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OfficeMax, Inc. (NYSE:OMX)

Q2 2008 Earnings Call

July 30, 2008 11:00 am ET

Executives

Sam K. Duncan - Chairman of the Board, President, Chief Executive Officer

Don Civgin - Chief Financial Officer, Executive Vice President - Finance

Samuel M. Martin - Chief Operating Officer, Executive Vice President

John Jennings - Senior Vice President, Treasurer, Investor Relations

Analysts

Matthew Fassler - Goldman Sachs

Christopher Horvers - J.P. Morgan

Gary Balter - Credit Suisse

Mitchell Kaiser - Piper Jaffray

Michael Baker - Deutsche Bank Securities

Operator

Welcome to the OfficeMax second quarter 2008 earnings conference call. (Operator Instructions) It is now my pleasure to introduce you to John Jennings, Senior Vice President, Treasurer and Investor Relations of OfficeMax, Inc.

John Jennings

I’m here with Sam Duncan, our chairman and CEO, Sam Martin, our Chief Operating Officer, and Don Civgin, our Chief Financial Officer.

Before I turn the call over to Sam Duncan, I have a few administrative items. Today’s conference call will be archived on our website for one year following the call. Note that this call may not be rebroadcast without prior written consent from OfficeMax. Certain statements made on this call and other written or oral statements made by or on behalf of the company constitute forward-looking statements within the meaning of the Federal Securities laws including statements regarding the company’s future performance as well as management’s expectations, beliefs, intentions, plans, estimates or projections relating to the future. Management believes that these forward-looking statements are reasonable. However, the company cannot guarantee that it will successfully execute its turnaround plans or that its actual results will be consistent with the forward-looking statements and you should not place undue reliance on them. These statements are based on current expectations and speak only as of the date they are made. The company undertakes no obligation to publicly update or revise any forward-looking statements whether as a result of future events, new information or otherwise. Important factors regarding the company which may cause results to differ from expectations are included in the company’s annual report on Form 10K for the year ended December 29, 2007 under Item 1A “Risk Factors” and in the company’s other filings with the SEC.

As always, after the call today please feel free to give me a call with any follow-up question. It’s now my pleasure to turn the call over to Sam Duncan, Chairman and CEO of OfficeMax.

Sam K. Duncan

On today’s call I’ll review our second quarter 2008 performance; Sam Martin, our Chief Operating Officer, will detail our operating segment performance; and Don Civgin, our Chief Financial Officer, will review the financial details. Then we’ll open up the call for questions.

From a top line perspective in the second quarter we continued to experience declining sales trends reflecting the weaker US economy along with our own deliberate focus on profitable sales. During Q2 we continued to concentrate efforts on our turnaround plan initiatives which we believe will more strongly position OfficeMax for long-term improvement. For the second quarter of 2008 total sales declined 6.9%. We recorded an operating loss of $902.6 million and a net loss of $894.2 million or $11.79 per diluted share including three unusual items we disclosed in our press release. These unusual items negatively impacted operating income by $942.4 million and net income by $913.6 million or $12.03 per diluted share. Sam and Don will cover the details of these unusual items.

We’re continuing to pursue initiatives in the near term to help manage the impact of the weaker macroeconomic trends which we expect will continue into 2009 while also focusing on strategies for the long term. One ongoing initiative in the US contracts since mid-2007 has been to aggressively manage account acquisition and retention. Our objective is to create win-win solutions that allow us to provide better service and lower costs for our customers while at the same time achieving appropriate profitability for OfficeMax. With our improved account sales and account evaluation processes, we have also enabled a more flexible US contract delivery model. This model is intended to adjust to customer delivery needs while targeting a more efficient cost of delivery to OfficeMax. Our contract initiatives produced results in the second quarter of 2008. While the asset impairment charge reduced contract operating income margin by 41.7 percentage points, we made solid improvement in gross margin rates and controlling certain operating expenses reflecting our improved selling culture, account evaluation process, delivery platform along with the benefit of lower incentive compensation expense.

In retail our results have been impacted most significantly by the weaker US economic trends since the second half of 2007. A recent University of Michigan and Reuter’s report indicated consumer sentiment for June was at its lowest level in 28 years and OfficeMax is feeling the weaker consumer and small business spending. But we are proactively seeking solutions to manage near-term trends and position our retail business for long-term improvement. For example, we implemented a reorganization of our retail store management during the second quarter of 2008. The essence of this reorganization was to better align our store management positions with individual store sales volume while putting more associates on the floor in customer service and selling roles. We expect the payback on the second quarter $10.2 million expense associated with this reorganization to be less than one year.

Our real estate strategy is another way that we are working to position our retail business for better near- and long-term improvement. We continue to believe it is important to balance new store openings along with existing store remodels. Our new stores or remodels in 2008 and beyond are targeted in top priority markets where we have existing stores and mostly where we already have a contract delivery presence to maximize our returns. In the second quarter of 2008 we opened 12 new domestic stores and five new stores in Mexico to end the quarter at 999 total stores. In 2008 we have completed 16 store remodels through Q2 using the elements of our Advantage prototype in the Denver, Phoenix and Tucson markets.

Looking forward we continue to expect to open a total of up to 40 new domestic stores in 2008. But in the second half we are limiting our store remodels to just 15 additional stores which were completed in July. These remodels combined with the 16 completed to date in 2008 bring us to a total of 31 remodels for the full year. We made the decision to reduce our 2008 remodels from up to 60 to 31 to maintain prudent capital investment given the weaker economic climate. While we reduced our remodel plans for 2008, we believe remodels and new stores will continue to be completed over the long term.

Overall we have maintained our focus on addressing the aspects of our operations that are manageable in a more challenging economy. We will continue to implement specific initiatives to address the weaker sales trends while also remaining focused on our long-term turnaround initiatives that are designed to position OfficeMax for improvement. We are making progress with many of these initiatives including leveraging the complementary aspect of our contract and retail businesses, driving differentiation in our product and service offerings, better service for our customers, and creating cost efficiencies across our business.

Now I’ll turn it over to Sam Martin to review the details of our contract and retail operating segment performance for the quarter.

Samuel M. Martin

For the second quarter of 2008 our contract segment reported an operating loss of $416.8 million including $464 million due to the unusual item for asset impairment. In Q2 contract experienced lower sales but we were pleased with higher gross margin rates and our ability to reduce core operating expenses.

Specifically for US contracts which represented about 70% of total contract sales, second quarter sales declined 12.9% from the same period last year with about half of this decline due to the weaker economy. The sales decline for US contracts primarily reflects three factors.

First, lower sales from our existing customers. Sales from accounts in place in the year ago period decreased by approximately 6% versus the second quarter last year reflecting weaker business spending in the US. Economic indicators that correlate to our performance including employment, industrial production, and GDP have all shown weakness since last year and our second quarter results reflect this weakness.

Second, since mid-2007 we have aggressively managed the way we’ve added and retained certain large corporate accounts. And as we have been for the past three quarters, we were impacted in the second quarter of 2008 by our decision not to retain one specific unprofitable large account which we terminated in July 2007.

And third, our second quarter US contract sales were impacted by lower small market customer sales which include sales from our public website and catalog business. This reflects the weaker US economy and our deliberate reduction in marketing investment. During the second quarter of 2008 we continued pursuing a key sales priority of targeting sales from higher margin little market customers. We are also pursuing impress print and document services within our US contract account base. The realignment of impress field sales teams within our US contract field sales organization completed in the first quarter is showing promise.

Contract gross margin increased to 21.7% in the second quarter of 2008 from 21.4% last year. The improvement reflects better account management for existing and new customers partly offset by deleveraging fixed delivery and occupancy costs. Delivery costs in the second quarter increased as a percent of sales due to significantly higher fuel rates with the cost of diesel up about 56% per gallon versus last year. We were able to partly offset these increased fuel costs with efficiencies created through our more flexible delivery model which targets cost of service improvements. These cost efficiencies include optimizing delivery routes which allow us to continue to reduce our private fleet vehicle count. We’re also pursuing fixed cost reductions including the consolidation of customer fulfillment centers which have been reduced by three in 2008 to a total of 27 CFCs in the US as of the end of Q2.

Contract operating expense as a percent of sales in the second quarter of 2008 was 59.2% including the 41.7% for the unusual item related to asset impairment. Non-impairment related contract operating expense as a percent of sales improved compared to last year due to targeted cost savings along with lower incentive compensation costs partially offset by deleveraging of fixed expenses from lower sales. Our contract segment has benefitted from lower operating expenses that we began generating in the third quarter of 2007. Overall we are pleased with the second quarter operating performance in our contract segment given the lower sales.

Turning to our retail segment, in the second quarter of 2008 we reported an operating loss of $480.7 million including $481.5 million due to the two unusual items. Retail results in Q2 were impacted by deleveraged fixed costs of sales and operating expenses as a result of the weaker US economy. Our same-store sales decreased 10% in the second quarter and we experienced lower store traffic than a year ago. As with our direct and broader retail peers OfficeMax continues to be impacted by weaker consumer and small business spending. We’re operating in an environment with higher prices for fuel, food and other products along with declining home values and a choppy job market which are all negatively impacting consumers’ purchase decisions. Our same-store sales declined in Q2 across all three major product categories, technology, supplies which includes impress sales, and furniture. We experienced the weakest comps for more discretionary items such as furniture and high-tech merchandise which are also higher transaction items, so our average ticket decreased in Q2 from last year.

For the 2008 back-to-school season which is always an aggressive pricing environment we’re continuing to adjust our advertising strategies to help drive more traffic in the stores without sacrificing overall margin levels. And we continue to rationalize and refine our marketing mix through various channels, not just circular advertising.

Retail segment gross margin in the second quarter of 2008 decreased to 27.7% from 29.9% last year. While we improved point of sale margins and had a mix shift toward higher margin products, this was more than offset by deleveraging of fixed occupancy related costs and increased inventory shrinkage. The higher inventory shrink accounted for about half of the retail gross margin decline due to results of our physical inventory true-ups. Higher costs in the gross margin also included deleveraging fixed occupancy related costs for new and existing stores along with our same-store sales decline. The mix shift benefitted us in the second quarter of 2008 as we had a higher percentage of supplies category sales at typically higher gross margin rates and a lower percentage of technology category sales which typically carry lower gross margins.

Retail operating expense as a percent of sales in the second quarter of 2008 was 82.8% including 54% due to the unusual item related to asset impairment and 1.2% due to the unusual item related to employee severance from the reorganization of retail store management. The remainder of the increase was due mostly to deleveraging of fixed operating costs partially offset by reduced incentive compensation expense.

Regarding the reorganization of retail store management, we expect to benefit near term with a payback of less than one year. The focus of this initiative was to eliminate overlapping assistant manager and supervisory positions at the store level and better align management positions based on store sales volume. By putting more associates in sales positions on the floor we expect to increase customer interaction in service intense categories including technology and furniture. In addition to this reorganization we continue to pursue other programs and tools for managing retail operating expenses.

As we move forward in the second half of 2008 for retail, we expect to continue being impacted by the weaker economy while we pursue near-term and long-term turnaround initiatives. This includes merchandising strategies utilizing our target customer research to enhance our product offerings. Some new private brand products are already available in our stores for this back-to-school season. Private label sales in the second quarter of 2008 increased 200 basis points to 23% of total sales excluding impress. We believe there are further opportunities to increase our private label percent of total sales in many key private label categories through unique category management and increased foreign direct sourcing and importing. So while we expect retail sales to continue to be impacted by the weaker economy, our merchandising initiatives, expense management and other initiatives are all aimed at enabling long-term improvement.

At this point I’d like to turn the call over to Don Civgin so he can review financial details for the quarter.

Don Civgin

I will start with the review of the P&L. For the second quarter of 2008 OfficeMax reported a net loss of $894.2 million or $11.79 per diluted share compared with net income of $27.4 million or $0.35 per diluted share for the same period last year. Results for the second quarter of 2008 include three unusual items not related to our core operating activities. These unusual items reduced income before taxes by $942.4 million and $913.6 million after taxes or $12.03 per diluted share. I’ll provide some more specific details of these unusual items as we go through the P&L.

Consolidated net sales for the quarter decreased by 6.9% to $1.98 billion from $2.13 billion in the second quarter of 2007. Contract segment sales decreased by 7.1% to $1.11 billion compared to the second quarter last year reflecting a 12.9% sales decline in US contracts and a 9.4% sales increase from international contract operations. In local currencies international contract sales decreased by 0.1%. Retail segment sales decreased by 6.7% to $872.7 million compared to the second quarter of 2007. Gross margin in the second quarter was 24.4% down from 25.1% in the second quarter last year reflecting higher contract segment gross margin offset by lower retail segment gross margin.

Operating expense for the second quarter increased to 69.8% of sales including 47.5% relating to the cumulative effect of the three unusual items from operating expense of 22.5% of sales in the second quarter last year. The first unusual item was an expense associated with a non-cash charge for asset impairment totaling $935.3 million or 47.1% of total sales. This non-cash charge breaks down into contract segment expense of $464.0 million or 41.7% of contract sales and retail segment expense of $471.3 million or 54% of retail sales.

OfficeMax is required for accounting purposes to assess the carrying value of goodwill and other intangible assets annually or whenever circumstances indicate the decline in value may have occurred. Based on the company’s sustained low stock price and reduced market capitalization, macroeconomic factors impacting industry business conditions, recent and forecasted segment operating performance, the competitive environment, along with other factors, we determined that indicators of potential impairment were present during the second quarter of 2008. As a result we assess the carrying value of acquired goodwill and intangible assets with indefinite life for impairment.

The measurement of impairment of goodwill and indefinite life intangibles consists of two steps which require us to determine the fair value of our reporting unit and to allocate reporting unit fair value to the individual assets and liabilities similar to a purchase price allocation. We have not yet completed the fair value allocation process necessary to determine the final impairment of goodwill and other intangible assets. Accordingly, in the second quarter of 2008 we reported an estimate of a non-cash impairment charge associated with goodwill and other assets that reduced income before taxes by $935.3 million at net income by $909.3 million or $11.98 per diluted share. The components of the $935.3 million estimated non-cash impairment charge consist of $850 million for goodwill, $80 million for trade name, and $5.3 million for fixed assets and is reported in both our contract and retail operating segments.

The estimates and assumptions made in the preliminary valuation and assessment for this charge are inherently subject to significant uncertainties. Accordingly, an adjustment to the fair value will be required and could be material but will be a non-cash adjustment. It is expected to be completed by the end of 2008 when we will finalize testing.

The second unusual item was expense reported in our retail segment totaling $10.2 million or 0.5% of total sales that is related to employee severance from the reorganization of our retail store management.

The third unusual item was a gain reported in corporate and other segments totaling $3.1 million or 0.2% of total sales related to the legacy Voyager Panel business. Voyager Panel was a legacy manufacturing business based in Canada and we sold our 47% interest in 2004. The gain in the second quarter of 08 was related to a release of warranty escrow.

Operating expense as a percentage of sales in the second quarter of 2008 was most significantly impacted by the cumulative effect of the three unusual items. The remainder was mostly due to deleveraging of fixed expenses from lower sales partially offset by a benefit from lower incentive compensation expense of approximately $18 million. The lower incentive compensation expense was across contract, retail and corporate and other segments and reflects a reversal of accrued incentives and a lower expense run rate than accrued for in quarter two of last year based on our current forecast. Our corporate and other segment expense for the second quarter of 2008 decreased by $4.7 million to $5.1 million compared to the second quarter of 2007 mostly from the $3.1 million unusual item along with lower incentive compensation costs.

Moving to the balance sheet, we ended the second quarter of 2008 with inventory $41.2 million lower than at the end of the second quarter 2007. The decrease is primarily related to lower inventory per location in both retail and US contract partially offset by store growth and an increase in international contract inventory mostly due to foreign currency exchange rates. We’re really pleased with our inventory management in the second quarter with the 12% decrease in inventory per store compared to the same period last year and while doing that maintaining high in-stock metrics that we benefitted from the supply chain and inventory management initiative. At the end of the second quarter our discontinued inventory remained low and through the first half remained at the lowest levels in the past three years.

Accounts payable at the end of the second quarter of 2008 were $43.3 million lower than the same period last year primarily reflecting the timing of vendor payments and lower inventory levels. Accounts receivable at the end of the quarter were $135.7 million higher than the same period last year primarily as a result of terminating our accounts receivable securitization program on July 12, 2007 with the simultaneous restructuring and improvement in our revolving credit facility. At the end of the second quarter of 2008 under our $700 million revolver, we had $614.5 million available reflecting our available borrowing base of $684.3 million, no borrowings, and $69.8 million of letters of credit issued under the revolver.

At the end of the second quarter of 2008 we had total debt excluding the timber securitization note of $383.8 million and cash and cash equivalents of $155.9 million. As we have discussed with you previously it’s important to note that we calculate total debt excluding the $1.47 billion of timber securitization notes since recourse on those notes are limited to the $1.635 billion of timber installment notes receivable.

Turning to cash flow, during the second quarter of 2008 we used $7.8 million of cash from operations a decrease of $130.9 million from the second quarter of 2007 primarily due to an $82 million benefit in the second quarter of last year for monetizing certain company-owned life insurance assets and changes in working capital. Capital expenditures totaled $42.7 million for the second quarter. Based on our review of capital projects and our lower store remodel plans for this year we now expect our capital expenditures for full year 2008 to total between $160 million and $180 million.

I’ll now turn the call back to Sam Duncan.

Sam K. Duncan

As we continue to execute our turnaround plan, we remain focused on improving our infrastructure, driving enhanced operating performance, and delivering solid financial results. Looking at the second half of the year we expect that we will continue to operate in a challenging consumer and business spending environment, but we look forward to the back-to-school season and operating initiatives designed to help us navigate the current trends. Overall we continue to position OfficeMax to navigate near-term challenges from the weaker US economy while pursuing improvement initiatives for long-term shareholder value generation.

This concludes our prepared remarks and now we’ll open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Matthew Fassler - Goldman Sachs.

Matthew Fassler - Goldman Sachs

The first question I’d like to ask I guess goes to Don and it relates to incentive comp. You spoke about an $18 million benefit. I guess I’d love to get a sense as to how much of that was reversal and how much of that was simply lower cost year-to-year? And then what do the incentive comp compares look like in the second half of 07 versus the first half of 07?

Don Civgin

Matt, the $18 million number for year-over-year comparison was comprised of about $8 million which was reversal and about $10 million which was simply a lower run rate this year compared to last.

Samuel M. Martin

And that is all above the corporate G&A line. That’s kind of in the operating divisions.

Don Civgin

It is all in, a little bit of it is in corporate and other about $1.5 million. The rest of it is in contract and retail.

Matthew Fassler - Goldman Sachs

And if you think about the incentive comps that you generated in the second half of last year versus the first half of last year, I would presume it was lower dollars?

Don Civgin

What we did last year is obviously our obligation is to look at it every quarter based on current performance and forecasts and make a determination as to how much we should accrue towards the back half of last year since we did not accrue full amount. We did reduce the accrual in the back half of last year.

Matthew Fassler - Goldman Sachs

So in other words, this probably will help you less over the rest of the year perhaps than it did in Q2?

Don Civgin

We would like for it to not help us at all, quite frankly.

Matthew Fassler - Goldman Sachs

As I think about contract and the domestic hits, I think you tried to segment this to some degree, but how much of the sales hit would represent your walking away from business? I know you have that one account and you cycled that one account I guess this month, but are there other accounts or groups of accounts that you walked away from or is it really just that one lumpy piece that is responsible for some of the decline?

Don Civgin

There were other ones but nothing to the magnitude of the one big one that we exited last year and we have not disclosed those in the past and will not in the future.

Matthew Fassler - Goldman Sachs

As we look at the expense line, at first blush the expense decline was pretty substantial $35 million year-on-year above the corporate line. I guess it sounds like about half of that probably will be tough to retain assuming that you continue to have a challenging sales environment. Beyond that though it still seems like in retail for example your SG&A dollars were down despite an increase in stores and contract tickets were down substantially. Do you feel like the expense cuts that you generated here are somewhat sustainable?

Don Civgin

The second half of the year we’re cycling the contract reductions we started the second half of last year and of course we’ll continue to try to look for improvements. And on the retail side, it’s all dependent on the economy which we don’t see getting any better and we can only reduce expenses so much in the stores. We feel really good about our reorganization where we get more sales people on the floor, but really it’s just all dependent on the economy which we don’t see any pot at the end of the rainbow in the near future or the long-term future.

Matthew Fassler - Goldman Sachs

Did the cycling that that one big account perhaps give you some relief from contract?

Don Civgin

Yes, I believe we cycled that here I think in the third quarter and we’ll have to verify that but I think it was the third quarter of last year, Matthew.

Operator

Our next question comes from Christopher Horvers - J.P. Morgan.

Christopher Horvers - J.P. Morgan

First a follow-up question on Matt’s question. At the store level are you hitting minimum staffing levels in the large portion of your stores?

Samuel M. Martin

There are certain stores that we hit minimum staff but it really goes across the board with opportunities to look at how we manage the stores and how we control costs again relative to the sales that go through the store. So it’s an ever-changing environment.

Sam K. Duncan

And I might say that store minimums are not something new. It’s something that we have done and looked at for a long time as does every retailer. So this is not something new.

Christopher Horvers - J.P. Morgan

A follow-up question on the stores. When do you look at potential store closures throughout your yearly process and is it something now where you say “Well, I’ve got this lease and there’s not that many years left and maybe given where productivity levels are trending, maybe I should get out of some of those stores”?

Sam K. Duncan

We look at that constantly. As you know Chris, when I first came to the company we closed a large number, 110, actually 109, we let one lease run out, and then it’s an ongoing process after that where you analyze your leases on an annualized basis. And we do that through our real estate meetings and we’ve closed some in the past couple of years and it’s all dependent on if we feel that the store can be profitable or not. But that’s something that we continue to look at on an annual basis.

Christopher Horvers - J.P. Morgan

Do you see the opportunity to close any stores in next year?

Sam K. Duncan

Not in mass numbers. It’s just strictly those with leases that are coming to an end, we’ll analyze them at that time.

Operator

Our next question comes from Gary Balter - Credit Suisse.

Gary Balter - Credit Suisse

First question on shrink. You called that out as about half of the gross margin decline in retail, about $9 million. Can you tell us what the components of that were and how we should think about shrink going forward? In other words, was it more one-time in nature?

Don Civgin

Yes. We’ve had a really successful several years on shrink management and that rate has come down kind of year-over-year. We’ve done a really nice job. Last year was flat but it was awfully low and this year we had a jump up. As you know we do our physicals and book it mostly in the second quarter so the number tends to get magnified in the second quarter. So I think the answer to the question is that it went up more than we would like. Some of it is the economy and math and lower sales and so forth, but it also gives us an additional opportunity to execute better, to look at the core causes of it, and make sure we’re on them. My confidence level is pretty high that the company knows how to do that because we’ve proven it in the past. We just have to get on it and take care of that and I think we will. And as it relates to the second half of the year, because we won’t have the physicals that we did in the second quarter I would anticipate that we’re accruing it at roughly an appropriate rate right now.

Gary Balter - Credit Suisse

So it seems like the shrink hit this quarter more than offset the incentive comp reversal. Is that the way we should think about it in terms of some of these one-time moving items?

Don Civgin

The numbers are pretty close to each other.

Gary Balter - Credit Suisse

My second question is just related to vendor incentives and whether you expect to continue to hit more volume tiers and see much weaker rebates going forward?

Sam K. Duncan

That’s all just dependent on the volume. Our vendor funding was relatively flat versus a year ago. It’s only off 10 basis points. So it all depends on how the volume continues to run in the economy and hopefully it will remain the same but that’s yet to be seen depending on how good or how bad the economy continues to run.

Gary Balter - Credit Suisse

Have you restructured any of your contracts with vendors to move away from tiered rebate volumes and more to just straight dollar rebates for promotions?

Sam K. Duncan

Not that I’m aware of.

Gary Balter - Credit Suisse

My last question is on the retail side and thinking about Staples continuing to move into new markets with Houston being their most recent entry. How are you positioning yourselves to play defense as they encroach in new markets?

Sam K. Duncan

Well we have a competitive intrusion plan that we put into place that we developed in the last couple of years and we’ve gone into some of these markets with remodel plans that we’ve already done and we try to make sure that our conditions in the store are where they should be, our customer service and those type of things, whenever a competitor comes in whether it be Staples or Office Depot.

Operator

Our next question comes from Mitchell Kaiser - Piper Jaffray.

Mitchell Kaiser - Piper Jaffray

I just wondered if you would talk a little bit about the new store pipeline for 2009 and then maybe any ability to potentially get out of some of those leases if you deem that to be appropriate.

Sam K. Duncan

We’re not opening up that many new stores. I think it’s 20 that we’re opening up this year.

Mitchell Kaiser - Piper Jaffray

I’m sorry. 2009. Next year.

Sam K. Duncan

You’re not going to see any big increases in the future. It’s still probably going to be relatively a reasonable number because our focus has been on the remodels. As far as the ones that we’ve already got signed up for next year, we have no intention to get out of a lease unless there’s something like a major tenant that is walking away or something like that. It’s all dependent on the contract and it’s something that our legal department would have to work with. But at this time we’re not looking to get out of any leases for next year.

Mitchell Kaiser - Piper Jaffray

This morning Office Depot talked about sales trends getting a little bit worse in the second quarter and picking up modestly in July. Do you care to comment on kind of how things progressed in the second quarter?

Sam K. Duncan

I’ll comment on the economy in general. There’s no sign that trends are going to get better. It’s quite obvious everybody sees the same stuff that we see as far as the housing and food prices and gas prices. There’s nothing that we see that gives any indication that it’s going to get any better in the near future. In fact, I’m concerned just about when are we going to hit bottom. There’s no indication that we see or I see that the bottom is near, so it’s very concerning but hopefully we’ll see an improvement soon.

Operator

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

Michael Baker - Deutsche Bank Securities

I just wanted to ask a question on the charge if I could. Just the thought process behind that and I guess really what is it telling us that you guys are thinking about the present value of the future cash flow of your business. How much more negative has that gotten since you last did your impairment test probably at some point in 2007?

Don Civgin

Let me see if I can add some color around the issue. It is first of all an accounting procedure that has to be done so I’ll go through it in a little bit more detail but you have to understand that it’s not something we sit around the room and say “Do we believe in the future of the company? Do we believe we’re doing the right things? Do we believe in the business model?” It’s really a pretty prescriptive set of accounting procedures that have to be followed and as we went through the tests to see whether there was impairment triggers or not in the second quarter, we concluded that there were sufficient things that had happened in the second quarter that this was an appropriate quarter to retest impairment. And when you test for the impairment issue, you’re really forced to take a market perspective which means one of the very relative data points you have to use is the market price, the market capitalization. And we’re not happy with where the stock price is but it is kind of what it is. So as we follow the procedures and we follow the steps we need to, we’re forced for accounting reasons to take that charge. And listen we take our responsibility to the shareholders and to the SEC very seriously, so we want to do everything the right way. So I wouldn’t read anything into it that we’re worried about the value of the company or that we’re worried about where we’re headed or whether we’re doing the right things or not. I wouldn’t ask you to ignore it because it’s an awfully big number, but to be perfectly honest it is an accounting process that we have to follow as opposed to any sort of larger feelings about our business or our industry.

Michael Baker - Deutsche Bank Securities

And I appreciate that. Just to follow up though, does it reflect a reduced estimate of your future cash flows?

Don Civgin

It reflects a series of complicated transactions that have to be done from a market participant perspective which forces us to look at it very much from the perspective of what the stock price is. So yes we have to use kind of cash flows as part of the analysis but it has to be done under the premise that if the stock is trading at $13.00 a share, that’s what all of us market participants are viewing it as. So that’s the perspective we have to use.

Operator

At this time there are no further questions.

Sam K. Duncan

Thank you very much for joining us today. Have a great week.

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Source: OfficeMax, Incorporated Q2 2008 Earnings Call Transcript
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