Office Depot, Inc. F1Q09 (Qtr End 03/28/09) Earnings Call Transcript

Apr.28.09 | About: Office Depot (ODP)

Office Depot, Inc. (NYSE:ODP)

F1Q09 Earnings Call

April 28, 2009 9:00 am ET

Executives

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

Analysts

Matthew Fassler – Goldman Sachs

Colin McGranahan – Sanford C. Bernstein & Co.

Oliver Wintermantel – Morgan Stanley

Dan Binder – Jefferies & Co.

Emily Shanks - Barclays Capital

Christopher Horvers – JP Morgan

Kate McShane - Citigroup

Joe Feldman – Telsey Advisory Group

Operator

Welcome to the first quarter 2009 earnings conference call. (Operator Instructions) I would like to introduce Mr. Brian Turcotte, Vice President of Investor Relations, who will make a few opening comments. Thank you Mr. Turcotte, you may begin.

Brian Turcotte

Thank you. 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 web cast slides for today's call are available on our website at www.OfficeDepot.com. Click 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 first quarter 2009 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 BSD and Charlie Brown, our President of International.

The first quarter 2009 total company sales were $3.2 billion, a decrease of 19% compared to our first quarter results last year. Our net loss on a GAAP basis was $55 million compared to earnings of $69 million in the first quarter 2008. The GAAP loss per share on a diluted basis was $0.20 for the first quarter versus diluted earnings per share of $0.25 one year ago.

Adjusted for charges, net earnings and earnings per share on a diluted basis were $27 million and $0.10 a share respectively. The charges, which include unusual items that are not considered indicative of our core operating activities, include pre-tax charges of $120 million or $0.30 per share for actions taken as part of the strategic business review.

We are very pleased that cash flow before financing activities was a positive $160 million and free cash flow was $67 million in the quarter. As we mentioned on our previous call, 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.

For the last three quarters cumulatively cash flow before financing activities has been $415 million. I will repeat that. Cumulatively for the past three quarters cash flow before financing has been $415 million. These are very strong results given the economic environment we are all experiencing. Adjusted for charges, total operating expenses decreased by $192 million compared to the first quarter 2008. Approximately $33 million of this decrease relates to lower G&A expenses reflecting reduced payroll, lower legal and professional fees as well as the impact from changes in foreign exchange rates.

EBIT, adjusted for the charges, was $57 million in the first quarter of 2009 or about 2% of sales compared to $124 million or 3% in the same period last year. As we go through the call today we will update you on our plans to continue to manage the company through this challenging period.

I will now turn the call over to Chuck Rubin to talk about North American retail’s first quarter performance and key initiatives.

Carl Rubin

Thanks Steve. First quarter sales in the North American Retail Division were $1.4 billion, down 16% from the prior year. Comparable store sales in the 1,138 stores in the U.S. and Canada that have been open for more than one year decreased 17% versus the first quarter of 2008 and were slightly better than the fourth quarter.

While transaction counts were down compared to last year the decrease was smaller than the fourth quarter and the drop in average quarter value was the greater contributor to our sales decline. This decrease in sales was driven by macro economic factors as consumers and small business customers reigned in their spending especially on large ticket items like furniture and computers, along with our deliberate decision to be less aggressive with advertising promotions in certain categories.

We estimate that our comparable store sales were negatively impacted by approximately 300 basis points from pulling back in these categories. Although this pull back reduced the top line it benefited operating profit in the first quarter and I will cover that impact in more detail in a moment.

Within each of our three major product categories of supplies, technology and furniture we experienced a sales decline compared to the prior year with the greatest percentage declines in furniture and technology. Our best performing categories, although still negative, continue to be ink, toner, paper and Design, Print and Ship services. Our tech services offering while still a relatively small part of our overall sales dollars was positive year-over-year. Also some of our more seasonal categories such as software, calendars and storage showed improved performance.

Florida and California continue to weigh heavily on our sales as our small business customers in these two markets continue to be impacted by weak economic conditions, high unemployment levels and limited access to liquidity. Combined these two states represented approximately 1/3 of our comparable store sales decline in the first quarter.

In the first quarter we closed 107 stores, one of which was not part of the strategic business review action, relocated one and opened zero bringing our total North American store count to 1,160 at quarter end. Operating profit for the North American Retail Division was $81 million in the first quarter of 2009, essentially flat with the $82 million of one year earlier.

Operating profit as a percentage of sales was 5.7%, up 90 basis points from 4.8% in the first quarter of 2008. The key component of the operating profit change versus a year ago include the following: On the positive side we had four key drivers of operating profit margins. First, an improvement in product margins for the third straight quarter. The increase was approximately $27 million reflecting an improvement in product mix as core supplies and key services contributed a larger portion of our sales along with improved rates in most product categories.

Second, we had a $15 million benefit related to lower charges for shrink and inventory valuation that resulted from our previously discussed efforts to lower our inventory, minimize our clearance and reduce our shrink exposure. Third, we had $15 million comparable benefit from closing 112 stores identified as part of the strategic review that generated operating losses last year. I should note that we continue to make every effort to retain a portion of the profitable business in those markets where we have closed stores by shifting business to nearby Office Depot stores or to our Business Solutions Division utilizing OfficeDepot.com, catalogs and our contract sales force if there are no other stores in the area.

I should also note that significant store closure costs for leases, severance, etc. are not included in the Division results but are included in the corporate charges that Mike will address later in the call.

Fourth, we benefited from $13 million in expense reduction which reflected tight expense management across the board including advertising and store pre-opening expenses. On the negative side the flow through impact from our sales volume decline negatively impacted operating profit by approximately $71 million compared to last year.

In North American retail we continue to focus on providing innovative products, services and solutions to micro business customers while continuing to manage our costs. I will take a few minutes to update you on our progress.

First our product assortment line reviews are going well. As a reminder, our goal is to deliver a more profitable assortment of supplies, furniture and technology from the most respected brands including Office Depot’s private brands. In the first quarter we continued to work with our vendors to create more attractive product presentations and improved pricing for our customers. Examples include our new label and binder set along with our new writing set that offers exclusive new looks, pack sizes and demonstration areas that provide customers an exclusive, smarter way of shopping in our stores.

In most cases we saw improvement in our sales trends after the new product assortments were implemented in the store. We expect those new product reviews to continue for the balance of the year and touch most of our product categories.

Second, our service offerings remain a critical component of our assortment. We are expanding our Design, Print and Ship services offering to include even more options and convenient on-site design and printing capabilities for resumes, small business marketing collateral, presentations and more. We have also expanded our in-store, large print format in self-service color copiers to address customer needs. Additionally, our tech services business continues to perform well with positive sales trends for last year and an attachment rate above expectations.

Third, we continue to manage our inventory very tightly. Our per store inventory at the end of the first quarter was $635,000, down 27% from the same period one year ago and nearly 8% lower sequentially. Average inventory per store in the first quarter was $657,000, down 31% from a year ago. These declines are a result of improved inventory management including the rationalization of assortments, reduction of excess safety stock, utilization of distribution center inventory to support retail locations and assortment changes that helped reduce exposure to large ticket inventory items.

We are confident that we are managing our inventory at the appropriate level to support our business. Our in-stock metrics continue at historically high levels. As we look to the end of the second quarter we expect inventory levels to be higher sequentially as we ramp up for back to school but lower on a year-over-year basis.

Fourth, we plan to open 12 or fewer new stores this year. Additionally with approximately 10% of our existing stores having expiring leases in 2009 we are making progress on our rent concessions as we work aggressively to reduce our occupancy costs. To date we have been successful in capturing dollar savings as well as landlord funded improvements for the physical structures.

Fifth, we remain committed to providing strong customer service in all of our stores. Our metrics, as measured by an independent third party, continue to show very high scores and to ensure the continuation of these we have tied these metrics to our store managers’ annual bonus.

In summary, I am proud of the North American Retail team’s efforts to successfully improve product margins, close unprofitable stores and manage expenses in this first quarter. Our operating profit this quarter demonstrates the rapid leverage we can regain if higher sales dollars are achieved. As we look at the second quarter which is historically our weakest sales quarter of the year we expect operating profit to be negative as we de-leverage on these lower sales dollars.

However, we continue to work to find new ways to deliver higher profitable sales not only for the second quarter but for the balance of the year.

I will now turn over the call to Steve Schmidt to review the first quarter results and key initiatives for BSD.

Steve Schmidt

Thanks Chuck. Total sales in the North American Business Solutions Division were $914 million, down 17% versus the first quarter last year due to continued significant spending cuts by our customers in all segments. Sales in both our small to medium sized business customer segment (NYSEARCA:SMB) and large national account customers continued to decline in the first quarter on both a year-over-year and sequential basis.

This decline was principally driven by a decrease in the number of transactions by our customers. I am pleased to report that during the first quarter we were not only successful in retaining existing customers but also acquiring a number of new large accounts that were put up for bid.

In the National Accounts segment we were successful in maintaining most of our existing customer count while winning almost half of the RFP’s in which we participated. On a product category basis the Division continued to see weaknesses in furniture, technology and perishables as customers delayed their purchasing of durables in favor of consumables. To this point we have not yet seen any indication this trend will be returning to a more historical, higher margin mix during the second quarter.

Similar to the fourth quarter the sales decline in Florida and California continue to exceed the overall rate of decline for the entire business in the first quarter. However, Florida sales were essentially flat on a sequential basis while the sales decline in California continued to accelerate. These two states continue to represent about 30% of the Division revenue and about 1/3 of the revenue decline in the quarter.

As I mentioned in our last call, state government continues to cut back on discretionary spending. This along with reduced access to liquidity for small, medium and large companies continues to have a negative impact on our Division’s financial performance. In regard to our government and education business I would like to mention that we are implementing a new structure that will simplify our pricing. It has been our experience that the structure of many of our customer contracts is very complex making it difficult to both our customers and ourselves to interpret and manage.

We believe that the simplified pricing structure will be favorably received by our customers and will lead to an industry shift towards more straight-forward pricing. North American Business Solutions operating profit was $33 million for the first quarter of 2009 down from $60 million for the same period of the prior year and up sequentially from a loss of $28 million in the fourth quarter of 2008.

The components of the first quarter operating margin decline versus one year ago included the following key factors. Approximately $36 million of the operating profit decline relates to the flow through impact of local sales levels. $13 million of the decline due to the negative impact of product margins including a less profitable mix, cost increases that were not fully passed on to our customers and increased promotional activity in the direct channel which was partially offset by increased vendor program funds.

Partially offsetting some of the operating margin decline was about $22 million in benefit from reduced selling and G&A expenses. Although difficult conditions persist, the Business Solutions Division continues to focus on taking a customer-centric approach to servicing new and existing customers.

I will take a few minutes to update you on our progress. First, we have reorganized a portion of our contract sales force that deals with small to medium sized customers to become more regionally focused. Sales representatives are now Territory Development Managers (TDM’s) responsible for all the sales and customers in a specific geographic area. These TDM’s not only take care of our existing customers but also continue to prospect for new customers to grow the business. We are encouraged by early results and have received positive reviews from our sales organization.

Additionally, our customer file which is a measure of unique customers who have purchased from us in the past year grew for the first time since the second quarter of 2008.

Second, within our telephone account management or TAM organization which supports both the contract and direct channels the key performance indicators we have put in place continue to improve the performance of our TAM partners. We have also expanded their responsibility to include both handling orders and making prospecting calls.

These positive leads coupled with third-party canvassing efforts like Feet on the Street are off to a good start. However, given the significant economic headwinds we are facing these improvements are not being truly reflected in our business results.

Third, the North American Retail and BSD organizations are working together to meet our customer needs. Customers want solutions and are not concerned if their needs are met by an associate in retail or BSD. Therefore, our store managers and TDM’s are now making a point to collaborate more closely in a customer-centric fashion to make sure no customer is left behind.

We will also ensure that our messaging and pricing is consistent across all marketing vehicles and that our customer’s interests are put first regardless of the division servicing them. We expect to start seeing the benefits of this initiative in the second quarter.

Fourth, in our Direct business we continue to test and revise our pricing and promotional strategies. In March we launched a new pricing strategy utilizing a sophisticated price optimization tool that will enable us to improve our portfolio. We will also continue to test new marketing strategies in an attempt to stimulate top line demand while maintaining profitability. Fifth, we continue to pursue new business opportunities in vertical product offerings. In addition we continue to invest in our knowledge management capabilities and learn more with each test although testing and reading results in the current environment is challenging given the unique economic times that we face.

In the first quarter 82% of total BSD sales were online, up slightly from the same period a year ago. Our global company internet sales for the past 12 months totaled $4.6 billion compared to $4.9 billion for the same period a year ago.

In summary, BSD’s first quarter top line results continue to be softer driven by significant spending cuts across our broad customer base. However, we have been successful in tightly managing our expenses and we will continue to do so during these challenging market conditions.

In the early stages of the second quarter we have not yet seen evidence of a material change in our customer spending patterns but we will continue to focus on maintaining and expanding our customer base while effectively managing capital and operating costs.

Charlie will now discuss the first quarter results and key initiatives for the international business. Charlie?

Charles Brown

Thanks Steve. The international division reported first quarter sales of $875 million, a decrease of 24% in U.S. dollars. Local currency sales decreased 9% with nearly all the countries in which we operate reporting a year-over-year decline.

The U.K., France and the Netherlands all reported double digit declines in local currency and accounted for approximately ¾ of the overall decrease in revenue. Similar to North America, conditions abroad remain difficult as business investment and office supply expenditures continue to be cut in the face of weakening demand as a result of worsening cash flows, tight credit conditions, deteriorating profitability and serious concerns and uncertainties about the potential depth and duration of the global recession.

While there have been some positive indications regarding the economic situation in North America, we have not seen similar signs in our major international markets. Therefore we believe the U.S. will likely lead in the broad based economic recovery with Europe’s markets trailing.

The direct channel declined 12% in local currency because of continued softness in big ticket items such as furniture and technology, increased competitiveness within the channel particularly from mass retailers and hyper markets and a general decline in the frequency and size of purchases as customers limit their spending to business essentials.

The contract channel continued to be under pressure, down 8% in local currency and has seen its sales in the past three quarters declined at a faster rate than the direct channel. This is mostly attributable to larger businesses reducing their non-essential expenditures as well as limiting purchases of office supplies to primarily their core lists. As background, core lists typically offer office products with lower margins. In retail sales were flat versus a year ago.

International Division operating profit was $19 million in the first quarter 2009 compared to $60 million in the first quarter a year ago. The components of the change versus a year ago include the following: On the positive side we saw an improvement in our operating expense as we reduced selling and distribution costs by approximately $21 million. The flow through of lower sales levels negatively impacts operating profit by approximately $42 million. An increase in promotional activity and cost increases that could not fully be passed onto the customer had a negative impact of approximately $13 million. Lastly, a change in foreign exchange rates driven by a stronger U.S. dollar unfavorably impacted operating profit by $7 million.

Although business conditions continue to be challenging we remain focused on strengthening our contact strategy and value proposition and improving the profitability of our business. First we are under the process of changing the way we market to our customers, moving from a channel approach to a customer-centric approach in Europe. This will be accomplished by monitoring the purchasing behavior of our customers and using this information to improve our segmentation. This knowledge will not only be used to help us better serve our existing customers but also help us identify prospective customers.

The key focus areas of this initiative include: Providing clear value propositions and branding, increasing our marketing capability for better integration and more effective use of our touch points. Strengthening our e-commerce capabilities where we aim to be the best in our industry and expanding the use of our more profitable private and exclusive brands.

Second, we continue to move ahead with our SKU rationalization and harmonization program. The objective of this program is to simplify inventory management while significantly reducing our operating costs and inventory levels. The initial results are encouraging and we expect to complete the initial phase of this program by year end. As a reminder, this initiative is just one of several that we have underway to improve our operating margins.

We continue to redefine our distribution footprint, consolidate our back office support functions and cost centers, reduce the complexity and cost of our organization and address unprofitable businesses such as Japan. We expect the operating expense improvement we demonstrated in the first quarter to continue through the year albeit offset by a continued disappointing sales environment.

Third, we continue to look to grow the international markets where Office Depot’s brands are represented. We entered into a franchising agreement with M.H. Alshaya Co., an international retailer operating over 40 international brands throughout the Middle East, Eastern Europe and Russia. In the second half of 2009 they expect to open two stores in Kuwait and plan to eventually open about 25 stores in the region.

Furthermore we are actively seeking additional opportunities where we can leverage the strength of the Office Depot brand with strong retail operators. We view this arrangement as a prudent way of expanding our presence into untapped markets while minimizing our direct investment.

In summary, although we don’t foresee the European economies exiting this recession in the near-term we will continue to execute our key initiatives to improve customer service reduce costs and streamline our operations in an attempt to mitigate the headwinds.

For the second quarter we do not see a significant change in the economic situation in our major markets. Therefore, we are expecting our revenue to decline in local currency at about the same rate as the first quarter. While operating profit will be more negatively impacted by de-leveraging on the smaller revenue base. As noted earlier, we are working hard to improve our results by creating a more customer-centric business with a more efficient cost structure.

With that I will turn it over to Mike to review the company’s first quarter financial results.

Mike Newman

Thanks Charlie. I will first give you a brief update of the strategic business review actions we announced in December of 2008 and updated in our press release and filing in early March. In the first quarter we recognized $120 million of pre-tax charges related to these actions with actual cash paid of $28 million in the period.

We closed 106 retail stores and five distribution facilities. We streamlined our European organizational structure, rationalized part of our Japanese business and reduced headcount in our headquarters operations. We have essentially completed our restructuring efforts in North America and should complete the streamlining of our European operations later in the year.

For the remainder of 2009 we expect to take an additional $110 million in charges related to both these actions and 2005 legacy initiatives principally due to the consolidation of our European supply chain operations and other international initiatives. The cash usage is estimated to be approximately $90 million and these actions should positive impact EBIT and cash flow by about $105 million and $60 million respectively for the balance of the year.

Looking at cash flow, our first quarter cash flow before financing activities was $160 million, slightly above the range of our earlier estimates. This total includes $69 million in sale lease backs of U.S. retail stores and European facilities. An additional $19 million of domestic sale lease backs were completed in the first quarter that were classified in the financing segment of our cash flow statement due to an accounting treatment.

Free cash flow for the first quarter was $67 million driven by positive earnings excluding restructuring charges and excellent receivable and inventory management. We reduced our domestic accounts receivable days by three in the quarter versus year end and also saw total company inventory turns improve to 6.2 versus 6.1 at year end.

While our total accounts payable balance was down as a result of lower purchases and sales our AP inventory ratio improved from 94% at year-end to 97% at the end of the first quarter.

Looking at liquidity, at the end of March our total available liquidity under our asset based lending facility plus cash on hand was $806 million, down $62 million from year-end availability of $868 million. At the end of the first quarter we had zero borrowings against the ABL as a result of excellent cash flow performance in the quarter and had $160 million in outstanding letters of credit against the facility. We expect to see our ABL availability increase by $100-150 million in the second quarter as our inventories ramp up to support our third quarter back to school season.

As I mentioned last quarter we expect free cash flow to be positive in 2009 and given the expected benefits from liquidity initiatives we expect cash flow before financing to be in the $275-325 million range for the year. I should note that liquidity initiatives completed in the first quarter contributed $160 million in cash. They include sale lease backs of owned properties in the U.S. and Europe, dividends received from a joint venture, tax refunds and the benefit from reduced capital spending.

To date we have realized about $200 million in liquidity action and are anticipating over $400 million for the year. With regard to 2009 capital spending we are now targeting a full-year spend of about $125 million. Assuming our second quarter is seasonally weak and we see a slight EBIT loss in the second half of 2009. Our liquidity position should provide an adequate cushion for running the business with little or no ABL borrowings at quarter end for the remainder of 2009.

Regarding our balance sheet we ended the first quarter with $176 million in cash and cash equivalents. Inventory totaled $1.1 billion globally, down 31% 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 $635,000 per store, down 27% from the same period a year ago. As Chuck mentioned, we are confident we are managing our inventory at the appropriate level to support our business and serve our customers and this improvement represents performance opportunities we have realized in our supply chain.

Our net debt at the end of the first quarter was $554 million including $675 million in long-term debt. With the asset based credit facility in place, $400 million in bonds not maturing until 2013 and the liquidity actions we are taking we remain comfortable that we have a capital structure in place to take us through this business cycle.

I will now turn the call back over to Steve.

Steve Odland

Thanks Mike. We are pleased that our results exceeded our expectations in the first quarter. It is extremely challenging to provide an outlook given the current state of the economy but the second quarter is typically our weakest quarter of the year and 2009 should be no different. It is likely there will be an EBIT loss as we experience our seasonal sequential decline in EBIT from the first quarter to the second quarter and we may use some cash in the second quarter due primarily to the normal back to school inventory build that Mike talked about.

Looking at the second half of the year, EBIT adjusted for charges should be slightly negative but we expect free cash flow to be $50-100 million in 2009 and cash flow before financing to be in the $275-325 million range. Although we have read signs that there is some improvement in the U.S. economy and it may have bottomed out and the outlook for retailers is improving, we do remain concerned about our small business customers’ liquidity. As a result, we will continue to take a very conservative approach to our liquidity position for both the near and long-term.

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

Operator we are now ready to open the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Matthew Fassler – Goldman Sachs.

Matthew Fassler – Goldman Sachs

A couple of questions about the charges and about the ABL. I believe that if you look at your release and your disclosure on charges today you talked about aggregate charges for the year expected to be $230 million and $120 million you booked and another $110 million. I believe at the end of the fourth quarter the number was $186 million. Did I read that right? If so what does the change relate to?

Mike Newman

All the numbers you quoted were correct. What change are you referring to?

Matthew Fassler – Goldman Sachs

I guess you said today based on the release you booked $120 million and have another $110 million coming. That is different I believe from the $186 million you said you were going to have in 2009 associated with charges. So it looks like the amount you expect to book in 2009 increased?

Mike Newman

I’ll have to get back to you on the details of what that increase is. There were two stages. There was the first phase that Matthew was talking about that we announced in December and I think the second phase we announced in February which got to the same levels we are referring to today.

Steve Odland

There are two phases. One on international. I thought you were talking about the changes in the aggregate total of the announcement that was in December and the announcement in February. I believe the total charges from those two initiatives have not changed that much relative to what we had said.

Matthew Fassler – Goldman Sachs

Second question, just looking at the Q it looks like the average borrowing for the quarter on the ABL were $240 million. What was the timing of the asset sales? So if we were to essentially look at the average cash on the balance sheet from the asset sales just for sort of pro forma, what would the ABL outstanding have been?

Mike Newman

The asset sales in the first quarter at 160 most were ratably over the quarter. The sales lease backs on the international side came earlier in the quarter. The domestic side were towards the end of the quarter. Tax refunds that we had of $40 million were earlier in the quarter. It was throughout the quarter. It wasn’t really towards quarter end. Average borrowings tends to be higher because we tend to at the end of the quarter aggregate our excess cash and pay down debt which we do not do at month’s end due to cash management systems, etc. So that is really what is driving that.

Matthew Fassler – Goldman Sachs

Relating to that you had $160 million of asset sales. Are there more to come? Would you expect to see additional cash raised through that process?

Mike Newman

Yes we do. Today it was $160 million in the first quarter. Through today we have gotten an additional trench of sale lease backs done in Europe to the total closer to $200 million today and we feel confident we have another $200 million to go in the balance of the year which includes both sale lease backs, receivable factoring and some other initiatives. We probably in my estimation have been on the high end of our expectations on what we have delivered to date on liquidity initiatives and we think that $400 million number for the year is very solid.

Operator

The next question comes from Colin McGranahan – Sanford C. Bernstein & Co.

Colin McGranahan – Sanford C. Bernstein & Co.

First, Chuck if you could talk a little bit about the line reviews. First just walk us through the process. Secondly, I am curious how far along you think you are in terms of by category looking at them, resorting the business and getting some potentially better rates? Then any color you can give us on the impact of those line item reviews on profitability.

Carl Rubin

The way the line review works is we invite all vendors both branded as well as private brands to come talk to us and show us their wares. It is a very intense process that we look at all factors from product assortment and brand recognition and share that a vendor might have, obviously cost. It is a holistic review. It is done category by category. As I mentioned it is very intensive. We have found them to be very successful so far. In terms of how far along we are there is really a couple of ways of looking at that. We are less than half way through. What you are seeing in-store is even less than that because keep in mind that once the line review is concluded it takes time to get the products in some cases built and then it takes time to get them set up in stores.

So we are certainly less than half way through. This process will continue certainly through the balance of this year. In terms of savings we are seeing good savings but keep in mind there are multiple purposes in this. We have looked at pricing things appropriately for the market place. Customers are seeing some of the savings. Obviously we have seen some nice cost benefits.

Also importantly we are very pleased with the assortments and how they are coming out in terms of how simple they are and it is just a smarter assortment for our customers to shop and the newness of the products that we are bringing in. We have had outstanding vendor support on this. We are very thankful for their support and people have come to the table aggressively to work with us.

Colin McGranahan – Sanford C. Bernstein & Co.

Steve, first if you can just talk about BSD how the sales breakdown plays out between existing customer sales and net change in accounts. Specifically you had said of the RFP’s you have participated in today you have won almost half of those. Can you talk about how many you have participated in year-to-date?

Steve Odland

We haven’t talked specific numbers. I would just simply repeat the majority of RFP’s with our existing customers we retained a significant portion of those and again based on all the national account RFP’s we went through where the customer was not our existing customer we won almost half of those. So we were very pleased with our results in that area and we continue to believe that we are gaining share particularly in that large, national accounts segment.

Carl Rubin

It is more than a couple. If you want a ballpark number let’s just use the term 20 new RFP’s that we entered into as part of this.

Steve Odland

These are the big multi-million dollar.

Colin McGranahan – Sanford C. Bernstein & Co.

Let me just push on that a little bit. If you look at your net number of national accounts at the end of 1Q09 would that be greater than or less than the number at the end of 1Q08?

Steve Odland

The net number would be higher.

Colin McGranahan – Sanford C. Bernstein & Co.

Sales for existing customers were down similarly for the total business or down a bit more than?

Steve Odland

The business segment of large national versus the rest?

Colin McGranahan – Sanford C. Bernstein & Co.

BSD was down 17%. Obviously that has got some catalog in there and has a big chunk of contract. I was just curious in your contract business sales for existing customers what that trend was.

Steve Schmidt

The trend for our large national account customers was less than the aggregate of the entire SMB or entire contract decline with a slightly greater decrease in our SMB segment.

Colin McGranahan – Sanford C. Bernstein & Co.

Mike, CapEx looks like it came down from 150 to 125. Is there more opportunity there given that you are only now opening about 20 stores or is that 125 pretty committed on supply chain and other spending?

Mike Newman

I think the 125 is about as tight as we can get it.

Operator

The next question comes from Oliver Wintermantel – Morgan Stanley.

Oliver Wintermantel – Morgan Stanley

A follow-up question to Colin’s question. Can you give us a little more color on how the different sectors of the business solutions division performed and if you could comment on the sales trends in small versus large and if you have seen some improvement in some of the sub-sectors versus the others?

Carl Rubin

As we talked, we are obviously facing significant headwind across all of our business segments. Our large national account customers continue to reduce spending and only focus on their core products. We continue to see declines, as we talked about, in technology and furniture and across basically any non-essential items. On the small to medium sized business sector we continue to see very significant headwinds really due to the lack of liquidity that exists in that segment and also a significant cut back in any discretionary spending.

We also as we talked about continue to have about 1/3 of our business in Florida and California. While we have seen some stabilization in Florida, California continues to decline at even a greater rate. As you are aware of the budget issues that existed there. So as we look across each of our core business segments that headwind exists. We see it also impacting our government business. We are the largest provider to state and government agencies in the United States. We are aware of all of the cutbacks going on in both state government and education contracts which continue to have headwinds.

Steve Odland

I think it is probably safe to say that we have actually picked up customers but that our customers are hurting and they are not able to buy as much. You have seen computers and furniture and some of the big ticket items come down and it is more of the consumables people continue to buy at this point. The reduction in sales is coming from the inability of our customers to buy.

Carl Rubin

As we talked in our opening comments, we were very pleased in the first quarter that for the first time we actually were able to grow our file as we talked about in the SMB segment. But once again the decline is simply coming from those customers buying significantly less than they did in prior years.

Oliver Wintermantel – Morgan Stanley

Have you closed all of the under performing stores you identified or if the sales environment stays like it is or decreases from here are you looking to close more stores in 2009 or 2010?

Steve Odland

No, we have closed the trench of stores that we wanted to close. There will be an occasional store closure as lease terms expire but that is normal course of business.

Operator

The next question comes from Dan Binder – Jefferies & Co.

Dan Binder – Jefferies & Co.

With Easter falling in April this year and spring break coming a little later I’m just curious if you can quantify what the benefit may have been to top line as a result of that shift. You provided some guidance on March 10 of EBIT loss of $30-40 million. Obviously you came in much better than that. I’m just curious where the major deviation from your expectation was from that point in time?

Mike Newman

I’ll start with the minus $30-40 million. The major deviation from that forecast was one we built a little conservatism into that forecast. More importantly we performed from a restructuring perspective at the high end of where we thought we would be in terms of the execution. We did realize in the first quarter about $25 million of benefit from the restructuring we took. Second in the North American retail business the mix in the business I think exceeded our expectations to what we forecasted for the reasons Chuck described earlier. Those two reasons plus some conservatism were the principle drivers in why we exceeded that forecast.

Steve Odland

I think we were very pleased with the margin results in the North American retail business as the line reviews and the active management of the mix and less promotionalism. I think we called out we actually gave up 300 basis points of top line to be less promotional. That helped our margin as well.

Carl Rubin

To Mike’s point we came in at the high end of our expectations on a lot of the components. We took a lot of actions over the past number of months and first quarter realized some nice benefit as a result of that.

Mike Newman

In terms of your question on Easter it has had a positive impact to a small degree in the first quarter. Interestingly New Year’s Day shifted in the first quarter as well. That had a negative impact. We measure these things both internally and we use an external firm to help us measure as well and then we compare the results. In both cases, internal and external analysis showed they were really a wash. The upside of Easter was offset by the shift in New Year’s. First quarter overall performance we think the two holidays blended out against one another.

Dan Binder – Jefferies & Co.

Will there be a negative shift in the second quarter?

Mike Newman

Easter, unlike most other retail businesses actually hurts us because people are off. So we will see some negative influence in the second quarter from Easter.

Steve Odland

I think it is important as you build your estimates we normally have the sequential second quarter drop off from the first quarter most pronounced in the retail business. It is most pronounced in the retail business but this year also Easter shifted from quarter-to-quarter which will hurt us a little bit. That is one thing to keep in mind with your estimates and we are trying to make sure we are conservative about how we manage the second quarter.

From an overall economic standpoint which is the other way to think about it, we see a continuation from the broad economic standpoint in North America of the first quarter. We don’t see things deteriorating from a broad economic standpoint. We do, however, do continue to be somewhat worried about Europe and particularly some of the big countries in Western Europe where the economies seem to be continuing to deteriorate slightly.

Dan Binder – Jefferies & Co.

Can you give us an update on what your private label mix is now and also how the effectiveness in your promotions and your business it sounds like retail is maybe down but other parts of the business continued promotional activity.

Carl Rubin

The overall private brand globally is just under 30%. That has bounced around a little bit. We have talked about before that direct import is we believe the more significant opportunity for us in terms of profitability of the product. The promotional effectiveness for retail, as I mentioned in my comments, we did scale way back specifically on big ticket things like computers and TV’s. What we were seeing was the prices we needed to sell it at for the customer to respond was just unprofitable for us and we pulled back on that. To my comments earlier and Steve’s a minute ago it had a significant impact on our top line, bringing down our top line, bringing down our top line for the first quarter. I’ll let Steve talk about BSD.

Steve Schmidt

On the promotional side during the first quarter, we talked about this in our opening comments. One of the difficulties we have right now is trying to measure cause and effect. During the first quarter we did run some aggressive promotional activity primarily in the catalog and web area and trying to balance and trying to hold and gain share versus the cost of that promotional activity. As I mentioned we are starting to see the fruits of our knowledge management system as we start to track each one of these different promotional activities.

It has been very challenging in these very tough economic times and significant headwinds. We tried to increase promotional activity and saw some stabilization on the revenue side but in any case like this you see some margin degradation going on. This continues to be something we are challenged with daily and trying to continue to improve the return on each one of the promotional activities we generate.

Dan Binder – Jefferies & Co.

Does the same hold true for international?

Charles Brown

On international what we are seeing the big part of our mix is paper, ink and toner is, as I’m sure you know. What we are seeing is as the sales trends soften, not just for us but for others, people coming out with really hot prices on a case of paper or particular ink and toner SKU’s. I would not describe it as irrational but it is a factor as people scramble for market share.

Operator

The next question comes from Emily Shanks - Barclays Capital.

Emily Shanks - Barclays Capital

Apologies if I missed it but in terms of the one-time charges related to lease accrual, severance expenses and inventory write down, did you give a break out as to which amount was assignable to those specific buckets?

Mike Newman

No, we didn’t give a break out but of the $120 million of EBIT charges we took in the first quarter a large portion of that was related to stores and DC closures. I would say 2/3 of that is stores and DC closures. The balance of that relates to international and domestic headcount reductions.

Emily Shanks - Barclays Capital

I am assuming there is a mix between cash and non-cash in that number?

Mike Newman

Yes there is. In the first quarter the cash impact of the charges in the first quarter was only $24 million and that would relate more to the people side of the pieces that I mentioned.

Emily Shanks - Barclays Capital

Around availability on the revolver, clearly it is down on a year-over-year basis. I absolutely appreciate that your accounts payable leverage improved which it looks like you did a nice job on the balance sheet. I just want to be clear that as you look at that availability is 100% of that shrinkage due to lower inventory levels or is there anything else going on there?

Mike Newman

In the second quarter from year-end it is principally driven by the fact that our inventories are at the lowest point they are going to be for the year. In the script we called out that we expect availability on the ABL to go up by $100-150 million again principally driven by the inventory build for back to school. This is the absolute low point for the year in ABL availability. We would expect that by year end we would see the ABL availability stay up in the $100-150 million range and continue through year end in that fashion.

Just from the asset base. It would go up by the asset base by that amount and we also have the balance of the free cash that we will generate for the year. So the asset base will go up by $100-150 and stay there and then we will generate additional cash consistent with the cash flow guidance of $275-325 million cash flow before financing.

Operator

The next question comes from Christopher Horvers – JP Morgan.

Christopher Horvers – JP Morgan

On the expense side, the $860 million of operating expenses in the first quarter was there any one-time items that would make this level unsustainable at this level of sales?

Mike Newman

A lot of the reduction in the first quarter we were down if you take charges out in the slide that is in the presentation excludes charges, we are down about $30 million in G&A and we are about $160 million in selling expenses. It is payroll, advertising and distribution. On the G&A side it is professional fees, it is compensation, it is legal and professional. Those are the result of the restructuring actions and all the actions we have taken last year to reduce costs. A lot of those are sustainable. If they are one-time items they are not the driver by any stretch of the imagination.

Christopher Horvers – JP Morgan

It sounds like on the international side there is opportunity forthcoming to take those costs down. Let’s say you had gotten them done by the first quarter what do you think the expense level would have been in the first quarter if you had made the international changes?

Charles Brown

You have got more restructuring coming. Therefore benefits will accrue. We have got in the first quarter some nice benefit from some of the restructuring changes we have candidly have been working hard on for the past couple of years. It is starting to come to fruition now. We expect that trend, as I said in my opening comments, to continue.

Mike Newman

We have more coming restructuring coming. It is difficult. I don’t think we have a number at this time that says what the rate would have been in the first quarter but it is lower in international when we get through towards the end of the year.

Christopher

So you think you are a quarter of a way through or half way through on the expense reduction side?

Charles Brown

I think it is an ongoing process. In fact, I don’t see an end of it this year. What I expect to see is the trends we showed in the first quarter to continue. But it will continue into next year.

Christopher Horvers – JP Morgan

Broadly, for the company at what level of sales do you think you need to add incremental variable expense? If your overall sales are going down about 20% as you start to get to a minus 15 do you have to add incremental cost or what is the runway on leverage?

Mike Newman

I think from an overall G&A standpoint we are going to try to hold things very tightly on the way back up. The place where we of course would have to add some expenses in the store labor number, so as sales improve we will be cautious about that but we certainly want to make sure we have the right service levels in our store.

Carl Rubin

To be clear I think we are actually adding resources, selling resources both in my business as well as Steve’s. What we are doing is we are taking out shall we say the less productive parts of our cost structure but we are adding to our selling source.

Christopher Horvers – JP Morgan

So there is some runway at year end in expenses but you could see sales get less worse and you are not adding a lot of incremental dollars to address those sales. Is that fair?

Steve Odland

I think that is a fair way to characterize it.

Christopher Horvers – JP Morgan

Finally, on the retail side you had mentioned on the fourth quarter call things were a little bit better. You came out with a minus 17. That is really only slightly better. Did you see a slow down in the back half of the first quarter? Did you make any comment about what retail trends were quarter to date?

Steve Odland

Remember we said we were less promotional and we actually improved our margins at the end of the first quarter and we said we would have been 300 basis points better on the top line had we been as promotional. We gave up a little more deliberately on the top line and achieved that pay out on the bottom line. Chuck I don’t know if you want to characterize?

Charles Brown

I think all that is accurate. Also, as I noted in my comments our transaction counts are down compared to a year ago but that drop is shrinking and actually improved in the first quarter when compared to the fourth quarter. The bigger contributor to our negative comp in the first quarter was our average ticket which again goes hand in hand with what we talked about in cutting back on some of the promotions.

In terms of second quarter we didn’t comment specifically beyond what we have said. We are planning conservatively and the second quarter is historically our low volume quarter in retail and we expect this quarter to be the same.

Operator

The next question comes from Kate McShane – Citigroup.

Kate McShane - Citigroup

I’m not sure if you said anything about this earlier so I apologize if it is repeating but can you talk about any price competition you are seeing either here in the U.S. or internationally?

Steve Odland

If I could characterize all of the business it seems to be very competitive out there as normal but we don’t seem to be seeing any abnormal levels of price competition. There are pockets here and there from category to category but I think overall people are trying to make sure we make money on the sales. Let me just ask any of the Division Presidents to callout any specifics you would like to mention.

Steve Schmidt

On the BSD side of the fence, I think everyone is aggressively promoting and trying to balance the level between promotion and trying to maintain margins because of the headwind we spoke about. So we do see aggressive promotion activity specifically on the web and catalog. On the contract side of the fence we have seen an increase in aggressiveness from a number of our competitors and we continue to try and both manage margin and at the same time try not to participate in some type of too aggressive a pricing level at this point. We do see pricing competition continuing to increase. Promotional activity is increasing.

Carl Rubin

On the retail side we are seeing pockets of increases as well. In the technology arena in particular it has been aggressive and we made the very conscious decision to not compete as heavily as we have in the past on some of that just because we don’t believe there is a way to make money on some of that level of aggressiveness.

Charles Brown

In international most of the competition we see again is fairly aggressive. It tends to be coming from the hyper markets, the big box general merchandisers and in some of the smaller web-based suppliers of toner. In terms of the large companies or the large competitors it is actually pretty rational.

Kate McShane - Citigroup

Any types of share gains you are seeing possibly from the transition of Staples integrating Corporate Express or even from Circuit City going out of the market?

Carl Rubin

On the retail side it is still sketchy. The data isn’t all complete. Obviously when we have closed the number of stores that we have closed you are going to lose some share of market that we vacated. In terms of Circuit City, I think that is still early to tell. We have not seen any negative impact as Circuit continues to liquidate some of their stores. That is how I would characterize the retail side.

Steve Schmidt

On the BSD side, we believe we are gaining share in the large national accounts segment relative to the Staples/Corporate Express merger. We are gaining certain small to medium sized customers as a part of that adjustment but again it is not something we see as significant at this time.

Operator

The final question comes from Joe Feldman – Telsey Advisory Group.

Joe Feldman – Telsey Advisory Group

To clarify the guidance, the EBIT guidance you gave for the second quarter and the second half, is that GAAP guidance or non-GAAP guidance?

Mike Newman

It is non-GAAP guidance.

Joe Feldman – Telsey Advisory Group

In terms of international you made the comment and I know you have been looking at Japan and what to do there. If you could give a little bit more color than what you gave on the call, in the transcript, as well as Mexico maybe the status of the joint venture there?

Charles Brown

In terms of Japan we are carrying through with the plans we had announced earlier this year which was to exit the retail channel. We had 27 retail stores at the end of the year. We have closed seven and we are now entering the bulk of the closures over the next 3-4 months. So we expect to be out of retail in Japan by the end of August.

The other parts of the business, the catalog and the contract business, we are maintaining that business and that is probably all I need to say at this point in time. The retail side was really the most problematic for us in Japan.

In terms of Mexico, the offer that was [inaudible] last year is really off the table. We continue to manage that business with our partner, the Groupo Gigante, to the benefit of both parents. As Mike announce, part of our liquidity in the first quarter was a dividend that the JV paid to us. So the business is holding up quite well and we are continuing to work closely with our partner.

Steve Odland

I would like to thank everybody for joining us today. I will just remind everybody that as we move into the second quarter the second quarter is always seasonally tough and we would just urge everybody to be conservative but we are heartened by the second half of the year which is back to school and really back to our prime season which is more like the first quarter for us. So we are very confident of our cash flow projections for the year and so forth.

We are very pleased and we would like to thank everybody in the company for their strong execution on the cash flow. I think it demonstrates our ability to drive cash flow and to drive our margins despite the economic headwinds we are facing. Finally, I know there are a lot of vendors on the call today and we would simply like to thank you all. Our vendors have been terrific. They have been very strongly behind us and we really appreciate your partnership. We have a terrific group of vendors who have helped to weather this time and it is tough on them and it is tough on us. We are going to get through this tough economy and emerge stronger.

Thanks to all of you for your support. With that I will end the call. We will talk to you next quarter.

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