in addition to going after new customers.

So we feel very good about where we came out in this entire process and obviously it's a tribute to our team and the relationship we have with our customers.

Relative to margin, it's really too early to call although I would simply say that if you recall, on the past agreement that we had, what we talked about should we have stayed in that agreement, we believe that we would have been put into a situation of losing money.

This will play out over the course of the entire a year based on mix of services, mix of products that our customers buy, but we feel optimistic at this point relative to the total business.

Great, and then just on your weather comments for NAR and BSD International, can you maybe help us quantify how much that is, how much that is impacting your business?

I'll take it first, Steve here, and then Kevin can handle on the retail side. This is a tricky one because clearly we've had severe weather in most parts of the country from Chicago to the Northeast to Texas and in the Southeast. And as we look at the month of March, we are now tracking over bad weather a year ago but clearly it has impacted our business. We have had many of our distribution centers down in those parts of the country. And obviously when people don't work, they don't consume office supplies. And so it is going to have an impact on our business at this point.

With that said, maybe we can have a great March and overcome some of that. But through the first two months of the quarter, it does have an issue on our business. We just simply haven't quantified exactly what that impact will be.

I would say the same thing holds true for retail. Certainly we had store closures and our supply chain was shut down due to weather. But March has historically been a good month for us and we are on the front-end of that, so we will just have to see how it plays out.

Great, best of luck.

In International, I really couldn't add much more. It's pretty much the same thing, very bad weather in the UK and Northern Europe, but again, we're looking for a very strong March.

Great, thank you.

Matthew Fassler.

This is actually John from Matt's team at Goldman Sachs. First question, would you mind detailing the magnitude of the incentive comp benefit to the quarter and how that fared relative to what you were thinking at the outset of the quarter?

This is Mike Newman. The incentive comp benefit to the quarter, we were not going to call out the call amount but we were favorable in G&A and it played a significant role in the favorability. I won't say it was the dominant role, but it did have -- it did make the top few items from a variance perspective. And that was fairly consistent with our thoughts at the beginning of the quarter.

Okay, so pretty much in line with what you were thinking. You mentioned solid sales for BSD in writing instruments, break room supplies, etc. Would you mind giving a little detail on how ink and toner trended throughout the quarter? And then just any other broader comments on the core office supply segment.

Regarding ink and toner with BSD, the trends continue to move in the right direction, as does paper. So we continued to see movement relative to revenue and profitability in both of those categories. So we are optimistic as we enter 2011 and hopefully those trends will continue.

Got it. And then finally, last question. I guess any updated thoughts on capacity in terms of potential for store closings as you think about the broader market? I know you guys are looking at downsizing stores and rent reduction, but any thoughts on actual store closings?

Other than what we've outlined in our opening remarks, we don't have plans to close stores beyond that.

Okay, that's it. Thanks a lot.

Oliver Wintermantel.

IT's ISI. Good morning, guys. In your press release, you said that you weren't able to pass through some of the product cost increases in International. Was it also an issue in the US?

On the BSD side, it was not an issue in the fourth quarter from a price increase. So we did not have significant price increase activity in BSD.

To be clear, Oliver -- this is Charlie -- the biggest issue that we have is around paper and we had a fairly large increase in the late part of 2010 and again, some of our customers are simply pushing back. A lot of it is due with the economics that they are experiencing.

Okay, great. The second question is just a more strategic or longer-term question. OfficeMax and Staples, they gave longer-term margins goals. Could you talk a little bit about where you think Office Depot margins could go back to? Can you see margins going back to 5% in the medium or longer-term?

Oliver, this is Mike Newman. It all depends on the type of recovery we have. I have been reluctant to get out there in front of the Street given our inability to see the top line. Once we see the topline stabilize and start to go positive, I think a lot of the restructuring actions that we've taken, we announced today will play a significant role in us starting to recover margins and get back to that 3%, 4%, 5% margin rate in the next three years. Do I think it's possible? Yes, but it's going to take some recovery.

I very much like what we have done with the restructuring actions we've announced today to help us accelerate that though. So a lot of it depends on the top line but we've done a lot of things here that we've announced today that are under our control that can help us get there as well.

Great, that's very helpful. Thank you.

Brad Thomas.

Brad Thomas, KeyBanc Capital Markets. I wanted to just follow up on the restructuring efforts just to make sure I understand the numbers clearly. Mike, so as we reconcile the $80 million to $90 million in P&L benefit in 2011 versus the $40 million to $50 million in reinvestments that you're planning, should we think of that as an EBIT benefit in 2011 of $30 million to $50 million? Is that the way to reconcile?

Yes, those items are mostly on both sides -- the cash, there isn't any cash dislocations from looking at the benefits and the reinvestments. Most of the restructuring actions we are taking are going to take place early in 2011, so we will get the benefit of a lot of those for the balance of the year. And the reinvestments that we are making, we are starting to put in place right now. So that's -- simply said, that's the right way to look at it.

Great, and as we think about the cash flow outlook recognizing that you may have $65 million to $70 million in costs associated with some of these restructurings, do you believe that you can be cash flow positive in 2011?

Yes, with all that's flowing through, we guided in the script on CapEx. We said our CapEx will be $180 million. Our D&A is looking to be in the $220 million range and we're looking at free cash flow with all these restructuring and reinvestments still in the $50 million range for 2011.

Clearly when you are taking the charges we are taking, the charges, the benefits we have articulated and the reinvestments, we are slightly under water with all those numbers that we guided. Just to reiterate, the charges in 2011, we said $70 million to $80 million, the benefits $80 million to $90 million, the reinvestments $40 million to $50 million, all that nets out to a negative number. We can absorb that and still deliver a free cash flow number of somewhere around $50 million.

Great. Thanks, Mike. Then just wanted to follow up on some of the commentary around the switch to variable based pay. I was hoping, Kevin and Steve, you could perhaps comment a little bit more about what it is that you've changed in terms of the compensation model. It certainly looks to have had a benefit in the fourth quarter.

I'm not sure I understand what you mean by our shift to variable based pay.

I think it was just a commentary in the press release around both the Retail Division and the BSD benefiting from adjustment to variable based pay during the quarter.

No, these were adjustments to basically variable based pay accruals in the quarter as opposed to a change in methodology on our compensation policies.

Okay, got you.

It's really a true up.

Just a true up, got you. Lastly, then was just hoping, Kevin, you could maybe comment a little bit more about the professional backdrop. One of your competitors last week talked about things looking a little bit more competitive, this in contrast to several quarters where it sounds like the industry has been a little bit more benign and rational from a promotional perspective. What are you seeing out there? What are your expectations for 2011?

I think the one thing that we talked about going into Q4 is that we were going to be less promotional than we have historically been. And so our opening price point strategies and our clearance activities I think aligned well to that. So I think a lot of the benefit that we got in Q4 was being a little bit smarter about how we price our products and I think we are certainly pleased with the results in Q4.

I don't see necessarily the level of promotional activity that we saw in Q1 a year ago. So to use your term benign, I think it's certainly less promotional. I don't know that it's necessarily benign, but I think it's less promotional than it certainly was a year ago.

Great, thanks so much and best of luck.

Emily Shanks.

Emily Shanks, Barclays Capital. Thank you for taking the question. I wanted to get a little bit of clarification around the tax benefits amount and specifically I noted in the footnote, in the sell reconciliation that you indicated that you will receive a tax refund. What is that dollar amount and when will that be received?

Yes, we have received considerable tax refunds this year that relate to prior periods. To reiterate, if you look at our fourth quarter and total year reported tax rate, we are 37% and 157% respectively. For the current period, the cash tax impact of those rates is relatively small, but we have received refunds from prior periods that are significant and actually in 2010, in excess of $50 million.

So we have had benefits this year that relate to prior periods. They are operational in nature. But those benefits that we have received do not relate to the current tax provisions in either Q4 or total year 2010. Does that help?

That helps a lot. That helps clarify it. To be clear, we should expect some type of tax refund, cash tax refund in fiscal year '11?

We would expect to see -- and we are not going to call the amount out, but we would expect to see additional cash tax refunds in 2011, yes. And that is factored into the guidance I gave earlier on free cash flow.

Okay, perfect. That's what I'm looking for. Then in terms of the International EBIT, I know that you noted that product cost increases were impacting that segment. Can you give a little color specifically around what that is and why that is not affecting North American Retail?

This is Charlie. In terms of speaking to the cost increases, this really falls into two areas. One I'd mentioned earlier, which is paper. And in the early part of the fourth quarter we experienced price increases around paper, and particularly increases that were in the lower grades, the so-called C grade paper, that we just had a hard time passing along and it's had a direct impact on our margins.

The other area where we've experienced some pressure is in ink and toner, where we have specifically taken a strategy to be more competitive in some of our pricing. That area is quite competitive in Europe, and we've taken the stance to match that competition. And the good news is we are actually growing our customer base again in the Viking direct business as a result of that.

But again, it's cost us some of the margin which is why, as Mike Newman pointed out earlier, our continuous process improvement it is really important to bring our costs down so we can continue to build our EBIT.

Okay, and are you seeing those same pressures in North American Retail and it's just being offset or is it something specific?

Emily, this is Kevin. I think if you think about obviously the mix, the retail store base mix in North America compared to Europe, we are fortunate in that whatever price pressure we feel for all intent and purposes we can pass on. We are not running the same business as Charlie is in International. So although the price pressures have not been as strong in North America as they have been in Europe, we have been able to pass on most of those price pressures.

Great, thank you for the clarification and the detail. Best of luck.

Anthony Chukumba.

Anthony Chukumba, BB&T Capital Markets. Just had a question in terms of your stores in terms of reducing the store size. Can you just sort of quantify how many -- what percentage of your store base I guess is still too large and what are your plans in terms of converting stores to the small store format in fiscal year '11?

Anthony, this is Kevin. It's probably a conversation that would take longer than we have I think today. But I guess maybe the easiest way for me to talk about it is we have call it roughly 100 leases that come due each year for renewal and we are using each of those opportunities to either relocate our stores and/or remodel and downsize the stores.

And so that was essentially the plan that we had in place this year. We had some success in relocating to smaller footprints and also remodeling and downsizing the store base. We will continue to do that in 2011.

The stores that specifically I think are a challenge for us are what we characterize as kind of the traditional store base. The traditional store base is best described as those stores that have the blue and red and white racking in it. It goes back to the days of kind of big-box retailing and those stores are probably closer to 30,000 square feet and present the big opportunities for us. So clearly as those come up to the lease renewal process, we will attack those and as opportunities exist outside of that to attack them, we will do that as well.

So as I think we mentioned last time, our new M2S and M2L model is kind of the go forward prototype for us. It's -- call it 17,000 square feet, so clearly opportunities for us to downsize our store base and lower our occupancy costs. We have had success with it in 2010; we're hoping to have similar success in 2011.

Okay, thank you.

Curtis Nagle.

Bank of America Merrill Lynch. This is just a quick kind of housekeeping item and forgive me if you've addressed this, but just regarding your diluted share count, it looks to me like last quarter in the third quarter, you had a share count again diluted of approximately 354 million and now it looks like it is back down to 275 million, 276 million range. I was just wondering I guess what accounts for that or how I should account for that?

Hey, Curtis, it's Brian. Each quarter we have to calculate our EPS both on a diluted and a basic basis and whichever is most dilutive, that's the share count we use. This quarter the basic was the most dilutive, so that's the share count. We have to check it every quarter and again use the most dilutive EPS.

Okay, is there a way that going forward we would account for that or should we just use the --? I understand what you are saying, but again just from a modeling perspective, should I continue to use the 276 million as the best number?

The thing to do is with your model I would use both methods and whatever is most dilutive, use that for your model. I will help you to go through with the calculation with you off-line, but I would say just do both.

Okay, that would be great. Thanks a lot. I appreciate it.

Michael Lasser.

This is Blake Wu sitting in for Michael Lasser at Barclays Capital. Thanks for taking the question. Just a quick follow-up to the pricing pressure that you guys talked about. Do you expect that to continue into fiscal '11 and are you seeing some push back for vendors just due to the current inflationary environment?

This as Charlie again. Yes, I think to some extent it will continue, because as you have probably read as we have read, the price of commodities, be it oil or other -- wood, those type of products has been trending upward. So we would expect -- in fact we have already had early warning signs of potential paper price increases coming in in 2011.

So ultimately this is -- the business that we run in Europe is very similar to the business that we run in BSD. You have catalogs out there that have certain prices on them and in terms of the Contract business, every price increase is obviously a conversation with the customer and we are fully committed to work on that. But I think we are dealing with a lot of underlying trends within the basic commodities that are driving price increases and of course, customers are still feeling the economic slowdown as we are. And so, therefore, that's the rub.

But we are fully committed to working on passing those price increases along as quickly as we can.

Great, thank you.

Stephen Chick.

FBR. Congratulations on some of the top line here. And I'm sorry if I missed some of this, but the improvement in the BSD sales down 3% beat our expectation. Is that an adjusted number? You've had some exit activities I think in that. Is that -- was there an adjusted figure or have you fully cycled those exit activities?

Steve, no, that's -- it is a real number. That's our true trend on the business and that's where we sit.

Okay, sequentially improved and I noticed direct turned -- looks like positive, which is very good to see. Is that -- how did the split -- what drove the sequential improvement? Did direct accelerate and get that much better or -- and Contract kind of get worse? How did you break out between the two?

No, Steve, we've talked for the last few quarters about the positive trends we've seen in our direct business as we started to get that business back to flat and then returning that business to growth. All of that is as a result of all of the efforts we have been putting behind our direct business relative to the Web, the significant improvements we've made there, effectiveness around catalog, direct mail, email, and all of the activity there and all the marketing plans we've put in place from a retention and loyalty standpoint. So we feel very good about the trends that we are seeing in the direct business.

Our Contract business made progress in Q4, evidenced by the margin increase that you saw in the total BSD business up to 4.6% operating margin. So we continue to see the trends going in the right direction. But I think as we have all said, the key will be can we start to see some tailwind from this economy? And at this point as we enter 2011, we don't see a lot of optimism at this point. But hopefully that will change.

Okay, as we move -- so now that we are post year-end and you've seen kind of the public sector business, it sounds like you're retaining a fair amount. Is -- can you quantify for us given the strength in Direct and some of the other parts of your business if like down 3% for BSD, is that something that we can build off from or could it get worse before it gets better? I don't know if you can kind of angle into that a little bit.

Yes, in the script as we talked to you today, we guided that in Q1, we would expect trends to be similar to Q4 and we haven't given further guidance than that. Obviously the economy will play a key role in that, but we don't see any other factors at this time that should negatively impact that.

Okay, so even with any attrition, you would expect Q1 to be similar to Q4. I would think that's probably pretty encouraging.

Yes, just so we are clear, what we have guided is on the revenue side only, not on the bottom line, because on the bottom line as we did guide, we guided that Q1 operating profit would be slightly below last year is what we guided. And our margins typically in Q1 are lower because back to business and we have some significant investment around advertising and promotion catalogs and other things that occur in Q1.

Okay, no, that's helpful. Thank you.

Okay, it's the top of the hour, so this concludes our webcast and conference call this morning. Thank you very much for participating and I'm available to take your calls later today. Thank you very much.

That does conclude today's conference call. We thank you all for participating. You may now disconnect and have a great rest of your day.