The third quarter of 2006 included items which are not expected to be ongoing. All financial measures designated in this release as "adjusted" are non-GAAP financial measures that exclude the effect of certain special items. A detailed description of prior quarter special items, and a reconciliation to the company's GAAP financial results, are included in this press release. Net income in the third quarter of 2007 increased 16% from adjusted net income in the third quarter of 2006 of $43.2 million, or $.56 per diluted share.
"Our results for the third quarter showed continued progress on our turnaround plans, even as we operated in a weaker economic environment that has had some impact on both our Contract and Retail operating segments," said Sam Duncan, Chairman and CEO of OfficeMax. "We are pleased that the actions we took earlier this year to reorganize and improve performance in our Contract division are generating positive results. In U.S. Contract, we reduced operating costs and expanded operating margin in the third quarter of 2007. In our Retail segment, operating margin declined primarily due to a category mix shift toward lower margin product sales that we could not offset with cost controls within the quarter. We continue to adjust our Retail promotional strategies and pursue other cost containment measures to improve our Retail operating margin."
Contract Segment Results
OfficeMax Contract segment sales increased 2.4% to $1.2 billion in the third quarter of 2007 compared to the third quarter of 2006, reflecting a U.S. Contract sales decline of 1.9% offset by International Contract operations sales growth of 16.2% in U.S. dollars, or 4.3% in local currencies. U.S. Contract sales declined in the third quarter of 2007 compared to the prior year period, primarily due to lower sales from existing customer accounts, and from the company's initiative to be more disciplined in new account acquisition.
Contract segment gross margin decreased to 22.1% in the third quarter of 2007 from 22.3% in the third quarter of 2006, primarily due to the continued impact of new and renewing large corporate accounts with lower gross margin rates and the impact of paper price increases. Contract segment operating expense as a percent of sales in the third quarter of 2007 improved to 17.5% from adjusted operating expense as a percent of sales of 18.4% in the third quarter of 2006, primarily due to effective cost management in U.S. Contract, lower incentive compensation costs, and expense leverage in International Contract operations. Contract segment operating income in the third quarter of 2007 increased to $55.0 million, or 4.6% of sales, from adjusted operating income in the third quarter of 2006 of $45.7 million, or 3.9% of sales.
Retail Segment Results
OfficeMax Retail segment sales increased 4.0% to $1.1 billion in the third quarter of 2007 compared to the third quarter of 2006, reflecting the impact of new stores and same-store sales increase of 0.8%. Retail same store sales in the third quarter of 2007 were favorably impacted by same store sales growth in technology categories and ImPress, partially offset by same store sales declines in core office supplies and furniture categories. Third quarter 2007 Retail sales trends reflected moderate improvement in Back-to-School season sales and some weakness in consumer and small business customer purchases.
Retail segment gross margin decreased to 28.9% in the third quarter of 2007 from 30.1% in the third quarter of 2006, primarily due to the impact of a shift in the mix of sales to a higher percentage of technology category sales at lower gross margin rates and a lower percentage of core office supplies and furniture category sales which typically generate higher gross margin rates. Retail segment operating expense as a percent of sales improved to 24.9% in the third quarter of 2007 from 25.1% in the third quarter of 2006, primarily due to lower incentive compensation costs, partially offset by higher store labor costs. Retail segment operating income decreased to $45.3 million, or 4.0% of sales, in the third quarter of 2007 from $54.8 million, or 5.0% of sales, in the third quarter of 2006.
During the third quarter of 2007, OfficeMax opened 9 retail stores in the U.S., closed 1 retail store in the U.S., and opened 3 retail stores in Mexico. OfficeMax ended the third quarter of 2007 with 869 retail stores in the U.S. and 65 retail stores in Mexico for 934 total retail stores, compared with 884 total retail stores at the end of the third quarter of 2006. The company continues to expect a total of approximately 60 new retail store openings in the U.S. for the full year 2007.
Corporate and Other Segment Results
The OfficeMax Corporate and Other segment includes support staff services and certain other expenses that are not fully allocated to the Retail and Contract segments. Corporate and Other segment operating expense in the third quarter of 2007 decreased to $10.0 million from adjusted operating expense of $18.8 million in the third quarter of 2006, primarily due to lower incentive compensation costs and reduced legacy-related costs.
As of September 29, 2007, OfficeMax reported total debt of $384.4 million excluding $1.5 billion of timber securitization notes. OfficeMax used $9.1 million of cash from operations in the third quarter of 2007, a decrease of $197.9 million from the third quarter of 2006, primarily due to the termination of the company's accounts receivable securitization program in July 2007. OfficeMax invested $41.9 million for capital expenditures in the third quarter of 2007 compared to $49.8 million in the third quarter of 2006. The company expects capital expenditures to total between $140 and $160 million for the full year 2007.
Mr. Duncan concluded, "While we are pleased to have made progress in our 2007 turnaround initiatives, opportunities remain across our business for improvement. We are focused on driving profitable sales, controlling expenses, and increasing operating margin. In our Contract segment, we continue to instill discipline in signing on new accounts, enable cost savings to our customers and better profitability to OfficeMax, and position us for aggressive middle market sales growth. In our Retail segment, we remain committed to effective category management and promotional strategies, controlling and leveraging costs, and implementing our real estate strategy."
