ODP Corp (ODP) 2012 Q3 法說會逐字稿

Good morning and welcome to the third quarter 2012 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 now begin.

Thank you and good morning. With me are Neil Austrian, Chairman and Chief Executive Officer, Mike Newman, Chief Financial Officer, Kevin Peters, President of North American, and Steve Schmidt, President of International.

Before we begin, I would like to remind you our discussion this morning includes forward-looking statements which are subject to the Safe Harbor provisions 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 can 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 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.

Neil will now make opening comments and then summarize Office Depot's third quarter 2012 results. Neil?

Thank you, Brian and good morning. I'm pleased to report that we've made progress executing our strategic plan which in turn has had a positive impact on our operating results despite the challenging global economic environment. Our results this quarter will driven by the successful implementation and execution of our key initiatives and strategies across the enterprise which we have emphasized on previous calls. Our third quarter 2012 EBIT, excluding restructuring and impairment charges, was $54 million, an increase of approximately 80% compared to adjusted EBIT of $30 million during the same period last year. For those of you who have followed us for some time, this improvement is right on target. From 2008 to 2011, we grew total Company full year adjusted EBIT by over $170 million, despite the significant deleveraging impact associated with the revenue decline of over $3 billion during that same period. In 2011, we achieved $180 million of gross initiative benefits and are projecting another $160 million of benefits in 2012. Looking forward, we expect to deliver approximately $300 million in additional initiative benefits over the next three years, which I'll discuss later in the call.

Third quarter reported sales were $2.7 billion, down 5% compared to the prior year in dollars, and 3% on a constant currency basis. We can attribute much of the decline to our strategy of focusing on gross profit dollars, which, when coupled with our key initiatives is having a positive impact on our financial results. This is not to say that we don't promote, but with the analytics developed by our marketing group, we're focusing on consumers and business customers where the gross profit contribution is demonstratively positive. The payoff of this strategy was that the total gross profit margin increased about 90 basis points in the third quarter compared to the prior year. As you can see on slide 4, this was our tenth quarter out of the past 11 that we increased total Company gross margin year-over-year. The improvement this quarter was driven by gross margin increases of 180 basis points in North American Retail and 110 basis points in North American Business Solutions.

Before I cover our overall third quarter financial results in greater detail, I'd like to review our progress delivering value through five of our current key initiatives shown on slide 5, where I think you'll really start to see tangible examples of our growth and cost control strategies taking hold. The first initiative is executing our North American Retail real estate strategy. We previously told you that we anticipated executing a strategy to down size our stores on a faster pace by 2013 and also commit significantly more capital to that program. We can now confirm that over the next five years we've committed to spend $60 million a year to down size or relocate approximately 500 stores into a small or mid-size format. We also anticipate closing between 10 and 20 stores a year as their leases expire over the same period.

For 2013, we will down size or relocate approximately 100 larger format stores with expiring leases and expect that the occupancy cost savings from these actions will be approximately $20 million a year beginning in 2013. However, it's important to note that while occupancy cost reduction is a key part of this effort, reducing working capital, modifying the labor model, and improving the customer buying experience are also critical components of this initiative that will drive efficiency improvement. In connection with our store downsizing strategy, as well as a downward revision to our forward-looking sales trends, we recognized a non-cash store asset impairment charge of $73 million in the third quarter. The second initiative is growing the revenue generated by our value added services and solutions. We continue to significantly grow our Copy and Print Services revenue in both our North American Retail and Contract channels during the third quarter versus the prior year. In Contract, for example, we had double digit sales growth in Copy and Print and high single digit sales growth in Cleaning and Breakroom Supplies this quarter. As we have discussed, increasing the mix of high margin services drives higher overall gross margins and is a focal point of our profit growth strategy in North America.

The third initiative is increasing our own brand and direct import penetration. During the second quarter, we developed a strategy to be significantly more aggressive growing our own brand and direct import penetration going forward in both North American Retail and BSD. While the strategy is not yet fully implemented, we continue to make progress in this area. North American Business Solutions significantly increased its penetration levels in the third quarter versus prior year. We've got a great opportunity for increasing our own brand and direct import levels in North American Retail as well. To assist with this effort, our global sources office team based in Shenzhen, China continues to work closely with our merchandising groups in the US, Latin America and Europe on these attractive margin enhancement opportunities.

The fourth initiative is driving sales growth with small to medium-sized business customers or SMBs, a high margin customer group in our North American Contract channel. During the third quarter, we significantly drove low single digit SMB sales growth versus the prior year. We believe that our capital investment and our new inside sales organization based in Austin, Texas, will drive sustained growth with these customers. For example, our inside sales organization is performing much better than the legacy Telephone Account Management effort through the outsource partners and is paying dividends in both the retention and growth of these SMB accounts. I should also note that we also continue to be successful in growing our large account base in Contract which contributed to the strong BSD operating profit growth this quarter versus the prior year.

And the final initiative I'd like to mention is our focus on controlling expenses. We've done a good job in this regard as evidenced by the reduction of another $36 million in operating expense on an adjusted basis in the third quarter versus prior year. A foreign exchange benefit, lower expenses from supply chain, and overall best cost to management contributed to the year-over-year improvement. I should note that since the end of 2008, we have reduced our operating expenses, excluding charges, by over $760 million. Our current operating expenses as a percentage of sales may appear high compared to our competitors due to the location of our expenses on the income statement.

It's our understanding that our OSS competitors report all shipping and handling expenses, as well as other product-related costs, in their cost of goods and not operating expense as we do. If we reported on the same basis, it would reduce our operating expense as a percentage of sales by about 6 points and would be comparable to our competition. This obviously reduces our reported gross margin by a similar percentage, but we have had a number of initiatives in place to drive further gross margin improvement. Our pricing and promotion initiatives, for example, directly impact gross margin and have delivered approximately $140 million of EBIT benefits over the last two years. We believe we can continue to improve our gross margin as we weave the pricing and promotion initiatives into our DNA and expand our initiatives to reduce our cost of goods sold while increase the focus on our own brand penetration.

Now I'll complete the summary of our third quarter results. The Company reported a net loss after preferred dividends of $70 million, or $0.25 a share in the third quarter of 2012 versus net earnings of $92 million or $0.25 a share in the same period one year ago. Third quarter 2012 results included approximately $96 million of pretax charges, primarily related to non-cash store impairment charges in North American Retail and intangible asset impairments in International, as well as restructuring activities and actions to improve future operating performance. As I mentioned, the non-cash store impairment charge in North American Retail includes the impact of our new retail store strategy that will address a store portfolio designed to operate at lower costs and better satisfy customer shopping trends. So excluding these charges and impairments, third quarter 2012 earnings after preferred stock dividends would have been approximately $18 million, or $0.06 per share. I should also note that third quarter 2011 results included approximately $6 million of charges primarily related to restructuring activities and actions to improve future operating performance, as well as the benefit from the reversal of $99 million of combined tax and interest accrual. Excluding these charges and benefits, the third quarter 2011 net loss after preferred stock dividends would have been about $700,000, which rounds to $0.00 per share.

Before Kevin and Steve review our third quarter 2012 performance in North America and International in detail, I would like to reiterate my comments last quarter that we're taking proactive steps to drive improved operating results at Office Depot. These steps have resulted in positive measurable improvement, which will augment with our ongoing and new initiatives and will position us as well to see further growth when the economies in the US and Europe improve. Following Mike's comments, I'll summarize our plans for growing the business profitably going forward.

I'll now ask Kevin to review our North American performance in the third quarter.

Thanks, Neil and good morning. The North American Retail division reported third quarter 2012 sales of $1.2 billion. A decrease of 5% versus the prior year. As Neil mentioned, we can attribute much of the decline to our strategy of focusing on gross profit dollars, which increased year-over-year despite our lower sales. Same store sales in the 1,090 stores that have been open for more than a year, decreased 4% for the third quarter. While the year-over-year rate of decline in the third quarter improved slightly from the second quarter, it still rounded to minus four and fell short of our expectations due to continued weakness in the Technology and Peripherals categories. As mentioned on past calls, we're fine tuning the technology assortment and completing the renovation of our Peripheral offering to benefit from current and future product trends. Although we're optimistic that we can profitably grow this category, progress to date has quite frankly been slower than we'd like. To accelerate this growth, we are narrowing the assortment of declining categories like cameras and software and expanding our adding categories such as headphones and smartphone accessories. But I can say at this point that we've done some testing, we like the results and we're in the process of scaling up across the network.

Sales of tablets and E-readers increased in the third quarter versus prior year while sales of computers and their related products were down significantly. We believe that there has been some pent-up demand for laptops and desktops as our customers awaited the release of Microsoft Windows 8 last Friday, which may lead to a sales lift in hardware sales during the fourth quarter. In regard to other product categories, Copy and Print continue to perform well this quarter, and although sales in the Supplies category were about flat, Ink and Toner sales were slightly positive versus the prior year. Sales of Furniture were down year-over-year as the result of a reduction in promotional activity versus last year. North American Retail's average order value was slightly negative in the third quarter and customer transaction counts declined approximately 4% compared to the same period one year ago.

Similar to the second quarter we believe that the transaction count decline was driven by a number of factors, including our focus on managing the margin in some of the competitive product areas and pulling back on weekly inserts in an effort to realign our media mix to more productive vehicles. The North America Retail store count at the end of the third quarter was 1, 114 stores. During the quarter, we opened one new store and closed four. For the full year, we still plan to close 25 to 30 stores in total. We also remodeled two stores and relocated five in the third quarter successfully reducing the square footage of those seven locations by over 40% on average. North American Retail reported an operating profit, excluding an approximately $74 million charge which was primarily related to the aforementioned store asset impairment of $53 million in the third quarter of 2012. This compares to an operating profit of $42 million in the same period last year. Excluding the charge in the third quarter of 2012, the year-over-year operating profit increase was driven primarily by year-over-year gross margin improvement of about 180 basis points, included lower occupancy costs and a decline in payroll and G&A costs, which were partially offset by the negative flow-through impact of lower sales.

As Neil mentioned, we are moving forward with our real estate strategy to significantly accelerate the downsizing of approximately 500 stores coming off of lease over the next five years. For 2013 we are committing approximately $60 million of capital to down size or relocate approximately 100 larger format stores with expiring leases. The majority of these stores will be remodeled into a smaller format of 5,000 to 7,000 square feet and the remainder in 15,000 to 17,000 square feet ranges. We also project closing between 10 and 20 stores in 2013 as their leases expire. As a result of these actions, we're targeting an occupancy cost reduction of about $20 million next year, but also see opportunities to reduce working capital through lower inventory requirements, modify the labor model and improve the customer buying experience. We're very excited about this strategy and look forward to updating you as we move forward.

We've also done a good job in optimizing our inventory. In the third quarter we achieved a total inventory reduction of approximately $80 million in North America. We lowered inventory levels in Retail by implementing replenishment controls for our slowest moving inventory to minimize over ordering, and creating a store-to-store rebalancing process to reposition SKUs to those stores that can sell them faster. As a result, we were successful in significantly reducing our aged inventory by over $50 million with expectations to drive an incremental $15 million reduction by the end of the year. We've tracked our out of stocks and service metrics during this inventory optimization effort and found that it had no unintended impact on service or on product availability.

In regard to back to school, we are pleased with our performance during the recently completed season where we utilized many of our wins in 2011 to drive a successful effort in 2012. We increased sales in our back to school supplies department and were much more profitable compared to the prior year. Customers certainly shopped early for the aggressive sales items but came back for the full basket as school start dates approached. We attribute the improved performance this year to a good stock position early for core back to school items, creative exclusive fashion items, a disciplined promotional strategy and a broader marketing reach effort. Turning to North American Retail's fourth quarter outlook, we anticipate sequential improvement in our same store sales rate and operating profit is projected to be down versus prior year due primarily to the $11 million favorable impact from the 53rd week in 2011.

Now let's shift our focus to the North America Business Solutions Division third quarter results. BSD reported third quarter sales of $827 million, a 1% increase versus the same period last year on a fiscal basis, as a sales increase in the Contract channel more than offset the sales decline in the Direct channel. On a calendar adjusted basis to match the same selling weeks, third quarter sales were relatively flat versus the prior year. In our Contract channel we saw sales growth across our small, medium, and large customer groups. This growth is attributed to the continued success acquiring new customers, particularly enterprise level accounts, and improved sales across our solution categories, including the single digit growth in Furniture, high single digit growth in Cleaning and Breakroom Supplies and double digit growth in Copy and Print.

Sales weakness continued among the federal and sate government accounts as these customers experience ongoing budgetary pressures. However, sales to our education related customers increased in the low single digits this quarter. Sales to small to medium sized Contract customers increased low single digits in the third quarter versus prior year and we're excited about continued growth in this attractive customer category. As Neil mentioned, our capital investment in the new inside sales organization is expected to drive sustained growth in this high margin customer group. Our inside sales organization is performing much better than the legacy Telephone Account Management or TAM effort, through the outsource partners, which is paying dividends in both the retention and growth of these SMB accounts. In fact, I should point out, year-to-date sales for our primarily TAM accounts that were transitioned to the new sales organization, inside sales organization have improved mid single digits year-over-year. This team is effectively selling both traditional office supplies, as well as products across our solution categories.

In our Direct channel, the year-over-year sales decline was attributable to lower purchases from customers who shop using catalogs and place orders through our inbound call centers. Conversely, E-commerce traffic and average order value were up as we continue to invest behind this important customer touch point. For example, we recently added some new features, including an improved navigation and presentation for Furniture collections, an innovative wireless printer Ink and Toner level check and reorder option on our mobile application. We've also made it easier for our customers to check inventory availability in our retail locations nationwide. It's worth noting that we're seeing a migration from customers using traditional browsers to mobile browsers while shopping and placing orders. This is a trend we can exploit given that our mobile web application often ranks number one by a third party analytical firm who benchmark performance across all US E-tailers. Our goal to increase our own brand and direct import of products continues to go well. BSD's own brand penetration increased significantly in the third quarter versus prior year and we believe that we can continue to significantly increase this level of penetration to our global sourcing organization, and the initiative that Neil mentioned earlier.

Third quarter 2012 operating profit for BSD was $56 million, excluding approximately $2 million of severance costs related to restructuring actions. This was a $17 million increase from the same period one year ago and I'm pleased to note that this was the highest operating profit level for BSD since the first quarter of 2008. The increase reflects a 110-basis point gross margin increase driven by our sales and margin initiatives, lower supply chain costs and reduced professional fees compared to the prior year partially offset by higher advertising expense. In regard to BSD's fourth quarter outlook, we expect sales to be down versus the prior year due to the positive impact of the 53rd week in 2011 and fewer selling days in 2012. Excluding the impact of the 53rd week, fourth quarter sales would be relatively flat versus the prior year. In terms of operating profit, we project the fourth quarter will be slightly up versus the prior year.

I'll now turn the call over to Steve to review our third quarter performance in the International division.

Thank you, Kevin. The International division reported third quarter sales of $692 million, a decrease of 12% compared to the prior year period in US dollars and a decrease of 4% in constant currency. As I speak to year-over-year sales comparisons by channel this morning, please note that I will do so in constant currency on a calendar-adjusted basis. Total European Contract sales decreased low single digits in the third quarter versus the prior year as growth in Germany and flat sales in the UK were more than offset by sales weakness in other countries. In Asia, our Contract channel reported a high single digit sales increase compared with one year ago.

While the rate of decline improved versus the second quarter in our European Direct channel, third quarter sales were still lower than a year ago. I should note that the London Olympics had a significant negative impact on our UK Direct and Contract business during the third quarter. As I mentioned last quarter, our Viking catalog business in Europe has been declining for a number of years. Recognizing that we need more focus and investment in our Direct channel, we have laid out our plan to fix our Direct business and you'll review the progress that we have made so far in a moment. European Retail channel sales in the third quarter decreased low single digits compared to prior year. While sales in France were relatively flat, weakness in Sweden drove the overall European Retail channel decline. In France, we completed the launch of Apple products in all of our retail super stores in the third quarter. The presence of Apple products has driven significant increased traffic to our stores and benefited total technology hardware sales.

In regard to Asia Retail, we continue to see high single digit sales growth in south Korea. The International division reported third quarter operating profit of approximately $1 million compared to $19 million reported in the same period the prior year. Excluding about $19 million of charges primarily related to asset impairment charges in Sweden and ongoing business restructuring actions, adjusted operating profit in the third quarter of 2012 was approximately $20 million. With adjusted operating profit of $23 million in 2011, the slight year-over-year decrease was primarily due to lower volume. Partially offset by a decrease in operating expenses, driven by our continuous process improvement initiatives and lower advertising and payroll expenses.

In Latin America, Office Depot de Mexico reported third quarter 2012 sales of $316 million, an increase of 10% in constant currency versus the prior year. EBIT and net income were approximately $27 million and $21 million respectively. We don't consolidate sales from our joint venture, but Office Depot's portion of the net income was approximately $10 million for the quarter and is a reported in the miscellaneous income net line on the statement of operations. Office Depot de Mexico ended the third quarter with a total of 253 stores and distribution facilities throughout Mexico, Central America and Columbia. We opened 1 new store in Mexico during the third quarter and a total of 12 stores in Mexico and Central America year to date. We remain very pleased with the performance of our Office Depot de Mexico joint venture. It is important in a standing business, with significant growth opportunities available throughout Latin America. However, we continue to recognize that our investment and 50/50 joint venture ownership position is not fully reflected in Office Depot's equity valuation. As a result, since early this year, we, along with our joint venture partners, have been exploring ways to both accelerate the growth of this business given the growth opportunities in Latin America and to better highlight its market value. Through these actions, we believe we can increase the recognized value of our ownership position without experiencing adverse tax implications.

As we look at our International business, we fully recognize the current economic headwinds in Europe and are making ever effort to drive operational improvements to mitigate those challenges. As I mentioned earlier, we need to improve the performance of our legacy Viking business in Europe by leveraging all of our existing assets and customer touch points with a focus on a redirection of our advertising expense into more effective e-commerce marketing strategies. Although we are in the very early stages of this initiative, we expect to see some improvement in the fourth quarter due to our focus on increasing our customer acquisition. In addition, we continue to work on improving our European cost structure and developing an agile high-performance organization. We are also evaluating other options in other nonprofitable, non strategic markets in order to optimize the overall portfolio of our business globally. We will update you on our progress as we move forward. In regards to the International division's fourth quarter outlook, we expect our sales in constant currency to decline high single digits versus the prior year due to the weak European economic condition. We expect fourth quarter operating profit, excluding charges to be up versus the third quarter but down significantly from prior year as the negative sales trends and an unfavorable calendar shift more than offset our cost reduction efforts.

Mike will now review the Company's third quarter financial results in more detail. Mike.

Thanks, Steve. As Neil mentioned earlier, the third quarter Company EBIT excluding restructuring charges and the intangible asset impairments was $54 million, an increase of approximately 80% versus EBIT of $30 million prior year. The water fall chart on slide 16 provides a snapshot of the factors driving the significant year-over-year growth in EBIT. On the plus side, we had approximately $43 million in benefits realized from our business initiatives. These benefits were partially offset by about $27 million from the negative impact of lower sales volume.

I'll now update you on our restructuring charges. In the third quarter, we reported $8 million of restructuring-related charges and other costs intended to improve efficiency and benefit operations in future periods. These charges included about $4 million for European business restructuring and process improvements, as well as portfolio optimization efforts. And approximately $4 million for business process improvements at the corporate level and severance costs related to restructuring in our North American operations. To provide a clearer view of our comparative third quarter performance, I thought it would be helpful to also discuss the year-to-date third quarter EBIT results versus prior year. Slide 17 shows that our year-to-date third quarter EBIT adjusted for charges of $97 million is up significantly when compared to the prior year total of $76 million, mostly due to key initiative benefits realized this year. Partially offset by about $86 million from the negative impact of lower sales volume.

Turning to slide 18, free cash flow for the third quarter was $190 million, about $50 million higher than the $139 million reported one year ago. This marked increase primarily reflects improved working capital driven by less of a decline in trade payables versus prior year and a $119 million reduction in total Company inventory driven by our initiatives. In North America, our day sales outstanding in receivables hit a record low in the third quarter, again driven by initiatives. We still expect to generate $80 million to $100 million of free cash flow for full year 2012 from an operational perspective and this excludes a negative $58 million impact of free cash flow from a first quarter pension settlement that was offset by a positive impact to cash flow from investing activities of the same amount. With the net result of having no total cash flow impact on Office Depot. Capital spending was $26 million for the quarter, and totaled $89 million during the first nine months of 2012, and we are now targeting about $130 million to $140 million of total capital spending for the full year.

Turning to our liquidity, we ended the third quarter with $620 million of cash and cash equivalents, and $700 million available from our asset base lending facility or ABL for a total liquidity of $1.3 billion. No amounts were drawn under the ABL at quarter end. Additionally, we have approximately $50 million available under an accounts receivable factoring agreement in Europe and that was activated in the fourth quarter of 2012. I should also mention that our $150 million of 6.25% senior notes due August 2013 were classified as a current liability on our balance sheet in Q3.

Total company third quarter operating expenses, adjusted for restructuring and asset impairment charges, were down $36 million versus the prior year. The year-over-year reduction in expenses was driven by-productivity improvements in both North America and International and also benefited from foreign exchange. The effective tax rate for the third quarter on a reported basis was a negative 6%. The effective tax rate for the third quarter adjusted for discrete items was 31%. For the full year we still project to pay cash taxes in the $11 million to $13 million range. During the third quarter, we recorded a dividend on our convertible preferred stock of approximately $8 million, which was paid in kind on October 1. We anticipate paying the dividend in kind for the fourth quarter and possibly 2013 as well.

Turning to our fourth quarter and full year outlook, we expect full year adjusted EBIT to be approximately $130 million, up about $10 million from 2011. And for the fourth quarter we expect approximately a 5% decrease in total Company sales excluding the 300-basis point negative impact related to the 53rd week in 2011. Excluding the impact of the 53rd week and foreign exchange, fourth quarter sales are expected to be down about 4% compared to last year. We expect fourth quarter adjusted EBITDA to be down compared to last year, principally due to the favorable impact of the 53rd week in 2011 and continued softness in our International division. As a reminder, our definition of adjusted EBIT excludes the impact of any restructuring charges and the $130 million of non cash store impairment and intangible impairment charges recorded in the first nine months of 2012.

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

Thanks, Mike. Before I summarize and open up the call to Q&A, I'd like to provide the long-range outlook for the business.

We expect the tough economic environment in the United States and Europe to continue at least through 2013. Despite this headwind, we'll continue to increase our investment in store down sizes, e-commerce and growing services to accelerate the momentum we've seen thus far. As I mentioned at the outset of the call we expect to deliver approximately $300 million in additional initiative benefits from 2013 to 2015 through cost reductions and margin improvement. The key areas include approximately $100 million of global gross margin improvement from our own brand and direct import growth, and a reduction in cost of goods sold. About $60 million in occupancy cost reductions through accelerated retail store down sizes, and approximately $120 million to $140 million in lower global advertising expense, European restructuring and portfolio optimization benefits, and G&A cost reductions. For 2013, we've identified initiatives to generate over $120 million in benefits, net of reinvestment, to offset organic sales pressure and deliver a full year 2013 adjusted EBIT of approximately $150 million. This would make the third consecutive year we would have generated significant initiative benefits to more than offset revenue pressure and the fifth consecutive year of adjusted EBIT improvement.

This morning, we announced that the Office Depot Board approved a rights agreement designed to protect all stockholders of the Company against potential acquirer's who may attempt to take advantage of the Company and its stockholders through coercive and unfair tactics aimed at gaining control of the Company without paying all stockholders a full and fair price. The Board believes the rights agreement will enable all stockholders to realize the long-term value of their investment by safeguarding the Board's ability to continue to evaluate and take actions that are designed to create value for all stockholders. In summary, it important for everyone to know that we're driving improved operating results here at Office Depot even during these challenging economic times. We're taking good progress on the five key initiatives, which are executing our North American Retail strategy, growing value-added services and solutions, increasing our own brand and direct import penetration, growing sales with small to medium-sized businesses, and controlling operating expenses. Our associates around the world are the key to this success. We've got a great team in place that's committed to improving the performance of Office Depot today and into the future. It's Depot time.

Thanks, Neil. We know that one of our competitors is hosting their earnings call this morning so we plan to end our call abruptly or sharply at 10 AM eastern time. If anyone remains in the queue at that time, I will try to follow up with you after the call.

Operator, we're now ready to take questions.

(Operator Instructions)

Christopher Horvers.

Thanks, JPMorgan. Good morning, guys. Wanted to focus on the PC category a little bit. In NAR, were comps basically flat ex the PC category alone? And can you talk about the early response you're seeing to Windows 8? Is this a hardware driver, and is there actually any impact to the software sales side given the consumers' ability to basically just go online and download it directly?

Kevin, you want to answer that?

Sure, Neil. Good morning, Chris. I think the best way to answer the first part of your question is, if you looked at the North America Retail business, ex Technology and related accessories, Tech would have -- or the overall comp sales would have still been slightly negative, but I think Tech and Peripherals probably was 50% to 60% of the overall decline. As it relates to -- and I should probably point out, the other piece of the decline was largely in the Furniture category. Most other categories were flat or positive, as we talked about.

I think in terms of Windows 8, I do think it is a hardware play, and software sales will either come through brick and mortar or through the online channel. We've had over 6,000 associates that have been trained and certificated to sell Windows 8, so we're certainly ready. We have 29 laptops, desktops and tablets in our assortment that carry the Windows 8 software, and I think the early response has been encouraging. The first week or so was largely people getting accustomed to Windows 8, lots of questions, but we're now seeing customers coming back a second time and making purchases. So, I think it's still early yet. But I think people are intrigued by Windows 8, and we're hopeful that that will continue to drive interest not only in the software but more importantly in the hardware.

Then as a follow-up, as you think about the EBIT outlook for 2013, just trying to gauge what the embedded sales assumption is there? It looks like year to date, your sales are down about 5%. That's created $86 million of deleveraging headwind, so just looking at big picture math, it looks like EBIT is going to be up -- expected to be up $20 million next year. Are you assuming that sales are still down next year, and so that incremental flow-through of initiative gets offset or largely offset by a down sales environment?

Yes, Chris. This is Neil. We're assuming down sales in the US and down sales internationally at this point, and the increase in EBIT is directly attributable to the initiatives that we laid out earlier.

Thanks very much.

Dan Binder.

Good morning, this is Dan Binder, Jefferies. I had a couple of questions as well. First, on the gross margin improvement, I guess I appreciate the fact that you're managing margins through promotion optimization and so forth. I guess what I was really kind of curious is, from a long-term perspective, why you wouldn't choose to reinvest some of those margin gains to take additional share, particularly in areas that are demonstrating some weakness such as the online business where that migration of direct to online in order to provide incentive for customers to really move online with you guys versus moving somewhere else. That's my first question.

This is Neil, Dan. I think we are making some significant investment in our e-commerce business, both in terms of improving the platform, as well as being more competitive. I think we have taken the position though that in a number of categories we're not going to match Amazon. Our online business is growing. I think what Kevin mentioned is on the overall Direct piece, we're seeing the downturn in revenue from the traditional catalog business, and that's moving to the online piece, but probably not as fast as we'd like. But I can assure you, we have got a significant investment, both this year and next year and the following years in our e-commerce business.

Dan, if you look at our corporate segment this quarter, the costs are up in our corporate segment, and they're really being driven by what Neil just talked about -- investments in e-commerce, investments in IT to drive these parts of our business. It doesn't show in the business unit segments, but it shows in corporate, and that's exactly what we're doing.

With a backdrop of fairly mediocre white collar employment growth and obviously, a little bit of this paperless office trend that's going on, why wouldn't you want to use price as a weapon and take less gross margin to get top line going a little bit faster?

We evaluate that on a constant basis. Our marking people are looking at that and have looked at that, and I think we basically have done that in selected product areas in Technology when we think we can play and gain where the customer really is going to have a long-term value as opposed to someone just cherry picking and buying that product, and it's one and done.

Okay. My second question was really on the own brand and direct import programs. I feel like Office Depot has been certainly a leader in that space for -- or in that initiative for many years, even under prior management. I'm kind of curious where you're finding this incremental opportunity on own brand. I think at one point the Company may have even moved a little bit too far and then had to come back. I'm just kind of curious where you're finding these new opportunities.

Kevin, you want to deal with that?

I'd be happy to. I think we have made a significant amount of progress in the global sourcing of products. I would differentiate, however, between those products that we sourced across the globe that didn't carry our brand name, versus those products that we sourced across the globe that had either the Office Depot brand name or one of our other private brands. So, I think we've made a lot of progress in global sourcing. I think we still feel like we have some room in a handful of key categories to increase our own brand penetration. I think largely the difference there is less about margin, but it's more about loyalty.

When people buy products off the shelves of our retail stores or online, or through our Contract sales force, buying a product that's got our name on it, we think, creates a greater opportunity for the customer to come back. While we've made certain progress in categories like Furniture, I think there's a lot more room, both in the Retail business and in the Contract business in the Supplies category and in the Peripherals category. I still think we're certainly not in the early innings, but my guess is we're closer to the middle innings, and we still have some penetration opportunity both from a margin standpoint, but also, probably more importantly, from a loyalty standpoint.

I might add in that, that one of the opportunities we think we have is in changing some of the product specs and moving our private brand up from what I'll call an entry-level position in the category to a good or better position, the way some of our competitors have done.

Great. Thank you.

Michael Lasser.

Good morning, it's UBS. Thanks a lot for taking my question. You gave some detail on your 2013 to 2015 outlook, including the expectation that you'll get $300 million in additional initiative benefits. Do you have a sense for how much of that is going to be reinvested, or is your expectation that all of it will fall to the bottom line?

I think it's probably a mix at this standpoint. I think a lot will depend on what happens with the economies over the next three years, and how much the volume does decline, but I would expect that we will invest a good part of that to try and grow the business, which we know we have to do.

And then on the Retail segment more specifically, let's say all else being equal, maybe sales are flat over the next few years, or you're able to achieve all of the remodels, relocations and closures that you expect, what is going to be the margin profile for the Retail segment when all is said and done three years from now?

I think that's forecasting, which we've never really done at this point. I think we have to wait. I think we've talked about the economics of our small store format. We expect to have 25 to 30 open this year. I would guess sometime mid next year, third quarter next year, we'll be in a much better position to talk about what it would look like going forward as we downsize and relocate approximately 500 stores over the next five years.

And have the recent remodels been consistent with that 90% recapture rate of the small- and medium-size formats that you've talked about early in the process?

Kevin?

Yes. So, what we've talked about in the past is, when we downsize and remodel in place, so we're using essentially the same real estate that we had a physical presence in prior to the downsize, our capture rate has been around 90%. When, in fact, we closed the store and moved to another location in the trade area, the capture rate drops off a little bit from that. So, there's been nothing that's happened here in the last quarter or so with our remodels that would suggest a change in the ones that we downsize in place, and we're seeing a slight improvement in the ones that we've actually relocated.

Okay, last one, and I apologize for being long-winded, but the 180 basis points in North American Retail gross margin, how much of that was due to selling less Technology products? Thanks.

I would say it's certainly a piece of it. It's a relatively small piece, but we did get certainly some pickup from mix, but most of the pickup came from rate improvement.

I'd add within that occupancy reduction in the quarter as well.

Yes, in the gross profit line.

Okay, great. Thank you very much.

Dave Gober.

Good morning, it's Morgan Stanley. Just one question from me, and it's on the Contract business. You mentioned the benefits of picking up some enterprise-level customers. Just curious what you're seeing there. Obviously, it's not showing in your margin results, but we [definitely see a] pickup in the competitive dynamics there. Are you seeing that as a more difficult environment or a more price-sensitive environment, and how do you see that going forward over the next couple of quarters?

Kevin?

I think we're very happy with the progress that we're making in the Contract organization, as we talked about, the investment that we made in our inside sales organization appears early on to be paying dividends. We've seen a nice increase year over year in those customer accounts that were transitioned from the out-sourced model to the in-sourced model, and our large and global accounts team has done a terrific job with account acquisition. We certainly feel very encouraged about the rate of wins that we've enjoyed here over the last several quarters, and we've done that, as well as improving gross margins in the Contract business. And I think externally, in terms of, is there anything changing in the marketplace in terms of more price pressure? No, we haven't really seen that.

So, as you're adding customers, it's not necessarily at lower gross-margin levels or anything like that?

No.

No.

Great. Thank you.

(Operator Instructions)

Allen Rifkin.

Alan Rifkin with Barclays, thank you very much. With respect to the $300 million in cost savings, can you maybe provide some color as to how should we expect that on an annual basis over the next three years? Will it be more linear or more skewed towards the back end?

Go ahead, Mike.

I think it will be linear. Keep in mind, we've been at this for a couple years. Neil mentioned we've delivered $180 million and $160 million in the last few years, so I think with the initiatives that we have in place, we're working on a lot of them already. I don't expect this to be a ramp-up, I expect it to be pretty straight line for the next three years.

Okay. And with such a significant portion, Mike, of the expense savings coming on the advertising line, what do you think the ramifications of that will be over the long-term on your top-line revenue?

There's not a big piece of that in advertising. Keep in mind that Nascar expiration occurs for calendar 2013. The bulk of this is in gross profit through COGS own brand DI, and then through operating expenses and G&A. So, advertising is not, by any means, the bulk of it.

My guess is some of that advertising is going to get re-purposed into other forms of media that might be more productive to drive growth in the business.

Okay. And one last one, if I may. Neil, with the planned downsizing or relocation of 500 stores over the next five years, I mean, with that being more so predicated on lease expiration, we should not think that earlier in the program you'll be closing the least profitable stores and thus getting a greater return earlier on as opposed to later on?

No, I wouldn't think that. I think you hit it on the head, it's based on lease expiration, and it's pretty linear over that five-year period in terms of how the leases expire.

Okay. And then just a breakdown of the 500, how many do you think will be downsized versus relocated?

We have not given that out yet, I don't believe, publicly. So, I think I'd rather wait on that. What we talked about is next year, we're talking about 100, and I think what I'd rather not do is give our landlords any ammunition that they can negotiate against us at this point.

Okay, fair enough. Thank you very much.

Carla Casella.

Hi. I'm with JPMorgan. A couple questions on the balance sheet. Your payable days increased. Wondering -- have you changed your vendor terms, or is this due to your mix shift at all?

This is Mike Newman. It's probably due to mix shift. We have not changed terms at all. We will see AP inventory fluctuate throughout the year. I think the focal point for me is, we've done a terrific job on inventory and working capital this year. We've taken significant amount out of inventory, as was discussed on the script, mostly due to initiatives and taking slow-moving inventory out of our stores without any impact on service.

We've also had a record day in receivable days, also through one of our initiatives, so we're probably at the high end of what I thought we would deliver from a working-capital perspective in 2013, so I'm really pleased with it. Payables are -- and vendor situation is the same, solid and great relationships.

Okay. Great. And then did you break out how much of the 53rd week accounted for by division on either revenue or -- I heard the $11 million on EBIT for the North American Retail, but the others -- have you given it by segment revenue and EBIT?

We've talked about a corporate impact of $6 million.

Right.

And then we've talked about the retail impact of $11 million, and beyond that, I think that's the only detail we've given.

Correct.

Okay, great. One last question on the Sandy -- any impact that you're seeing on residual distribution now from any fuel shortages?

Kevin?

I think Sandy, for us in the retail business, probably wasn't as significant as it was in the Contract channel. Mostly just due to businesses being closed and either not being able to order, or when they do open up, not having access to delivery mechanisms. But specifically as it relates to fuel, we've not yet seen an impact for diesel fuel availability, and our ability to get fuel to make deliveries to our Contract customers.

Okay, great. Thank you.

Michael Baker.

Yes, this is actually Adam Sindler, dialing in for Mike Baker, from Deutsch Bank. Just a follow-up on the cost savings. You talked about $760 million since 2008. About how much do you think more there is to go? And then the nature of those expenses, is that more on the variable side or is it fixed? And then maybe just a follow-up on the private label and direct imports.

Yes. This is Mike. So, we talked about $300 million-plus of initiative benefits in the next three years. We've talked about approximately $100 million of that being gross profit driven through COGS, own brand, et cetera, so the balance of that almost $200 million is going to be in either selling or G&A or occupancy costs. We called out $60 million of occupancy costs. Roughly 50% of it from outside of the gross profit impact of $100 million and occupancy of $60 million, the balance is all going to be cost. So, that's the piece that will continue to push going forward to add to the $760 million that we talked about in the past three years.

Okay. So, of the $140 million of the costs, you said advertising is a small piece. How much do you think the European restructuring might be able to --

I think you're going to see, of that remaining piece, probably 40% to 50% of it be international driven.

And is most of that fixed or is that --

It's a blend of operating and G&A. Probably a little bit too much detail to get into that kind of breakout.

Sure. Just because of time, I'll follow up offline. Thank you.

Great.

Okay.

Joe Feldman.

Hi, Telsey Advisory Group, thanks, guys. Question about -- you mentioned the European business and portfolio optimization. Can you give a little more color on that, and what you're looking at? Should we think of stores? Is it actually exiting more countries? How should we think about that?

Steve, you want to deal with that?

Sure, Neil. Yes, as we think about the portfolio across Europe, it's really looking at all aspects of the business. We're looking at each of the individual countries, we're looking at partnerships that we've got, we're looking at mix of business, and so it really is an entire portfolio optimization in order to improve the long-term aspects of our business both from a revenue and from a profit standpoint. We don't want to provide any specifics at this time. It's work in progress. And we'll be advising as we move forward.

Got it. Thank you. And then another question I wanted to ask was about -- I know the online business, you talked about making more investments there and where you think it might be heading. I guess we're just curious as to what we should be looking for in that front, where you think you see the most opportunity to make some changes or keep funding things?

Kevin?

Sure. I think several platforms. I think we want to continue to make sure that we've got a differentiated experience online. I think equally we want to make sure that the lines between our e-commerce platform and our brick-and-mortar Retail business become much more blurred over time, and customers can freely shop between channels and enjoy the same experience. So, I think we'll continue to make investments in mobility. We talked in the script about seeing a greater number of our browser transactions coming in from mobile devices, and we want to make sure that we have got a great experience there, putting a kiosk inside of our stores so that customers who can't find what they're looking for can navigate via the kiosk.

And I think inside the e-commerce platform, we're looking at ways to improve search and select, as well as content, and become really an information source for customers. So, I think it's both omni channel, as well as improving the experience for our customers once they're on our site, and then certainly finally investing in mobile.

Got it. That's helpful. Thanks. And good luck with the quarter, guys. Thank you.

Thanks, Joe. I think the queue is empty, so that concludes our webcast and conference call this morning. Thank you very much for participating, and I'll be available to take your calls later today. This is Brian. Thank you.

That concludes today's conference. Please disconnect at this time.