Office Depot, Inc. Q2 2009 Earnings Call Transcript

Jul.28.09 | About: Office Depot (ODP)

Office Depot, Inc. (NYSE:ODP)

Q2 2009 Earnings Call

July 28, 2009 9:00 am ET


Brian Turcotte – VP IR

Steve Odland – CEO

Mike Newman – CFO

Chuck Ruben – President North American Retail

Steve Schmidt – President North American Business Solutions

Charles Brown – President International Business


Oliver Wintermantel - Morgan Stanley

Colin McGranahan - Sanford C. Bernstein

Chris Horvers – JPMorgan

Matt Fassler – Goldman Sachs

Michael Baker – Deutsche Bank

Kate McShane – Citigroup

Mitch Kaiser – Piper Jaffray


Welcome to the second 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. Mr. Turcotte, you may begin.

Brian Turcotte

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 accompanying web cast slides for today's call are available on our website at, click on Investor Relations under Company Information.

Office Depot’s Chairman and Chief Executive Officer, Steve Odland, will now summarize our second quarter results.

Steve Odland

Good morning and thank you for joining us for Office Depot’s second quarter 2009 earnings conference call and webcast. With me today are Mike Newman, Chief Financial Officer; Chuck Ruben, President of North American Retail; Steve Schmidt, President of North American Business Solutions; and Charles Brown, President of International.

The second quarter 2009 total company sales were $2.8 billion, a decrease of 22% compared to our second quarter results last year. Excluding the impact of foreign currency translation on our international business the sales were down 18%.

As our business leaders discuss their second quarter results today, the consistent theme will be that we were adding new customers in the second quarter but both our new and our existing customers were buying less office products due to the weak economy.

Our net loss on a GAAP basis was $82 million compared to a loss of $2 million in the second quarter of 2008. The GAAP loss per share was $0.31 for the quarter versus $0.01 a year ago. Adjusted for charges the net loss per share were $60 million and $0.22 respectively.

These results were consistent with our forecast given the current economic environment and the typical seasonal weakness in the second quarter. The charges which included unusual items that we do not consider indicative of our core operating activities totaled $35 million or $0.09 per share for actions taken as part of our strategic business review.

We are pleased that cash flow before financing activities was above our expectations at $55 million for the quarter. As we previously mentioned cash flow and liquidity are key focal points for us in these challenging times and Mike Newman will cover our results in greater depth later in this call.

For the last four quarters cumulatively cash flow before financing activities totaled $470 million which are strong results given the weak economic environment during this past 12 month period.

Adjusted for charges total operating expenses decreased by $143 million compared to the second quarter of 2008. This decrease primarily reflects lower payroll and advertising expenses as well as reductions in distribution costs and professional and legal fees.

EBIT adjusted for charges was a loss of $62 million in the second quarter of 2009 compared to EBIT adjusted for charges of $21 million in the same period last year. As you know we recently announced that private equity firm BC Partners, made a recent preferred stock investment in Office Depot.

We’re very pleased that BC Partners made this $350 million investment and that Raymond Svider, Jamie Rubin, and Justin Bateman have joined our Board. They have a very successful investment track record and consistently demonstrate a commitment to working with companies to implement their long-term strategic plans.

Now I’d like to ask Chuck Ruben to update us on the North American Retail results.

Chuck Ruben

Thanks Steve, second quarter sales in the North American retail division were $1.1 billion, down 21% from the prior year, due in part to having 114 fewer stores open in the second quarter of 2009 versus the same period a year ago.

Comparable store sales in the 1,138 stores in the US and Canada that have been open for more than one year decreased 18% versus the second quarter of 2008 and were slightly lower than the first quarter as expected.

While transactions were down in the second quarter compared to the same period last year the rate of decline was lower than the previous six quarters. The greater contributor to our sales decline in the quarter was a double-digit percentage drop in our average order value.

Consistent with previous periods, the decrease in sales was driven by macroeconomic factors as consumers and the small business customers continue to rein in their spending especially in large ticket items like furniture and computers and our commitment to proactively reduce promotions in certain low margin durable categories.

As was the case in the first quarter we estimate that our comparable store sales were negatively impacted by approximately 300 basis points from pulling back in our sales of notebook computers.

Within each of our three major product categories of supplies, technology, and furniture we experienced a sales decline compared to the prior year. While supplies continued to show improvement in trend versus previous quarters, the division’s negative comparable sales continue to be driven by fewer sales of higher ticket discretionary categories in furniture and technology.

Some of our best performing categories were consumables including ink, toner, and paper as well as our design, print and ship services. Our Tech Depot services offering while still a relatively small part of our overall sales dollars, experienced double-digit growth year over year.

Weak sales in the Sun Belt continue to weigh heavily on our results as our small business customers in Florida, Texas, and California in particular continue to be impacted by a weak economic environment, high unemployment levels and limited access to liquidity.

Our best performing markets in the second quarter were in the northeast, Canada, and the mid west. The good news on the sales front is that we did grow the number of our work life reward loyalty members. These loyalty members spend more than non-members and they shop more frequently.

In the second quarter we did close five stores, opened three and relocated one store brining our total North American store count to 1,158 at quarter end.

The operating loss for the North American retail division was $13 million in the second quarter of 2009 versus a loss of $4 million one year earlier. The key components of the operating loss change versus a year ago include the following. On the positive side we had four key drivers.

First we had a $23 million benefit related to lower charges for shrink and inventory valuation that resulted from our previously discussed efforts to reduce our shrink exposure and minimize clearance.

Second we had a $15 million comparative benefit from closing the underperforming stores identified as part of the strategic review that generated operating losses last year. As I noted last quarter the store closure cost per leases, severance, etc. are included in the corporate charges that Mike will address later in this call.

Third we had an improvement in product margins for the fourth straight quarter. This improvement resulted in an increase of operating profit of approximately $6 million and reflects 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.

And fourth we benefited from $16 million in operating expense reduction including lower depreciation from prior impairments. On the negative side the flow through impact from our sales volume decline impacted operating profit by approximately $64 million compared to last year.

And we increased our reserve for previously closed stores by about $5 million to reflect a risk with sublet tenants. In North American retail we continue to focus on providing innovative products, services and solutions to micro business customers that will position us well when the economy begins to recover while continuing to manage our costs.

I’ll briefly update you on just four of these key initiatives. First our product assortment line reviews are going well and the benefits are beginning to flow through. We expect these product line reviews to continue for the balance of the year and touch most of our current product categories.

Second our service offerings remain a critical component of our assortment. Our Tech Depot services business continues to perform well with sales trends to last year and attachment rates above expectations.

Third we launched the Small Business Self Bail Out Plan, a one of a kind program that provides small businesses with the tools, resources and support they need to help their businesses not only survive, but thrive in this current economic downturn.

Office Depot is committed to doing everything it can to help small businesses during these tough times. As part of our small business self bail out plan we created the survival of the smartest website, a new online resource dedicated entirely to small businesses.

In addition we extended our program that provides free copies of resumes and free faxing for those actively seeking employment opportunities. Customers can now take advantage of this special offer for the remainder of the year by visiting the Copy and Print Center in any one of the more than 1,100 retail store locations nationwide.

And fourth we’re making progress in 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 to the physical structures.

In summary we continued to make progress with our strategic initiatives. We improved product margins, reduced our operating expenses, launched a new marketing program, and improved the product assortment in the historically challenging second quarter.

As we look forward we continue to work hard to find new ways to deliver higher more profitable sales. Remember that the third quarter has historically been our second highest sales quarter of the year due to the back to school season and we do expect our sales and operating profit results to improve sequentially.

Although we expect improvement we do anticipate back to school to be promotional and our competition to be very aggressive this year. I’ll now turn over the call to Steve Schmidt to review the second quarter results and key initiatives for North American Business Solutions.

Steve Schmidt

Thanks Chuck, second quarter sales in the North American Business Solutions division were $868 million, down 18% versus the second quarter last year as our customers continued to reduce spending on office products.

However we do believe that the sales decline began to stabilize in the second quarter with relatively flat sales comps sequentially versus the first quarter. Sales in both our small to medium sized business customer segment, or SMB and large national account customers continued to decline in the second quarter on a year over year basis.

However the rate of decline for our SMB customers in the second quarter decreased compared with the first quarter. The decline in both segments was principally driven by a decrease in the number of customer transactions.

In the large national account segment we did see extremely aggressive pricing being offered by some of our competitors. Our approach has been to exercise increased discipline around the pursuit of accounts that would be sustainable over time.

Overall we grew the size of our customer file in the second quarter but new and existing customers are buying less due to the weak economy. On a product category basis the division continues to see the most weakness in furniture, technology, and perishables, as customers delayed their purchases of durables in favor of consumables like paper, ink and toner.

We have not yet seen any indication that this purchasing trend will be changing in the near-term. In the second quarter the sales decline in California continued to exceed the overall rate of decline for the entire business while the Florida sales decline was slightly better than the overall rate for the total business excluding Florida and California.

On a sequential basis the sales decline in California continued to accelerate which was not surprising given the challenging facing this public and private sectors in that state, while Florida’s rate of decline was slightly lower than the first quarter.

These two states continue to represent approximately 30% of the division’s revenue and about one third of the revenue decline in the quarter. As I mentioned on the past earnings calls the public sector in general and state governments in particular continue to cut back on discretionary spending which includes office products.

This reduction in public sector spending in addition to reduced access to liquidity for small, medium, and large companies continues to have a negative impact on our division’s performance.

However we did see an increase in government spending at the end of the second quarter. North American business solutions operating profit was $23 million for the second quarter of 2009 down from $49 million for the same period of the prior year.

The components of the second quarter operating profit change versus one year ago included the following key factors. First approximately $36 million of the operating profit decline relates to the flow through impact of lower sales levels.

Second a $6 million decline due to the negative impact of product margins including a less profitable product mix and cost increases that were not fully passed on to our customers due to timing issues.

And finally partially offsetting some of the operating profit decline was about $16 million in benefit from reduced selling and G&A expenses, lower customer rebates tied to volume, and lower charges for shrink.

Despite the challenging business conditions the business solutions division continued to focus on executing initiatives that will position us well when the economy begins to recover. I’ll briefly update you on a few of those initiatives.

First as a result of the contract sales force reorganization, process changes within the telephone account management or TAM organization, and the third party canvassing efforts like feet on the street, we are growing our customer file and acquiring new customers.

Second, we launched the new website in the second quarter with improved search functionality, a chat feature, customer friendly checkout, and enhanced key word search. Customer reaction to this new site has been very positive.

Third we made significant enhancements to our product catalogues in the second quarter to make it even more customer friendly including improved pagination, sharper graphics, and helpful benefit statements.

We also optimized our catalogue circulation during the quarter. In the second quarter 82% of total BSD sales were on line, up from 81% for the same period a year ago and our global company internet sales for the past 12 months totaled $4.3 billion.

In summary the business solutions division made progress on a number of fronts in the second quarter in a challenging business environment where the top line results continue to be soft driven by significant spending cuts across our broad customer base.

We continue to tightly manage our expenses, while focusing on the key initiatives that will provide growth when the economy does recover. As we look forward we remain cautiously optimistic that we could potentially be at or near a bottom of this economic cycle.

Although we have yet to see customer behavior change or much needed liquidity reach our SMB customers we will be overlapping our weak sales results from the second half of 2008 and believe that the year over year sales decline should improve in the second half of the year.

In addition the third quarter P&L should be similar to the second quarter. Charles Brown will now discuss the second quarter results and key initiatives for our international business.

Charles Brown

Thanks Steve, the International division reported second quarter sales of $830 million, a decrease of 25% in US dollars compared to the second quarter of 2008. Local currency sales decreased 12%, with all but a few of the countries in which we operate reporting a year over year decline.

The UK, France and Germany all reported double-digit declines in local currency and accounted for over 70% of the division’s local currency decrease in revenue. Sales declined more in the second quarter than the first quarter because of the shift in the Easter holiday.

Excluding the impact of Easter from both quarters, the decline is the same in sales per day were consistent with our expectations. Business conditions in the global markets continue to track those mentioned by Chuck and Steve. Like North America concerns regarding worsening cash flows, tight credit conditions, deteriorating profitability, and the global recession are driving a reduction in both business investments and office supply expenditures.

Although our customer acquisition has improved compared to 2008 sales in the direct channel declined 15% in local currency because of continued softness in big ticket items such as furniture and technology.

Increase in purchasing from sales catalogues and greater competitiveness within the channel and then a general decline in the frequency and size of transactions as customers limit their purchases to their essential needs.

Contract channel sales continued to be under pressure being down 11% in local currency. This sales decline is mostly attributable to larger businesses reducing their work forces and limiting purchases of office supplies to primarily their core lists.

Our international retail sales were down about 4% versus one year ago primarily as a result of our previously announced plans to exit the retail business in Japan. The international division operating profit was $3 million in the second quarter of 2009 compared to $51 million in the second quarter a year ago.

The components of the change versus a year ago include the following; first on the positive side we saw an improvement of approximately $24 million in our operating expenses as we reduced selling and distribution costs.

These expense reductions were more than offset by the flow through impact of lower sales levels of approximately $49 million. The non recurrence of a $13 million gain booked in the UK in 2008 following the curtailment of a local pension plan.

Increased promotional activity and product cost increases that cannot be fully passed on to the customers had a negative impact of approximately $8 million and a change in foreign exchange rates driven by a stronger US dollar unfavorably impacted our operating profit by $2 million.

Although business conditions continue to be challenging we remain focused on improving our service model and the overall profitability of our business. I’ll briefly update you on a few of our key initiatives.

First we have successfully implemented the first phase of our plan to move from a channel centric to a customer centric model in Europe. This effort will allow us to design the right contact strategy and value proposition to best acquire and retain customers and grow our share of wallet while also reducing our costs.

Second we continue to move ahead with our SKU harmonization and rationalization program and they should be completed in the third quarter of this year. The objective of this program is to simplify inventory management while significantly reducing our operating costs and inventory levels.

Third we are investing our capital in high return projects. For example we recently opened our new distribution center in The Netherlands and its service metrics are already running above our European average.

We also recently broke ground on a new distribution center in Israel which will replace a very old and outdated facility. And fourth we continue to show leadership in the areas of environmental and social responsibility.

For example we issued our first pan-European green catalogue in the second quarter. This leadership gives us a competitive advantage to win government business and other larger accounts where these values and offerings are a prerequisite.

In summary we maintain our tight focus on improving customer service, reducing costs, streamlining our operations and pushing our sales initiatives in the second quarter. This focus on improving customer service is paying off as we retained our two largest accounts in the UK without going to tender in the second quarter.

Looking forward we still believe that the US will likely lead any broad based economic recovery with the European markets trailing. In the near-term the third quarter is Europe’s traditional holiday season. Additionally companies are increasingly investigating ways to reduce costs by extending facility closing periods or furloughing employees.

As a result we don’t anticipate a significant change in the economic situation in our major markets, expect revenues to decline in local currency at about the same rate as in the first half of 2009.

However we’re more optimistic about our fourth quarter performance. With that I’ll now turn it over to Mike who will review the company’s second quarter financial results in more detail.

Mike Newman

Thanks Charles, in the second quarter we continue implementing our strategic business review actions and we recognized $35 million of pre-tax charges related to these actions during the quarter.

Actual cash paid totaled $24 million in the second quarter. For the remainder of 2009 we expect to recognize between $85 and $115 million in additional charges as activities are completed and accounting criteria are met including $10 to $20 million related to our 2005 legacy initiatives.

The company expects these activities and charges to be completed by the end of 2009. The cash usage is estimated to be approximately $75 million in the second half and these actions should positively impact EBIT and cash flow by about $70 million and $40 million respectively for the balance of the year.

Slide 18 on cash flow, in the second quarter or cash flow before financing activities was $55 million, significantly exceeding our earlier internal estimates. This total included $47 million in sale leaseback transactions of properties in the US and Europe.

Free cash flow for the second quarter was a use of $14 million driven primarily by a normal seasonal inventory build for our back to school season. Increased inventories in the second quarter had a $115 million negative impact on free cash flow.

We maintained our days’ sales outstanding in the second quarter and inventory turns improved to 6.3. Our accounts payable to inventory ratio was 93% at the end of the second quarter.

Total cash flow before financing for the first half of 2009 was [$215] million. We expect full year cash flow before financing to be in the $210 to $220 million range and free cash flow is expected to be in the $30 to $50 million range.

This cash flow before financing range is lower than our prior forecast. As a result of our recent convertible preferred stock investment by BC Partners we likely will cut back on our sale leaseback transaction efforts involving US owned stores and international distribution centers.

We had previously targeted about $40 million in second half opportunities for sale leaseback transactions. These full year cash flow estimates exclude $40 million in proceeds from land sales, land sale leaseback transactions, accounts receivable factoring that will be characterized in the financing section of our cash flow statement.

Our capital spending continues to be estimated at about $125 million for the full year. Slide 19 on liquidity initiatives, through the first half of 2009 we have realized $283 million in cash generated from liquidity initiatives, primarily property sale leaseback transactions, a reduction in capital spending, benefits from our strategic business actions, tax refunds, and a dividend from our Mexican joint venture.

We anticipate an additional $130 million in cash from initiatives in the second half of 2009 mostly from reduced capital spending, benefits of our strategic business actions, and factoring of European accounts receivable not currently pledged under our asset based credit facility.

Additionally we have successfully completed our preferred stock transaction with BC Partners in June resulting in net cash proceeds of $327 million. Slide 20, an update on our liquidity, at the end of June our total available liquidity under our asset based lending facility was $753 million, up $123 million from our first quarter ABL availability of $630 million. With an additional $559 million in cash and cash equivalents our total liquidity was $1.3 billion, an increase of over $500 million from our March total liquidity level of $806 million.

At the end of the second quarter we had zero borrowings on our ABL for the second consecutive quarter and expect that that will be the case for the remainder of 2009. We had $168 million in outstanding letters of credit pledged against the ABL at the end of the second quarter and we expect our ABL availability to remain relatively flat in the third quarter compared with the second quarter.

Moving to the balance sheet on slide 21 of the $559 million in cash and cash equivalents, about $327 million was a result of the preferred stock investment from BC Partners. Inventory totaled $1.3 billion globally, down 23% 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 $714,000, down 21% from the same period a year ago.

We’re confident that we are managing our inventory at the appropriate level to support our business and serve our customers and this improvement is a result of operational efficiencies we have realized in our supply chain.

Our net debt at the end of the quarter was $173 million which includes $669 million in long-term debt. With the asset based credit facility in place $400 million of bonds not maturing until 2013 the additionally liquidity actions we are taking and the investment by BC Partners we remain comfortable that we have a suitable capital structure in place to take us through this business cycle.

Before I turn the call back over to Steve I’d like to comment that although our second quarter results met our own internal expectations it appears that it was tough for many of you to forecast our selling expenses and G&A.

In an effort to assist you in modeling the company going forward, I’ll provide some color on those line items. Our selling expenses in the third and fourth quarters of 2009 are projected to be $20 to $30 million higher than the second quarter due to seasonally higher sales revenue.

Our third quarter G&A is forecasted to be an increase of $20 to $30 million over the second quarter due to a number of factors including the amortization of our new enterprise software system, the effect of accelerating vesting of certain employee’s stock options, and additional expenses related to change in control features in certain employment contracts.

Our fourth quarter G&A is projected to be only about $10 to $20 million higher than the second quarter as a portion of the third quarter increase is one-time and will not repeat. With that I’ll turn the call back over to Steve.

Steve Odland

Thanks Mike, in summary although were disappointed with the loss in the second quarter driven by the global macroeconomic impacts on our businesses, the results were consistent with our forecast and our cash flow significantly exceeded our expectations.

In addition our three business divisions continue to make progress with their strategic initiatives that will provide growth when the global economy does recover. A company wide strategic initiative that you’ve heard us mention over the past couple of years is our global IT project.

Our goal has been to replace the legacy IT systems inherited from years of acquisitions, these systems didn’t communicate with each other and were an inhibitor to our success and we’re replacing that with a single world class ERP platform.

I’d like to take this opportunity to thank all of our IT, finance and human resource and other associates at Office Depot who worked tirelessly for months to successfully launch the first release of our net platform in June as scheduled and without any disruption.

This release included financial modules for AP, AR, credit and collections, cash management, etc. We plan to launch additional finance and business function releases in coming months as we move forward to reaching our goal of getting all of our associates on a single ERP platform and putting the company on the right track for taking care of business.

Looking forward its extremely challenging to provide an outlook beyond what Mike has already provided given the state of the economy but our third quarter performance is typically seasonally better than the second quarter but not to the level of the first quarter and 2009 should be no different.

Also as we’ve said before we most likely will have an EBIT loss in the second half of 2009. In closing I would like to reiterate that we are committed to leading the company through these challenging times and we 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.

Now I’ll open up the call to questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from the line of Oliver Wintermantel - Morgan Stanley

Oliver Wintermantel - Morgan Stanley

Could you give us a little bit more color on your small, medium sized business, national large accounts. I know you gave some details on your prepared remarks but could you maybe give us some more details on how the trends were during the quarter in these businesses and then also on the retail side, how the trends were during the quarter.

Steve Odland

I think overall across the entire company we saw a trend towards picking up more customers. I think each of the three divisions saw an increase in their number of customers and especially given our focus on SMB, in that space. I think one of the critical things that happened however is our new and existing customers bought less in the quarter.

So I’m very pleased about that. Maybe each of the divisions could give a little color on the SMB focus.

Chuck Ruben

I think I mentioned our work life reward program which is how we track our customers in retail as well as in direct. That membership grew in the second quarter. Its an incredibly important program. I mentioned they shopped more frequently, they spend more money then non-members do.

They also are an identified base of customers so we can communicate to them directly and that program has been up and running for a few years and we continue to enhance our abilities to talk to them.

So we’re pleased that they’ve expanded but to Steve’s point we did see them spending less then they have in the past.

Steve Schmidt

On the SMB side of the fence we were pleased with the fact that during the latter half of the second quarter we started to grow our customer file and so we’re adding more customers to our file and that’s very, very encouraging and obviously at this point the decline that we’re seeing is simply those customers buying less than they bought in the past.

But our restructuring is having is a positive impact on our ability to grow our customer file and that will have benefit long-term. On the enterprise side of the fence we continue to retain customers at historical rates which we feel very pleased about and we continue to work aggressively on acquisition of customers on a selective basis as we talked about during the call.

So all in all we’re seeing some competitive pricing with our large customers but not seeing anything significantly different that we saw in the second quarter.

Charles Brown

And for the international division, again I would echo some of the things that Steve has said in terms of the SMB and the large accounts. We’re seeing very, very similar trends particularly in Europe. The only thing I would really add is that in some of our major markets in Europe in these times because of our improved execution we have evidence that we’re capturing some level of market share.

Oliver Wintermantel - Morgan Stanley

Could you also give us a little more details about the trends within the quarter, April, May, June, have you seen any pick up in the businesses or has it stayed the same during the whole quarter.

Steve Odland

I think overall we saw a little bit of a hit from Easter moving between our two quarters so we were negatively effected in the early part of our quarter because of that shift from March last year. Any other trends in particular you want to point out within the quarter.

Chuck Ruben

Within retail, to Steve’s point that hit us at retail for about 80 basis points. That happened in April so we saw things stabilize somewhat from there. On the consumables part of our business it was especially stable as the quarter unfolded. As I had mentioned in my comments we pulled back on some of our technology promotions, so that suffered a little bit during the June Father’s Day timeframe.

So consumables we saw steadied progress in things getting better minus the Easter shift on the durables, on the computers in particular, we saw that choppy a little bit more.

Steve Odland

And you may want to mention that we’ve been trying to improve our profitability by cutting back on our computer promotions, you might want to mention the effect its had on our top line. Its improved our margins significantly.

Chuck Ruben

Yes, when you look at our comps we published a minus 18. I said in my comments that the pull back on promotions in big ticket technology was about 300 basis points and then when you throw the Easter shift in there which negatively impacted second quarter of about 80 basis points on a pure basis we’re running in the lower teens in terms of a comp negative. But it did to Steve’s earlier point help our overall mix and we think it’s a healthier mix of our business as we look forward.


Your next question comes from the line of Colin McGranahan - Sanford C. Bernstein

Colin McGranahan - Sanford C. Bernstein

First question just on the free cash flow outlook it sounded like the entire change there from the $50 to $100 million prior guidance was the reduction of $40 million of sale leasebacks, is that correct and I thought you defined free cash flow as cash flow from operations less CapEx. So how does the sale leaseback of the facility fit into that definition.

Mike Newman

I think the previous guidance was cash flow before financing of around $250, we’ve lowered that by about $40 million which is the sale leasebacks. The free cash flow forecast is fairly consistent with what we’ve done previously.

So that number is consistent, the only change in the total cash flow before financing is driven by the fact that with the additional liquidity we’re walking from some of these sale leasebacks that have higher cap rates. We don’t think that’s an efficient way to get additional liquidity.

We will continue to look at the receivable factor because that’s a very low cost way of getting additional liquidity.

Colin McGranahan - Sanford C. Bernstein

Just to follow-up on that I’m looking at the first quarter conference call and it says expect free cash flow to be $50 to $100 million in 2009 and you define free cash flow as cash flow from operations less CapEx and it doesn’t look like the CapEx has changed, you’re now expecting free cash flow $30 to $50 million, so am I correct—

Mike Newman

That’s down a little bit and some of that is in working capital.

Colin McGranahan - Sanford C. Bernstein

And then just a broader question on G&A appreciate the guidance, that’s helpful, that is a hard item for us to forecast but I’m curious why G&A is going kind of up or in the second quarter really didn’t go down at all on a year over year basis despite the reduction in sales. And if I look back historically the last time you had sub $12 billion in total revenue which is looks like where you’re heading this year, total G&A at the corporate level was a 2002, 2003 kind of at the $490 to $580 level, so what’s going on in the G&A line, how much opportunity is there, if you can be a little bit more helpful on what the longer-term trajectory is on that line.

Mike Newman

If you look from a rate perspective from fourth quarter into the first and second quarters, we’re down significantly from where we were at year end. So the first and second quarters we had G&A’s in the $160 range and what we’re articulating today is that as we look into the third quarter we called out some of the increases.

We’re bringing our ERP system on line, we had some, the explanations that I called out $30 million increase, by the way those are mostly non cash and then as we go into the fourth quarter its mostly about, that increase I called in my script is mostly about the simplified depreciation and some related IT costs as we’re not working on the project any more.

We’re depreciating it. So we have seen significant cost reductions as we go forward and I recognize we’ve got a lot of moving parts in the business. We’ve got three different businesses. We’ve got restructuring activities and we’ve got some of these unusuals and we’re bringing depreciation. We just wanted to give you a little bit more color.

But we are on both operating expenses and G&A we’ve done a hell of a job taking costs out. Steve talked to the fact that our selling expenses are down almost $140 million in the second quarter due to a lot of good things that we’ve done in labor and also in distribution and delivery costs internationally and we think that’s a good story.

Steve Odland

I think we also should point out that a year ago we had some unusual favorables in UK pension pick up, and a bonus pick up that we didn’t have this year and also foreign exchange hurt us a little bit on the G&A side. So I think comparable G&A quarter to quarter—

Mike Newman

We’re really down closer to $20 million, because you’ve got some unusuals from last year into Q2 but then again I just want to point out as you look forward we do have some increases in Q3 that you should be thinking about as you look at our business.


Your next question comes from the line of Chris Horvers – JPMorgan

Chris Horvers – JPMorgan

A couple of follow-up questions, first can you repeat what you said about store warehouse and selling expenses in the fourth quarter, are you expecting positive earning in the third quarter and then on the sales side, can you talk about what the intra quarter trend is and what the BSD intra quarter trend was.

Mike Newman

I’ll repeat what I said on selling expenses, our selling expenses in the third and fourth quarter are projected to go up from the second quarter level by about $20 to $30 million principally due to the higher seasonal sales level.

Chris Horvers – JPMorgan

Okay so that line should be roughly flat third quarter and fourth quarter.

Mike Newman

Quarter to quarter, yes, within roughly flat, probably a little higher in the third quarter because it’s a little stronger quarter.

Steve Odland

We’re talking sequentially now not year over year.

Chris Horvers – JPMorgan

Are you expecting positive earnings in the third quarter.

Mike Newman

We’re not going to call out third and fourth, we are expecting to see a modest loss in EBIT for the second half.

Steve Schmidt

Regarding BSD intra quarter trends as we talked during the call basically we saw the same decline in the second quarter as we saw in the first. We think that’s an indication hopefully that things have bottomed out and then as we move forward through the second half of this year we obviously start to overlap some significant declines from prior year so we would see those trends improving as we go throughout the rest of the year.

Chris Horvers – JPMorgan

Maybe I’ll follow-up on that for both your division and retail, when did, there was a step down last year in the third quarter versus the second quarter when did trends really start to take a hit. Was it July, was it August, was it September, so we can get an idea of maybe what’s happening right now in July and how we should think about the balance of the quarter.

Mike Newman

For the whole business in the second quarter we just told you the sales number is down 22 in total. We’re up against the minus one last year. Third and fourth quarters total business we’re up against respectively minus seven and minus 15. So it really started to step down late third quarter and then all of the fourth quarter and the other issue is that the currency impacts in the fourth quarter will start to get up again, its easier currency comparisons where instead of having a 1200 basis points impact like we did this quarter it’ll almost be neutral in the fourth quarter.

Steve Odland

And the big step down last year was really around September 15 and the Lehman bankruptcy when all the spending from our customers just kind of dried up.


Your next question comes from the line of Matt Fassler – Goldman Sachs

Matt Fassler – Goldman Sachs

A couple of questions, the first relates to retail and the second is basically an accounting question. On the retail side as it looks like really across the business, being focused on retail in particular the revenue declines are more or less hitting bottom and presumably as [inaudible] you’ll move towards flat. What can margins do from here in the absence of sales declines. Is it feasible to get margin expansion in your view without sales actually moving higher on the year on year basis.

Chuck Ruben

The margins will expand as sales start to stabilize. We’re pleased with the mix of the business shifting more towards higher margin consumables and core supplies and on the service side of it. As I mentioned a minute ago, when you decompose the second quarter we had a negative 18 comp, you take out the pull back in computers and you take the shift out of Easter and that translates kind of to a minus 14.

But it is lower volume and you can see that we managed the flow through pretty well to our operating profit for the division. So as sales start to stabilize we do think that there’s expansion in our margins. Pleased with all the components underlying the operating margin when you look at product margins, they continue to expand. And when you look at our expense management so as sales stabilize we think that we reverse our operating performance.

Mike Newman

This is the second quarter in a row on retail where gross margins were up year over year despite the de leveraging impact. And I would expect that that would for the balance of the year to Chuck’s point that would continue and keep in mind fourth quarter last year we were a little bit more promotional then we wanted to be so we’re up against that and we’ll likely be out there but not quite as promotional.

Matt Fassler – Goldman Sachs

So I guess as we take a look at the long run, I’m thinking much less about Q3, Q4 and more about sort of when the sales level stabilize year on year, it looks like of the four dollar numbers that you identified that drove margins one way or the other drove profits in the second quarter, the one that might have some legs is the $6 million associated with retail margins. I would take it that there’s no ability to leverage your infrastructure or your fixed costs or your labor with any other than a positive comp or am I missing something on the opportunity front.

Chuck Ruben

Product margins will be the driver of that. We continue to try to find ways to control the expenses and there are still things that we can do to lower that operating base without impacting payroll. But product margin upside is the mix of the business and the other initiatives that we’ve had around direct import and the things we’ve talked about in previous quarters kick in and we get more out of it.

Steve Odland

I think the other thing is we’re consciously trying to manage our computer promotions. It hasn’t proven to drive overall basket. We’re not getting the kind of attachments we want to get and so forth so it gives away margins. So what we’re trying to do is balance that and as a result of that we are giving away some top line but improving the margin and this has been kind of a tough balancing act here over the past few quarters.

Chuck Ruben

To Steve’s point, you look at the computer market overall and there’s a deflationary component that’s going on in computer business throughout most retailers where the average selling prices deflating, forget year over year its deflating quarter by quarter.

So to Steve’s point, trying to balance that out and get a basket that’s attractive, we’re making progress on that but we have a natural deflation of the price on the computer that’s going on and the marketplace for computers has become far more competitive today than it was a year ago.

Matt Fassler – Goldman Sachs

And then my second question is a simple one I think relates to the share count and thinking about the share count in the future in the context of BC’s investment, if you give us some guidance as to how you think that plays out and what the different scenarios are that will influence that calculation.

Mike Newman

I don’t know if this will answer your question or not but from an EPS calculation there’s two different methods we look at. If you look at the income statement that was published with the press release there’s a line called net earnings attributable to Office Depot. First calculation is you’ll take that line, you’ll deduct the preferred dividends which of course are $350 million at 10%. You’ll take that numerator over the existing share base which is 270 and you’ll calculate an EPS calculation.

Alternately you’ll look at the same loss attributable to Office Depot, you’ll just ignore the preferred dividends, you’ll take that numerator over a fully diluted base of 340 million shares, you’ll calculate EPS and the one that is the most delutive is the one you’ll see on the earnings page which happens to be the first calculation that I gave you because we’re in a loss position.

Matt Fassler – Goldman Sachs

And so long as you’re losing money on the year, I take it that will be the, or not making much money, that will probably be the MO and then just kind of test it every quarter.

Mike Newman

Generally, yes.


Your next question comes from the line of Michael Baker – Deutsche Bank

Michael Baker – Deutsche Bank

So two questions, I think both more related to the delivery business, first you mentioned a couple of times aggressive pricing I guess not only delivery but across the whole business I’m wondering is that a function of the different competitive dynamics in your business over the last year with basically Staples buying Corporate Express, is that enabling them to be a little bit more aggressive in pricing.

Steve Schmidt

I would say that in general what we’re seeing is more aggressive pricing on the enterprise side not necessarily being driven by the Staples Corporate Express acquisition but by other competitors out there. We’re also seeing significant price decreases coming from the regional players across the board particularly the large regional players across the US.

Michael Baker – Deutsche Bank

So its really outside of the big three where you’re seeing the aggression.

Steve Schmidt

There is some going on with the big three, its just I would just say its more focused on one versus the other.

Charles Brown

And for international we’re seeing the same thing. A lot of the regional players, there’s been a number of what I’ll call regional players in Europe that actually have gone out of business and so I think its really a fight for survival for some of these smaller players.

Michael Baker – Deutsche Bank

And then can you just give us some color on what’s going on with the government contracts, how big is that as percent of your total delivery business and I think some large portion of that is made up through one buying consortium so how you think about that and the sort of lack of diversity in the customer base there.

Steve Schmidt

We talked in previous calls that when you look at our state government contracts and that’s really the bulk of the discussion it really is not a significant portion of our revenue and/or our profitability across the board but we continue to cooperate with any in discussions with any of the states and continue to be part of that process.

And so at this point we really have nothing additional to report there. What you’re referring to in terms of the cooperative is our relationship with the US community’s relationship and that’s really simply a group of thousands of customers who participate across the United States as part of that US community’s relationship and that continues to be a positive factor for us.

Steve Odland

But I think you could take your entire public sector base and it’s a meaningful percentage of your total business but that’s broken up in to states, federal government, counties, military, and so I wouldn’t think of it as a monolith of a customer and even though US communities relationship is just a facilitator for thousands and thousands of other customers so I don’t of it, we don’t think of it as one concentrated customer base, it just happens to be in the public sector versus in the private sector.

Michael Baker – Deutsche Bank

So I guess what I’m getting at, so US communities is some large percentage I think of your BSD business, maybe 10 or 15% and so is there a concern that if this one buying consortium chooses to move elsewhere that you lose in one fell swoop a big portion of your business or is that not the right way to think about it.

Steve Schmidt

Yes, the way I would think about it is simply that its simply a facilitation and that each of the agencies that participate as part of that contract make an independent decision and so the relationship we have is simply a facilitation that enables us to offer that program to the multiple agencies across both the federal and state level as well as on the education side.

And should we decide to go a different direction which we’re not planning to, we have a good relationship but should that change we would still be able to continue to do business with the agencies that are part of that contract.

Steve Odland

And should they choose to change or alter the way they’re doing it, it doesn’t obligate any of the participants in that contract to change either so theoretically it’s a hunting license.


Your next question comes from the line of Kate McShane – Citigroup

Kate McShane – Citigroup

In the 10-Q that you released this morning you did say that you expect back to school to be promotional and that other retailers will be very aggressive, can you talk a little bit about what you’ve seen so far this season that may be differs from what you saw last year and then are there certain categories that people are being more aggressive than other categories.

Chuck Ruben

I think what we’re seeing is what you’re seeing as a customer. The range of players continues to be large from drug store to discount to office supply and everyone in between. The amount of advertising that’s out there so far seems to be very extensive. We also believe that schools are going back to school later this year generally across the country which I think will ultimately translate into a bit of a shorter window for lots of players to try to grab their part of the business.

So I think that we’ve seen promotionability high at this stage, certainly you see it in technology plays. Just look at the Sunday ads, look at this past Sunday’s ads of whose out there selling computers but you’ve also see it into core supplies and we do anticipate that as you look later into the back to school window that that promotionability will be very, very high as I say with that slightly shorter window as kids go back to school later, parents start to think about it more seriously a little bit later than maybe they did last year.

So it will be a fight for those dollars.

Kate McShane – Citigroup

And is this more aggressive than you were anticipating or basically in line with what you’re anticipating for the season.

Steve Schmidt

Well so far we’re seeing what we expected. What’s to come, we’re prepared for an aggressive season. I don’t know exactly what our competition will do just as they don’t know what we will do. But so far we’re pleased with our strategy but we’re not really into the heart of back to school just yet. We’re just at the very beginning stage.

Kate McShane – Citigroup

And I think you mentioned during your prepared comments that at least on the retail side of the business that you were acquiring new customers what is your opinion of where you think those customers are coming from and why you’re gaining these customers now as opposed to maybe in the first quarter.

Steve Schmidt

We also gained some loyalty customers in the first quarter. We have had a greater focus on the consumable part of our business, the basic supplies, and that plays well to our loyalty customer. We’ve also tuned our marketing to be more focused on that micro business customer. I talked about the stimulus plan the, self bail out if you will, that we have in our marketing program.

We think those things are contributing through attracting more people to sign up to be a member of our loyalty program. And that’s why we’re encouraged by that. As we talked in our prepared comments they’re spending less today but when you have a large file of those customers, it allows us to better market to them on a one to one basis as we move forward, it gives us a very good asset to leverage both in BSD and retail to that smaller end business customer to help work through, to capture some additional sales.


Your final question comes from the line of Mitch Kaiser – Piper Jaffray

Mitch Kaiser – Piper Jaffray

I just want to make sure that we’re clear on this, on the SG&A the numbers that you gave up $20 to $30 million versus Q2 and Q4 being up $10 to $20 million, is that SG&A in total or is that just selling and operating or G&A, I just want to make sure that we’re clear on that.

Mike Newman

Yes, in the second quarter excluding charges we had operating expenses of about $660 million so our comment that going forward we would be $20 to $30 greater than that in Q3 and Q4 for what I called selling expenses and its relatively the same in third quarter and fourth quarter.

In G&A in the second quarter excluding charges we were about at $165-ish in G&A and we called out that we would be $20 t o $30 greater in Q3 because of one-timers and then our ERP depreciation. In Q4 we would be $10 to $20 higher than in the second quarter because of the non recurrence of these one-timers.

Mitch Kaiser – Piper Jaffray

And I know that ERP is coming on, could you give us a D&A estimate for the year on what that might shake out to be.

Mike Newman

I still think we’re looking in the $225 range, plus or minus.

Mitch Kaiser – Piper Jaffray

And then on back to school, you had talked about the aggressiveness is there anything in particular that you’re calling out or is it just kind of across the board. Is there anyone in particular that you’re really seeing being aggressive.

Steve Schmidt

As I mentioned a minute ago I think we’re early into the season. We’re seeing a variety of sellers be aggressive out there. The season really gets into the meat of it as you move into August and we’ll see what happens but as I mentioned, just pick up your Sunday paper, you see what’s happening thus far.

Steve Odland

I think you just have to look at Wal-Mart as an example of the aggressiveness out there and we’ve got to think beyond our channel. It’s the mass merchandisers, it’s the drug stores, it’s the club stores and we’re seeing aggressiveness across the board. We’re worried about the aggressiveness in computers in general which we’ve said that we’re trying to manage our margins on.

So all of that, everybody is trying to grab the basket by footballing some of these categories and that’s kind of what we’re seeing early and we also expect that the season will be a little later this year so I think that’s what we’re trying to characterize.

Mitch Kaiser – Piper Jaffray

And then have you seen the bid for contracts on the BSG side, has there been any change with your improved liquidity position.

Steve Schmidt

As we look at the process, I wouldn’t call it any specific improvement other than obviously as part of any contract bid process one of the criteria in some of the contracts is the financial stability of the organization and so obviously the refinancing would help in that type of evaluation but nothing specific that I would call out.

Steve Odland

I don’t think we saw any big sensitivity to that from a contract standpoint. The place where we were having the most discussion and who its really coming from us was with our vendors and of course that’s just really resolved itself. I think from our view with the BC Partners investment all discussions of liquidity have moved on and we’re focused on how do we possibly grow the business again, get our margins to recover and so forth.

Well thanks to everyone for joining us on the call and this will conclude our call for this morning. Thank you very much.

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