Office Depot, Inc. F4Q08 (Qtr End 12/29/08) Earnings Call Transcript

| About: Office Depot (ODP)

Office Depot, Inc. (NYSE:ODP)

F4Q08 Earnings Call

February 24, 2009 9:00 am ET


Brian Turcotte – Vice President, Investor Relations

Steve Odland – Chairman, Chief Executive Officer

Carl Rubin – President, North American Retail

Steve Schmidt – President, North American Business Solutions

Charles E. Brown – President of International Business

Mike Newman – Chief Financial Officer


Oliver Wintermantel – Morgan Stanley

Kate McShane - Citigroup

Michael Baker - Deutsche Bank Securities

[John Lash] - Jefferies & Co.

Aaron Whiteman – Appaloosa Management

Emily Shanks - Barclays Capital


Good morning and welcome to the fourth quarter 2008 earnings conference call. (Operator Instructions)

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

Brian Turcotte

Thanks, [Tammy].

Before we begin I would like to remind you that our discussion this morning may include forward-looking statements, which are subject to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements reflect the company's current expectations concerning future events and are subject to a number of factors and uncertainties that could cause actual results to differ materially.

A detailed discussion of these factors and uncertainties is contained in the company's filing with the SEC. The press release and the accompanying webcast slides for today's call are available on our website at Look on Investor Relations under Company Information.

I'll now turn the call over to Office Depot's Chief Executive Officer, Steve Odland. Steve?

Steve Odland

Good morning and thank you for joining us for Office Depot's fourth quarter 2008 earnings conference call. With me today are Mike Newman, our Chief Financial Officer, Chuck Rubin, our President for North American Retail, Steve Schmidt, our President for North American Business Solutions, and Charlie Brown, our President of International.

Since our third quarter earnings call in October 2008 the global economic crisis has worsened, as you know. The U.S. housing crisis that began in 2007 deepened throughout 2008 and spilled over to the global economy as underlying assets declined, creating a global banking and credit crisis. This in turn has resulted in a deep recession, systemic lack of liquidity and significant cuts in spending and employment. These events have severely impacted Office Depot's customers and therefore our sales and earnings in the fourth quarter of 2008.

Fourth quarter 2008 total Office Depot sales were $3.3 billion, a decrease of 15% compared to our fourth quarter results last year. Our net loss on a GAAP basis was $1.54 billion compared to earnings of $19 million in the fourth quarter of 2007. The GAAP loss per share on a diluted basis was $5.64 for the quarter versus diluted earnings per share of $0.07 a year ago.

Adjusted for charges, the net loss and loss per share on a diluted basis were $199 million and $0.73, respectively. The charges, which included unusual items that are not considered indicative of our core operating activities, include first a non-cash charge of $1.27 billion or $4.54 per share recorded for goodwill and trade name impairment and second, a pre-tax charge or charges of $1.67 million or $0.37 per share for actions taken as part of the strategic business review.

Other pre-tax charges related to business downturn totaled $125 million in the fourth quarter.

Although we're disappointed with our earnings decline in the fourth quarter, we are pleased that cash flow before financing activities was a positive $4 million. Cash flow and liquidity are key focal points for us in these challenging times and Mike will cover our liquidity position in greater depth later in this call.

Adjusted for charges, our total operating expenses increased by $42 million compared to the fourth quarter of 2007. Fourth quarter 2008 adjusted operating expenses include approximately $89 million for asset impairments as well as charges to increase reserves on credit cards and other receivables. Despite these increases, which were principally due to macroeconomic factors, we were able to reduce certain operating costs, including payroll and advertising expense. EBIT adjusted for the charges was a loss of $210 million in the fourth quarter of 2008 or a negative 6.4% of sales compared to a positive $6 million or 0.2% in the same period last year. Excluding all the charges, EBIT was a negative $85 million in the quarter.

For the full year, sales decreased 7% to $14.5 billion. EBIT adjusted for charges decreased to a loss of $51 million. The GAAP loss for fiscal 2008 was $1.48 billion compared to earnings of $396 million in fiscal 2007. The GAAP loss per share on a diluted basis was $5.42 in 2008 compared to earnings per share of $1.43 in the prior year period. The diluted loss per share for fiscal 2008 adjusted for charges was $0.41 versus earnings per share of $1.54 in 2007.

We're disappointed with these fourth quarter results, which are largely a barometer for what is happening in our economy. Our sales are office products and services, which are G&A spending for our customers. And as these times have gotten tougher, our customers have significantly cut back their spending, including their spending on office products. But despite the economic challenges, I assure you the management team and 43,000 associates worldwide here at Office Depot will continue to do everything we can to provide innovative products and solutions to our valued customers, to manage our costs and control our cash flow. As we go through the call today we will update you on plans to continue to manage the company through this challenging period.

I'll now turn the call over to Chuck to talk about North American Retail's fourth quarter performance and key initiatives. Chuck?

Carl Rubin

Thanks, Steve.

Fourth quarter sales in the North American Retail division were down 17% to $1.4 billion. Comparable store sales in the 1,207 stores in the U.S. and Canada that have been open for more than one year decreased 18% versus the fourth quarter of 2007. This sales comp decline was driven by lower transactions and lower average order value. Transaction counts were down compared to last year, but fairly stable for the past few quarters.

Our average order value was lower, with the largest percentage decline over the previous year of any quarter in 2008, as customers reduced their spending for big ticket and discretionary items such as furniture, computers, printers and televisions, and spent mostly on necessities, including core supplies like ink, toner, paper and Design, Print & Ship Services.

While we continued to experience sales declines in the three major product categories of supplies, technology and furniture in the fourth quarter of 2008 compared to the fourth quarter of 2007, the greatest declines were in technology and furniture. We know that most of the decline in North America can be attributed to macroeconomic factors, as indicated by our third-party econometric modeling; however, we also made a conscious effort to reduce inventory, particularly in low margin technology products. We feel that these two efforts had an adverse effect on our sales comps, especially in technology.

Business conditions continued to weaken across North America in the fourth quarter. Although it appeared that the rate of sales decline in California had stabilized for the nine months of the year, the fourth quarter proved to be much more challenging. And our most developed market, Florida, continues to be the most troubled macroeconomic market.

In the fourth quarter we opened two new stores, closed 10 and relocated one, bringing our total store count to 1,267 at year end. We also remodeled 11 stores in the fourth quarter, all of which received landlord funding.

The operating loss for the North American Retail division was $119 million in the fourth quarter of 2008 versus an operating profit of $23 million one year earlier. This included a significant noncash store impairment charge of $78 million and an additional reserve of $12 million. The reserves were increased for previously closed store sublet assumptions and potential bad debt related to our private label credit card.

Other key components of the operating profit change versus a year ago include the following: On the positive side, we had an improvement in product margins for the second straight quarter. The increase was approximately $25 million and reflect improvement in product mix and lapping the vendor program negative adjustment last year. Flow through from sales volume decline negatively impacted operating profit by approximately $66 million to last year and we had an $11 million negative impact from increased property cost.

Getting to our full year performance, sales for 2008 were $6.1 billion, down 10% to 2007. Comp sales for the year were down 13%. Operating profit declined from $355 million for 2007 to a loss of $29 million in 2008. This decline was mostly driven by $98 million in asset impairment, $34 million in shrink and inventory related charges, $49 million due to increased property cost, and the balance due to lower sales.

In the face of this very challenging economic environment, we're placing a stronger emphasis on providing core products, services and solutions to our customers while continuing to tightly manage costs. I'd now like to take a few minutes to summarize some of our key initiatives.

First, we're increasing services critical to the micro business customer, including Design, Print & Ship and Tech Depot services. These services fulfill additional customer needs, while differentiating Office Depot from the competition.

With respect to Design, Print & Ship, Office Depot continue to be the only company with Xerox-certified associates that guarantee the best quality. We have also expanded our service offerings to include printing photographs, producing large-format posters and blueprints, as well as design and complete presentations and business cards. These services, along with the differentiated customer service experiences, position Office Depot as the source for all micro business customers' marketing needs.

Tech Depot services is another example of how we provide a solution based on the needs of our customers. Using a low-cost, capital light third-party model, we have the ability to install or repair technology products at any one of our retail stores or at the customer's home or office location. Tech Depot services gives us flexibility in providing professional reliable services more profitability than some of our other more capital intensive services offered in the marketplace.

Second, our product assortment line reviews continue and the initial results show encouraging signs of improved sales and margins. The goal is to deliver a more profitable assortment of supplies, furniture and technology from the most respected brands, including Office Depot's private brand, that captures new customers and expands share of wallet with existing micro business customers. This will also result in better prices and more attractive product presentations for our customers. A great example of this is our new Sharpie Try and Buy Center that will provide customers with more options, better value and the ability to experience the product before purchasing. We expect the product review process to continue through 2009 and touch most of the current product categories.

Third, we continue to manage our inventory very tightly. Our first store inventory at the end of the fourth quarter was $689,000, down 28% from the same period one year ago, primarily due to lower technology and furniture inventory levels. Average inventory per store in the fourth quarter was $776,000, down 25% from a year ago. I'm pleased that despite the lower inventory levels, our in-stock inventory levels in mystery shop stores remain very high. As a result, we're convinced that the actions we're taking in the current economic environment will improve the business model and provide significant leverage when sales do improve.

And fourth, we plan to open approximately 15 new stores during 2009. We would prefer not to open new stores this year, but we have lease commitments which were pushed out from 2008 that require us to open within a set period of time. We will continue to work to reduce the number of new store openings. We plan to close 118 stores in 2009. This includes stores we identified as part of our strategic review in December that should be closed and inventory liquidation completed around the end of the first quarter.

In summary, we are disappointed with our fourth quarter results but know that they were driven by macroeconomic factors and our overexposure to technology sales, specifically computers, that slowed dramatically in the fourth quarter. While we did pull back our advertising and inventory support for computers in the fourth quarter, they still represented a significantly larger percentage of our business when compared to other office supply competitors.

As we move into 2009 we will further reduce our exposure to the computer category by refining our assortment by store volume and cutting back on entry level price point computers, which are typically the most cherry picked part of our offering and therefore the worse profitability. Certainly during the fourth quarter, this cherry picking customer behavior was most evident, especially on Black Friday. We anticipate that these changes will improve our operating margins going forward.

I should note that although we're only two-thirds of the way through the first quarter, our sales comp is currently tracking better than our fourth quarter performance.

With that, I'd like to turn the call over to Steve Schmidt to review the fourth quarter results and key initiatives for North American Business Solutions.

Steve Schmidt

Thanks, Chuck.

Total sales in the North American Business Solutions division were $920 million, down 14% versus the fourth quarter of last year. Similar to the previous quarter, the sales decline was caused by severe spending cuts by our customers.

On a sequential basis, the sales declines among our small to medium-sized business customers or SMB and large national account customers accelerated in the fourth quarter. Driving this decline was a reduction in average spend per order and a decrease in the frequency of purchases by our customers.

In the public sector, we saw an improvement in the federal government accounts in addition to state contract renewals in New York, Delaware, Nebraska and Illinois. However, the California budget crisis continues to negatively weigh on our business in that state.

Further driving the sales decline was a continued weakness in our furniture, technology and perishable sales as customers postponed their purchases on non-essential discretionary type items in favor of lower margin core office supplies. Similar to the reduction in customer spending reported by North American Retail, many BSD customers are restricting their employees to only purchasing office supplies that are on their core product list, and these products typically have the lowest margins.

Declining sales in Florida and California continue to exceed the overall rate of decline of total business. These two states represent about one-third of BSD's revenues. Mandates by the state governments to cut discretionary spending along with reduced access to liquidity for small, medium and large companies have negatively impacted our division's financial performance.

The North American Business Solutions division had an operating loss of $28 million for the fourth quarter of 2008 compared to earning $1 million for the same period in the prior year.

The components of the fourth quarter operating margin decline versus one year ago include the following: Approximately $20 million of the operating profit decline relates to the flow through impact of the lower sales levels; next, about $6 million of decline from increased allowances for bad debt and other negative items minus the benefit of lapping a vendor program negative adjustment last year; and a $3 million decline due to lower margins caused by unfavorable customer and product mix and increased promotions in direct that did not produce the desired sales results.

With respect to our full year performance, sales in 2008 were $4.1 billion, down 8% versus 2007. Primarily impacting sales was a weakness in the Florida and California markets and a declining sales growth trend among our SMB customers. Full year operating profit for the Business Solutions division was $120 million, down approximately $100 million from 2007. Please note that these results do not include the goodwill impairment charges reported at the corporate level.

Although business continues to remain tough, the Business Solutions division continues to focus on taking care of business by taking a customer-centric approach going forward and leveraging existing assets to aggressively service new and existing accounts. This plan is reflected in our five operating principles, which I'll cover briefly.

First, we are committed to increasing the number of small to medium-sized business customers in our customer mix. Presently, large lower-margin customers account for two-thirds of our customer mix, while the higher-margin SMB customers account for the balance. Therefore, it is critical for us to have the right approach when engaging these SMB customers.

For this reason, we continue to refine our customer contact strategy to ensure that our salespeople have the right tools and processes to compete for this business. We've also added additional third-party sales representation or feet on the street to drive prospecting for new SMB customers. In addition, the launch of a comprehensive loyalty program is planned for the first quarter.

Second, we have been making improvements to our telephone account management or TAM organization. Specifically, the key performance indicators we have put in place have dramatically improved the performance of our TAM partners. As a result, our TAM sales representatives are now spending more time on the phone prospecting for customers, retaining customers by providing excellent service, and selling. New information and selling tools have also been added.

Third, in our direct business we continue to refine our catalog circulations with the goal of increasing the customer file. One example of an enhancement is revising our pricing and promotional strategy. With the help of a sophisticated price optimization tool that takes into account price elasticity across categories, we now know what each of our customer groups buy and price it accordingly based on channel, category and competitive influences. We have also begun leveraging the knowledge management capabilities of our data warehouse.

Fourth, we continue make customer-focused enhancements to our website. These enhancements include confirming delivery times, improving the search functionality and return policy, providing recommendations for add-ons and introducing live chat, which allows customers to get their questions answered by a product expert. Our customer conversions rate ranks among the best in the industry, which is very important as more price conscious customers flock to the Internet to comparison shop.

And fifth, we reorganized our contract selling organization structure in the fourth quarter to align with the current economic environment, reduce cost and improve effectiveness. We've fully integrated TAM, feet on the street, and our direct market capabilities to optimize each customer experience.

In the fourth quarter, 82% of total BSD sales were online, up slightly from the same period a year ago. Our total company Internet sales on a global basis for 2008 totaled $4.8 billion compared to $4.9 billion for the same period a year ago. The number of customers ordering products was up year-over-year, but a decrease in both the number of items ordered and the average order value primarily drove the sales decline. The decline is a result of our customers' focus on the essential items and more price comparison shopping.

Further, we made progress in new business development in the fourth quarter and are launching new product tests in the first quarter that could drive new profitable revenue later in the year. Our associates will continue to take a customer-centered approach to improving our business and focus on shifting our mix to include more SMB customers while tightly managing our expenses during these challenging market conditions.

In summary, we are disappointed with BSD's fourth quarter results, but know that they were driven by severe spending cuts by our customers and increased promotionality in our direct business. Nearly half of our operating loss in the fourth quarter was related to increased investment in promotions and ad spend in our direct business, but the customer buying support wasn't there. We are now testing changes to our spending in direct which should positively impact our operating profit going forward.

Charlie will now discuss the fourth quarter results and key initiatives for International Business. Charlie?

Charles E. Brown

Thanks, Steve.

The International division reported sales of $963 million in the fourth quarter. That's a decrease of 15% in U.S. dollars and 4% in local currencies compared to the same period last year.

The direct channel declined 7% in local currencies as a result of small to medium-sized businesses reducing their discretionary expenditures and increasing competitiveness within the channel.

The contract channel once again outperformed direct; however, this channel also experienced a contraction in spending among its customers resulting in a sales decline of 2% in local currencies.

Retail sales were up 1% versus one year ago because of our third quarter of 2008 acquisition in Sweden.

Similar to the U.S., the macroeconomic trends continue to deteriorate worldwide. The U.K. and most of Europe have officially entered into recession. China is now feeling the effects of the global economic crisis, with factories shutting their doors and companies laying off thousands of employees as global demand for their products have dramatically slowed. And Japan reported that its GDP shrank at its quickest pace since 1974 in the final quarter of 2008, contracting by an annualized rate of over 12%.

Division operating profit was $10 million in the fourth quarter of 2008 compared to $60 million in the fourth quarter a year ago. The components of the decline versus a year ago include the flow through impact of lower sales levels impacting operating profit by approximately $23 million; intangible asset write-offs in Asia and Europe increased expenses by $11 million; higher costs and increased competition in key items had a negative impact of $10 million, and a change in foreign currency exchange rates unfavorably impacted operating profit by $6 million.

Turing to our full year performance, sales for 2008 were $4.2 [billion], up 1% versus 2007. Sales in local currency was down 2%. Full year operating profit was $157 million, down $74 million from 2007, but please note that these results do not include the goodwill impairment charges reported at the corporate level.

While business conditions continue to be very challenging, we are moving forward with four key initiatives aimed at improving profitability.

First, we are focused on providing a differentiated value proposition by introducing new products, services, and solutions. We have developed an asset lite version of [Tech Depot] for Europe. This centrally hosted [inaudible] site is run through a triple play, offering over 40,000 SKUs online. We currently operate this service in the Netherlands and the U.K., and have plans to roll it to four additional countries by year end. We also plan to test Office Depot Tech Services in 2009, the same service offered by our North American Retail division, as well as expand our telephone account management and regional sales teams to drive greater penetration in the small to medium-sized business segment.

Secondly, we are working to improve our gross margins. Currently we operate micro brands in Europe, and we're offering similar products but often different packaging and pack sizes. This exists not only by channel but also by country. The objective is to harmonize our SKU assortment among channels and countries, which simplifies inventory management and significantly [decreases] our operating costs and inventory level.

Direct import of private branded products is another opportunity for us to improve margin, and it's truly a global effort. From the [direct] sourcing office in Shenzhen, China, the direct import team is sourcing products in close coordination with local manufacturers, reducing the cost and improving the quality of our private branded products. We believe that we can direct source about half of our private branded products, adding an incremental 100 to 200 basis points to our margins.

Third, we remain committed to reducing operating costs while improving service and customer satisfaction. As I've mentioned on previous calls, our customer service and supply chain metrics in the U.K. continue to get better, and we are now providing our customers with record service level metrics. We're also focused on limiting redundant IT costs in Europe, driven by our current reliance on multiple legacy systems that differ by channel and by country.

And fourth, we continue to grow the number of markets where Office Depot brands are represented. We are looking for creative ways to expand through strategic alliances, franchise agreements and/or partners. For example, we recently announced a franchise agreement with M.H. Alshaya Company, an international retailer operating over 40 international franchise brands throughout the Middle East, Eastern Europe and Russia. Alshaya has been granted the exclusive rights to Office Depot branded stores and Office Depot products and services in the Middle East. Furthermore, they have exclusive rights to establish B2B operations using our brand name in those countries. We believe this is a great example of how we can expand the Office Depot brand while minimizing our direct investment.

In summary, we will continue to innovate, improve customer service, reduce costs and remain focused on streamlining our operations while being mindful of our capital spending in this difficult economic environment.

I'll now turn the call over to Mike, who will review the company's financial results in more detail.

Mike Newman

Thanks, Charlie. I'll now give you a brief update of the strategic business review actions we announced in December of 2008.

North American Retail closed six underperforming stores in the fourth quarter of 2008 related to the strategic review and expects to close an additional 118 stores in 2009. We closed one North American distribution facility in the fourth quarter and plan on closing an additional five facilities during the first quarter of 2009. Additionally, we're taking restructuring charges related to a number of items, including the rationalization of some of our International businesses, a software writedown, and other initiatives in North America. These actions should benefit 2009 EBIT and cash flow by approximately $130 and $105 million, respectively.

We recognized charges totaling $1.44 billion in the fourth quarter of 2008. The largest charge was a $1.27 billion write-off of goodwill and trade names, including $2 million for North American Retail, $348 million for North American Contract, and $920 million for International. Additionally, we recognized about $167 million of pre-tax charges related to the strategic business review actions I just reviewed. During 2009 we expect to recognize approximately $186 million in additional charges related to initiatives covered by the strategic review and projects initiated under our 2005 restructuring program.

Adjusted for charges which totaled $1.44 billion, the net loss and loss per share on a diluted basis were $199 million and $0.73, respectively. The adjusted loss of $199 million includes $125 million of additional pre-tax non-cash items, including $78 million for FAS 144 charges, about $28 million of credit card and bad debt reserves, and about $18 million of asset writedowns. Excluding the $125 million of non-cash items from our fourth quarter result provides an operationally based view of our performance in the quarter.

In light of our operating performance, we are pleased with our management of working capital and overall cash flow performance in the fourth quarter. We were able to offset the negative cash flow impact from earnings with improved working capital and we received $20 million in proceeds from the sale and leaseback of four North American Retail store locations. As a result, our cash flow before financing activities was $4 million for the quarter. For our definition of cash flow before financing activities and a reconciliation to our GAAP financial measure, please go to our website under Investor Relations.

Our fourth quarter capital spending was $52 million, $10 million below the $62 million of depreciation and amortization we recorded, and totaled $330 million for the full year. Given the uncertain conditions we're facing, we continue to flex our CapEx towards maintenance levels and now project out full year 2009 spend to be about $150 million or about 60% of depreciation and amortization.

For the 12 months ended December, cash provided by operating activities was $468 million, cash flow before financing activities was $119 million, and free cash flow was $138 million.

In addition to the asset-based loan facility or ABL, we are actively pursuing internal sources of liquidity in 2009, including sale-leasebacks of owned properties in both the U.S. and Europe which could total up to $200 million, the sale of certain accounts receivable in Europe, which could total up to $100 million, and about $105 million in cash benefit from the strategic business actions we announced in December, and about $50 million in dividends from a joint venture and tax refund.

At the end of December we had drawn $139 million on our ABL and had $178 million in outstanding letters of credit against the facility, leaving us with $712 million of availability. Given the ABL availability and the $156 million in cash we had on hand at the end of December, we exited 2008 with $868 million in available liquidity.

We're also working hard to make changes to improve EBIT in 2009. Excluding all charges, we reported negative EBIT of about $85 million in the fourth quarter. A significant portion of this was due to ineffective marketing efforts with computers and in our direct business. Both of these strategies now have been modified. We will work hard to improve EBIT throughout 2009 and it will likely be somewhat negative, but we believe that the company will be free cash flow positive in 2009 based on good working capital management and the benefit of the $400 million of liquidity enhancing initiatives. If we assume that the extremely challenging business conditions we faced in the fourth quarter continue, the additional liquidity should provide an adequate cash cushion for running the business without drawing further on our ABL in 2009.

Regarding our balance sheet, we ended the fourth quarter with $156 million in cash and cash equivalents, as I just mentioned. Our investment in global inventory totaled $1.3 [billion] globally, down 22% from the same period last year. This decrease was driven primarily by lower inventory in North American Retail, with inventory per store at quarter end at $689,000, down 28% from the same period a year ago. This inventory reduction was primarily the result of improved inventory management throughout the supply chain, including the elimination of redundant SKUs, a reduction in safety stock, and alternate sourcing. We don't believe these inventory management actions risk our ability to serve our customers, but rather present performance opportunities we have realized in our supply chain.

Our net debt at the end of the fourth quarter was $725 million, including $689 million in long-term debt. With the new asset-based credit facility in place, $400 million of bonds not maturing until 2013, and the additional liquidity actions we are taking, I remain comfortable that we have a capital structure in place to take us through this business cycle.

I should note that we spoke with our 50 top global vendors to discuss our current financial condition and projected liquidity. We were pleased that our key vendors were encouraged by the company's liquidity position in this recessionary environment and committed to partnering with us now and into the future.

And with that, I'll now turn the call back over to Steve.

Steve Odland

Thanks, Mike.

Clearly, we are disappointed with our results, but we are very pleased that we are cash flow positive in the fourth quarter. Given the world in which we all operate today, liquidity is paramount. Although we don't know the depth or the duration of this global crisis, we are taking a very conservative approach to our liquidity position for the near and the long term. It's extremely challenging to provide an outlook given the state of our economy, but I'm pleased that our North American Retail sales comps are a little better in the fourth quarter and that we do project positive free cash flow for 2009.

In closing, I would like to reiterate that we are committed to leading the company through these challenging times and that we will continue to do everything we can to provide innovative products and solutions to our valued customers, to manage our costs, and to control our cash flow.

Operator, we're now ready to take questions.

Question-and-Answer Session


Thank you. (Operator Instructions) Your first question comes from Oliver Wintermantel – Morgan Stanley.

Oliver Wintermantel – Morgan Stanley

Steve, you mentioned in the past that you think that consolidation of the office space would be healthy. Has your opinion changed over the last few months or how do you think about that?

Steve Odland

Yes, Oliver, we've been very consistent over the past few years saying that we think consolidation should happen in this industry. As you know, it's a very fragmented industry, not only within the channel, where there are several players, but also more broadly. The channel itself only has a small market share, and so the market for office supplies is split across many channels - mass, grocery, drug, wholesalers and so forth.

Oliver Wintermantel - Morgan Stanley

Can you comment on the promotional environment and if that changed at the beginning of the year versus the fourth quarter? And could you also give us some color how the backtobusiness season was for you guys?

Steve Odland

I think that as we talked about in the division reports, we tried a lot of things to stimulate sales, and some of our loss in the fourth quarter is explainable by the promotions that we lost money on that just simply didn't work. And I think that we've said clearly that we will modify things going forward because our customers simply can't buy. We were trying to stimulate some incremental purchases, especially in technology, where we lost money on computers, and we simply can't and won't sustain that going forward.

We have said that the comp environment has improved for us in the back-to-business season, but I think if you look at how this thing started, early on we had weakness in retail and among the smallest of our customers and I think beginning in the fourth quarter we started seeing that softness spread to our largest customers. So there's a difference here as time has gone on, and I think that's consistent with what others have seen as well.

Chuck, you may want to comment on any specifics related to merchandising.

Carl Rubin

Yes. I think, Steve, you hit the nail on the head. I think in the fourth quarter we saw big ticket items across computers and printers and televisions slow dramatically. And to your point, Steve, on the first quarter of back-to-business, things have stabilized and we are seeing thus far a trend in our comp performance that's better.


Your next question comes from Kate McShane - Citigroup.

Kate McShane - Citigroup

Of the 15 stores that you're opening in 2009, are you getting better lease terms or were you already committed to a certain lease term? And are any of these stores located in California or Florida?

Carl Rubin

We have gone back on those 15 stores. We also have been aggressively pursuing terms on all of our leases across the chain. We believe that we will make some additional progress. We already have made progress both quantitatively and qualitatively on the lease terms. So quantitatively there are improvements that we're seeing on rent terms that we have for leases that are currently out there for us, as an example, and you're up to speed on how that works with co-tenancy issues and a variety of means that we're negotiating with the landlords. That's the quantitative side. Qualitatively we also are seeing benefits as landlords are improving the sites that we're operating in, whether it's a parking lot or upgrading the exterior of the building, so we're seeing improvements there.

As far as the locations of the 15 stores, the vast majority of them are not in California and in Florida.


Your next question comes from Michael Baker - Deutsche Bank Securities.

Michael Baker - Deutsche Bank Securities

Three questions, I guess. One, I just wanted to ask you about the asset-backed facility. How secure is that? Is there any possibility that your lenders can pull that in?

Second question, you talked about conversations with your top 50 vendors and your key vendors were on board, but was there some percentage of vendors that maybe had a little bit more pushback?

And then my last question, I'm just trying to figure out what is the right EPS number, I guess, for the quarter? So you have $199 million, but that includes $125 million in pre-tax charges. What's the post-tax charge in that additional $125 million that perhaps we should exclude?

Mike Newman

As far as the ABL, no, the lenders do not have the opportunity to pull back in. In fact, part of the ABL process is we have an annual call with the banks. We had that two weeks ago. We talked to them about our liquidity position, our fourth quarter results, the things that we're doing as far as these additional liquidity actions we called out on the call today, and I would characterize that conversation as having gone very well with the banks. They're solidly behind us.

The vendor effort, a group of us - merchandising, finance, operating people - have talked to our top 50 global vendors in the last two weeks. I would guess in total we probably had over 100 different discussions with them. Those calls, as you mentioned, the key vendors, first, they were very appreciative, appreciated our candor. We signed NDAs with all of them and had the same discussion that we're basically having with you today. I would characterize the reaction from the vendors as excellent, and we do not have - certainly we always have an issue here or there as it relates to an open item or an undershipment or whatever - but from a macro perspective our vendors, the reaction has been very good.

The EPS question that you've asked, when you take our GAAP numbers, eliminate the goodwill, eliminate the restructuring pieces, and then we also called out $125 million of onetime charges in the quarter - as we highlighted, it relates mostly to FAS 144 store impairments and bad debt write-offs - I believe the underlying EBIT for the quarter is around $85 million.

We've not put an EPS number on that because it's difficult to calculate the tax impact of that; I'll let you guys do that. But I will comment on the fact that we don't believe that that $85 million is a run rate going forward. We think it's actually lower. One, a lot of the restructuring activity that we've taken in the fourth quarter will reduce that $85 million fourth quarter loss going forward. And then we also talked about some of the things that we've tried in merchandising and in direct marketing that we're going to curtail going forward. So that number going forward may still be slightly negative, but we think we've taken significant steps to even reduce that level in the future.


Your next question comes from [John Lash] - Jefferies & Co.

John Lash - Jefferies & Co.

My first question is still about vendor support. We heard many reports that there were certain small vendors of yours in Europe that we having a hard time getting credit insurance and we were hoping to get an update from you guys on the scope of this issue and how it's been developing over the past few weeks.

Mike Newman

Yes. The credit insurance issue is one that really came on the heels of the Circuit City announcement. A lot of the credit insurers are people like [Cosmiths], [Eurhermays], Atradius. They have reduced their exposure to retail in general and that has had some impact on us in Europe. I would characterize this as a localized impact in Western Europe. It has affected us in, I'll say, a small way with some of our European vendors.

We've spoken with those three insurance providers at length. They have reinstated some of their credit for some of our key vendors to allow them to keep working, but we don't believe that's a major issue. We continue to monitor it and it has had to date no impact on our operational efforts to ship to our customers or our supply.

So we continue to monitor that and, as I said, mostly it's been localized in Western Europe.

John Lash - Jefferies & Co.

You said that inventory per store is down 28%. If we back out the impact of technology and furniture, can you give us an idea of where inventories per store might stand?

Carl Rubin

The inventories per store in supplies also were down. They were most significantly down in tech and in furniture on a percentage basis. We have recorded that. I don't have that at my fingertips. If we want to come back for it, we'll provide that to you.

But we purposely cut back on our promotions and our inventory in tech and furniture; we saw the slowdown coming. And we were disproportionately hit because our technology business, even with that pullback, is the most developed in the space, so we did get hit on our top line as a result of that. But we had seen some of it coming and were able to react by cutting back on our inventory, and at this point our inventory is in very good shape on a per store basis.

John Lash - Jefferies & Co.

Can you just talk about the margin impact from higher bad debt reserves and separately from lower credit profit sharing on the third-party credit portfolio? And where do you expect this to be in 2009?

Mike Newman

Overall, the total impact, probably the best way to answer that - and I'll let you guys do the math  is in the one-time charges that we took, the $125 million that we call out, we probably had all in about $28 to $30 million of impact from credit and we also had some additional reserves on our [Citi] private level credit card.

We think that going forward that that puts our reserves in a sufficient position for 2009. It may go up some, but it's not going to be a significant number going forward, an additional increase. Those reserves were done based on our 2009 projections.


Your next question comes from Aaron Whiteman – Appaloosa Management.

Aaron Whiteman – Appaloosa Management

In terms of your one-time charges, do you expect that in Q4 to have been about 100 that was included within COGS and SG&A -

Brian Turcotte

Excuse me. Aaron, we can barely hear you. Could you speak up just a bit please.

Steve Odland

You're cutting in and out.

Aaron Whiteman - Appaloosa Management

In terms of your one-time charges that were included within COGS and SG&A to get to your negative 85 of EBIT, that's approximately $100 million of one-time charges, correct?

Mike Newman

Yes, the one-time charges we called out of approximately $125 million, probably COGS and SG&A is most of that; it's almost $120 million of that.

Aaron Whiteman - Appaloosa Management

And where do you expect to get your SG&A down to for '09 from a [break in audio] high for Q4?

Mike Newman

Yes. It's tough to say. We don’t give specific earnings guidance or line item guidance. Suffice it to say that we're doing everything we can to control our SG&A and to take it down depending on where sales go; you know, the percentage of sales could go up. But we're trying to get the dollar amount down year-over-year, and I think that that should be possible. The other thing is that, depending on what bonus comes in, that can impact it as well.

So in dollars down and percentage depending on sales I guess is the best way to answer that.

Steve Odland

Yes, I'd agree with that.

Aaron Whiteman - Appaloosa Management

Is there any potential to get a larger tax refund?

Mike Newman

In the liquidity actions that we've talked about, we have the extent of the tax refund baked into those liquidity actions that we discussed. I probably won't call out a number specifically because then I'll have to give you the whole list, but it's a significant number. And we'll continue to look at that, but we think we have that sized correctly. It's not a significant piece of the $400 million plus of liquidity actions that we talked about. It's not significant, but it's meaningful.

Aaron Whiteman - Appaloosa Management

And what are the actual main risks to you achieving that $400 million number?

Mike Newman

The key pieces in the $400 million, some of those pieces are actions we can control. We'll take our CapEx down. We had it earlier in the year or late last year guided $200 million. Now our guidance for CapEx for next year is $125 million. That's a piece of the liquidity actions.

But the major pieces that have -

Steve Odland

$150 million in CapEx.

Mike Newman

$150 million on CapEx, sorry.

The major pieces are sale-leasebacks, which we are working on. At this point in time, of the $450 million we're looking at approximately $150 million we'll have in hand at the end of the first quarter. Those would particularly be around sale-leasebacks of domestic properties and then sale-leasebacks of European DC and headquarter facilities, which we are actually frankly very close to closing a tranche of those today. We also have a $100 million factoring receivable opportunity in Western Europe that we expect to close in late March, early April.

So there's a fairly significant piece of that that we expect to happen in the first quarter and a sizeable chunk that we'll see in the first half.

Steve Odland

And suffice it to say that a huge amount of that, at least about half of it, is going to hit free cash flow, and that and working on the EBIT actions that we talked about should allow us to follow our projections to hit positive free cash flow for the year.

Mike Newman


Aaron Whiteman - Appaloosa Management

And your estimates to have positive free cash flow in '09 are only achievable if you get this $400 million?

Steve Odland

No. No, free cash flow includes about half of the $400 million in actions.


Your next question comes from Emily Shanks - Barclays Capital.

Emily Shanks - Barclays Capital

I was just hoping for slightly more clarity around the charges that were just touched upon in the last question. The $125 million which is indicated primarily relates to the North American Retail impairment. What amount of that is non-cash?

Mike Newman

If we're talking about the $125 million that we called out as one-time charges that are in addition to the adjusted results that we talked about, [inaudible] to that there's approximately $80 million for store impairment and that's North American Retail. There's approximately $28 million of bad debt; that's principally our BSD business. Then there's approximately $10 million of customer list write-offs that are International driven, and then there's some other noise that gets you to $125 million.

So really those three pieces line up nicely with the business results or the business units that we have. Those are the key pieces of the $125 million.

Emily Shanks - Barclays Capital

And so they therefore are all non-cash.

Mike Newman

They're all non-cash.

Emily Shanks - Barclays Capital

And then as I look at the P&L, the line item below goodwill and trade impairments, the other asset impairments of 202 [spot 5], how does that reconcile with your definition of Charges, capital C? I get the $1.27 billion of goodwill and trade name impairment, but then you also cite in your Charges, capital C, pre-tax charges totaling $167 million. Is that other asset impairments of 202 spot 5?

Mike Newman

Yes, the other asset impairments of $202 million includes a number of those items that I've also mentioned and probably the best thing to do is to get you offline to get you the details because it would be probably way too detailed to do it on the call, or I could do it but I'd probably bore you to death.


And I am showing no further questions at this time.

Brian Turcotte

Okay, if there are any other questions we'll hang on here a minute. I know that we're running into other calls this morning and we apologize for that. Obviously, we schedule these things long in advance, but we know we landed on a variety of other corporate calls, which is probably why the questions are down. But let's just hang on another 30 seconds or so and see if anybody else wants to get into the queue.

All right. Well, it looks like we've run through the questions that are in the queue, so this will conclude our conference call this morning. Please note that we will be updating our supplemental investor presentation on our website in the Investor Relations section. Thanks very much for participating in today's call.


Thank you. That does conclude today's conference call. You may disconnect at this time.

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