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Original Source: FD (FAIR DISCLOSURE) WIRE
. Brian Turcotte, Office Depot, Inc., VP IR . Steve Odland, Office Depot, Inc., Chairman, CEO . Chuck Rubin, Office Depot, Inc., President North American Retail . Steve Schmidt, Office Depot, Inc., President North American Business Solutions . Charlie Brown, Office Depot, Inc., President International . Pat McKay, Office Depot, Inc., EVP, CFO . Danielle Fox, Merrill Lynch, Analyst . Brian Nagel, UBS, Analyst . Matthew Fassler, Goldman Sachs, Analyst . Steve Chick, JPMorgan, Analyst . Colin McGranahan, Sanford C. Bernstein, Analyst
. Brad Thomas, Lehman Brothers, Analyst . Chris Horvers, Bear Stearns, Analyst . Seth Basham, Credit Suisse, Analyst . Dan Binder, Jefferies & Co., Analyst
Co. reported 3Q07 total Co. sales of $3.9b and GAAP net earnings of $117m. 3Q07 GAAP diluted EPS was $0.43 and adjusted diluted EPS was $0.43.
A. Key Data From Call 1. 3Q07 total sales = $3.9b. 2. 3Q07 GAAP net earnings = $117m. 3. 3Q07 GAAP diluted EPS = $0.43. 4. 3Q07 adjusted diluted EPS = $0.43. 5. 3Q07-end cash and short-term investments = $187m. 6. YTD share repurchase = approx. 5.7m shares of common stock for $200m.
S1. 3Q07 Business Review (S.O.) 1. Independent Review by Audit Committee:
1. The review, which arose from a whistleblower complaint,
revealed that during the period beginning in 3Q06 through 2Q07
funds due or received from vendors previously recognized in
3Q07 should have been deferred into later periods. 1. This is solely related to the timing as to when those funds were recognized.
2. Vendor program funds recognition timing issue was identified
through internal processes and now has been corrected,
impacting a limited number of vendor arrangements over the past four quarters. 2. Management Change: 1. Kim Maguire has joined ODP in the new role of EVP of Merchandising. 3. 3Q07 Highlights: 1. Although Co. grew its sales by 2% vs. 3Q06, it is disappointed with the results. 2. GAAP net earnings were $117m vs. earnings of $129m in 3Q06. 3. GAAP diluted EPS was $0.43 vs. $0.45 in 3Q06. 4. For the first nine months of 2007 GAAP EPS have been up 5% vs. same period in 2006. 5. Adjusted diluted EPS was $0.43, down 9% vs. 3Q06. 1. Net results significantly benefited from a reduced tax rate that resulted from specific events, which occurred, in 3Q07. 6. Operating earnings were impacted by weak late qtr. performance in two of the businesses. 1. In North American Retail, 3Q07 was highly promotional with disappointing sales and margin impacts, and vendor program support was less than expected. 1. This lower than expected vendor program support was
unrelated to the recognition issues that delayed the earnings.
2. In International, a weak performance in the UK negatively
impacted results. 3. In North American Business Solutions division, had impact of customer mix and cost increases contributing to the weaker results during 3Q07. 4. All three of the businesses experienced operating margin compression vs. 3Q06. 7. While Co. is reacting to some of the external factors affecting performance that are beyond control such as the US economy, it is clear that Co. needs to execute better in short-term and over the long-term 1. In 3Q07, took actions to reduce costs and discretionary
spending across the organization. 2. Opex as adjusted decreased as a percentage of sales by approx. 50 BP, primarily reflecting lower performance-based variable pay commensurate with the reduced operating results and benefits from cost management initiatives which were
partially offset by investments to support growth in International business in addition to some other items. 1. Unfortunately these efforts were not sufficient to mitigate the GM compression experienced in 3Q07. 4. Action Plans: 1. North American Retail: 1. Moderating CapEx by reducing new store openings, moving to about 70 stores overall for 2007 with the new target of 75 stores for 2008.
2. Continuing with M2 store remodels, a critical investment in
the future. 3. Focusing on improving offering to small business customers while tightly managing expenses. 2. In North American Business Solutions, Co. is refocusing efforts on attracting small and medium sized customers including those (indiscernible) during the Allied integration and expanding operating margin.
3. In International, Co. needs to focus on improving performance
in the UK while continuing the good progress made in developing markets that it entered. 1. Operating margin expansion is a key to the success. 4. In all three businesses, continued private brand penetration is the area where Co. has intense focus. 5. Continues to believe that share repurchases are a good use of cash. 6. Has been focusing on cutting CapEx in improving cash flows so that Co. can do more of it. 7. Continues to review overall capital structure and spends a lot of time looking closely at all the options available to balance short-term and long-term capital needs while maximizing ability to return value to shareholders.
S2. North American Retail Division (C.R.) 1. 3Q07 Results: 1. Sales were flat at $1.8b. 2. Comparable store sales in the 1,111 stores in the US and Canada that have been open for more than one year decreased 5%. 1. Challenging economic conditions particularly in some of the most profitable geographies drove decline in sales and actions taken during 3Q07 to moderate those declines have had minimal impact to date. 2. Virtually all of the comparable sales decline was related to macro economic variables mostly housing econometrics. 3. Concentrations of weaker consumer spending have occurred in Florida and California, two states which combined represent
about 26% of sales and about 25% of total store contribution to operating profit and accounted for about 40% of total comparable sales decrease. 3. Many of the positive comping markets were in the Northeastern Canada, where Co. has limited number of stores.
1. Mexico was strong but is not included in the division's North American comparable sales. 4. Other drivers of negative comparable sales include: 1. Cannibalization from the new store build out of about 70 BP. 2. Competitive intrusion of about 50 BP in private brand penetration of 10 BP. 3. Design, Print and Ship continued to perform well, adding about 30 BP of comparable sales growth.
4. Market share was down slightly driven by sales declines in
Florida and in California. 1. This occurred in July and Aug., with gains made in Sept. 2. Believes that the share gain in Sept. is due impart to the re-launch of customer loyalty program. 2. 3Q07 Core Product Categories: 1. Technology share was flat in the broad consumer electronic market, although down in the office supply stores market due to competitors entering what had previously been an under penetrated market for them. 2. Did achieve strong comps in notebook computers, calculators, software, cameras and GPS systems. 3. Supply share was down slightly but up in Sept. with improvements across many categories. 1. In Furniture, gained share on a unit basis but lost share on a dollar sales basis as Co. transitioned to a lower price point take-with mix. 2. Design, Print and Ship business, which had strong comps, gained share.
3. 3Q07 Additional Metrics: 1. Disappointed with the operating profit of $80m, a decline from $114m in 3Q06. 1. This has occurred after 14 straight quarters of operating profit growth.
2. Some drivers of this operating profit margin contraction were specific to Co. while others such as the weak business conditions were attributable to broader economic factors. 2. As expected 3Q07 was highly promotional as a result of competitive back-to-school season with office supply stores, warehouse clubs, drug stores and discount stores all taking aggressive actions to stimulate sales. 1. These influences lowered GM by approx. 110 BP. 3. Pursued inventory clearance activities, which mitigated inventory risk but further compressed product margins by approx. 50 BP.
4. Lower than expected vendor programs support further reduced
margins by approx. 40 BP. 5. GM was negatively impacted by shift in category mix of about 60 BP, deleveraging of fixed property cost of 50 BP, and higher supply chain costs and other items of approx. 40 BP. 1. These negative factors were partially offset by approx. 160 BP of lower Opex comprised primarily of approx. 60 BP from lower performance based variable pay commensurate with lower division performance and approx. 40 BP of lower advertising
expenses as Co. redirected ad spend to programs with the highest ROI. 6. Comparable avg. sales per sq. ft. were $250. 7. Avg. order value was about flat, so essentially the entire comparable sales decline was due to lower store traffic. 8. At 3Q07-end ODP operated a total of 1212 office product stores throughout the US and Canada, including the newest store opening in Puerto Rico, which brought approx. half of the stores into the current M2 format. 9. Continues to be disappointed in evaluating individual new store openings and overall execution strategy based on the
internal hurdle rate and current business environment. 1. Have scaled back expansion plans from the original 150 new stores target in 2007 to about 70 stores this year. 2. Anticipates opening approx. 75 stores in 2008, down from previous plan. 10. Continues to believe that Co. has significant opportunity to expand its store count and that the stores are productive over the long-term but have moderated the rollout strategy in response to the current environment in order to lower expenses and redirect operating cash flow. 4. Remodeling: 1. Remains focused on refreshing existing store base and during 3Q07, completed 31 remodels. 2. Total remodels for 2007 should total 177 stores. 3. Goal is to have most of the North American retail stores in the M2 format over the next few years. 4. The combined cumulative performance of remodel stores over the past two years has produced GM expansion and increased sales by approx. 75 BP vs. control stores after considering any cannibalization impacts. 5. Since Co. is in catch up mode, level of store remodels in a given year is proportionately much higher than that experienced by most retailers. 1. Excluded the brief three week construction period from comparable store calculation in an attempt to best present store performance without most of the noise resulting from the destruction in sales during this remodel period. 5. Action Plans: 1. Will expand private brand assortment. 1. Penetration continued to expand in 3Q07 as furniture supplies in technology all increased. 2. Private brand present penetration for North American retail is in the high-20s and believes there continues to be opportunity for further growth as Co. continued to expand its assortment to achieve potentially 35-40% penetration in coming years. 3. Believes private brand products can contribute 500-1000 BP to GM over comparable nationally branded products. 4. Will balance assortment between private brands and national brands to satisfy customer demands. 5. With the new global office in Shenzhen, China, Co. will leverage global purchasing power and increase on direct import of office products.
6. Believes direct sourcing will add [hundreds] of BP in incremental margin. 2. Will grow loyalty program. 1. In Sept. re-launched Worklife Rewards customer loyalty program which Co. believes is now the best in the industry providing a stronger value of proposition to small business customers by offering 10% back in all ink, toner, paper and design print and ship services plus 1% back on nearly everything else with unlimited earnings potential. 2. Worklife Rewards program will continue to expand and offer new benefits to customer base. 3. Believes Sept. share gain was driven by the re-launch of this program. 4. Recently launched Worklife Rewards visa card rewards 5% back to customers on ODP purchases and offers additional benefits to customers during this holiday season. 3. Will continue to enhance Design, Print and Ship (DPS) offering.
1. DPS business grew to grow at a rapid pace posting double-digit sales growth and contributing 30 BP in overall comparable sales growth as Co. increased customer awareness and …