ODP Corp (ODP) 2009 Q2 法說會逐字稿

Good morning and welcome to the second quarter 2009 earnings conference call. All lines will be in a listen-only mode for today's presentation, after which instructions will be given in order to ask a question. At the request of Office Depot, today's conference is being recorded. I would like to introduce Mr. Brian Turcott, Vice President of Investor Relations, who will make a few opening comments. Mr. Turcotte, you may begin.

Thank you, Michelle. 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 Provision 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 filings with the SEC.

The press release and accompanying webcast slides for today's call are available on our website at www.officedepot.com; 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?

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 Rubin, President of North American Retail, Steve Schmidt, President of North American Business Solutions, and Charlie 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 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 include 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 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 the 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 Spider, Jamie Rubin and Justin Bateman have joined our Board. They have a very successful investment track record and consistently demonstrate a significant working with companies to implement their long-term strategic plans. Now I would like to ask Chuck Rubin to update us on the North American retail results. Chuck?

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 opened 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 opened 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 macro economic factors as consumers and the small business customers continue to rein in their spending, especially on 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 continue 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 Midwest. 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, bringing 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 $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 for leases, severance, et cetera 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 sales -- improved rates rather, 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 will 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 through 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 benefit continues to perform well with sales trends to last year and attachment rates above expectations.

Third, we launched the small business Self Bailout 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 Bailout Plan we created the Survival of the Smartest website, a new on-line 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 1100 retail store locations nationwide.

And fourth, we're making progress on our rent concessions as we work aggressively to reduce our occupancy costs. To date we have been successful in capturing dollar savings as well as landlord funded improvements 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 marking 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 will now turn over the call to Steve Schmidt to review the second quarter results and key initiatives for North American business solutions.

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 continue 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 size business customer segment, or SMB, and large national account customers continue 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 challenges facing this public and private sectors that in state, while Florida's rate is 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 increasing 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 continues to focus on executing initiatives that will position us well when the economy begins to recover. I will 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 a 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 catalogs in the second quarter to make it even more customer friendly, including improved pagination, sharper graphics and helpful benefit statements. We also optimized our catalog circulation during the quarter. In the second quarter, 82% of total BSE 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 in 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. Charlie Brown will now discuss the second quarter results and key initiatives for our international business. Charlie?

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 and 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 investment 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, increasing purchasing from sales it catalogs and greater competitiveness within the channel, and in the general decline frequency and size of transactions as customers limit their purchases to their essential needs.

Contract channel sales continue 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 third quarter lifts. 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 2009 compared to $51 million 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 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 a curtailment of a local pension plan. Increased promotional activity and product cost increases that could not be fully passed on to the customers had a negative impact of approximately $8 million. A change of foreign exchange rates driven by a stronger US dollar unfavorably impacted our brand profit by $2 million.

Although business continues to be challenging, we remain focused on improving our service model and the overall profitability of our business. I will 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 both 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 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 catalog in the second quarter. This leadership gives us a competitive advantage to win government business and other large 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 the same rate in the first half as in the first half of 2009. However, we're more optimistic about our fourth quarter performance. I will now turn it it over to Mike who will review the Company's second quarter -- results in more detail.

Thanks, Charlie. In the second quarter we continued implementing our strategic business review actions and we recognized $35 million of pretax 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 million and $115 million in additional charges as activities are completed and accounting criteria are met including $10 million 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, our cash flow before financing activities was $55 million, significantly exceeding our earlier internal estimates. This total includes $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 had a $115 million negative impact on free cash flow. We maintained our day sales outstanding in the second quarter and inventory turns improved to 6.3. Our accounts payable 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 million to $220 million range and free cash he flow is expected to be in the $30 million 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/lease back 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. The full year cash flow estimates excludes $40 million in proceeds from land sales, lease-back transactions, accounts receivable factoring that will be characterized in the financing section of our cash flow statement. 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 issues, 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 2009, mostly from reduced capital spending, benefits of our strategic business actions and factoring of European accounts receivable not current pledged under our asset based credit facility. Additionally, we've successfully completed our preferred 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 2009. We had 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 additional liquidity actions we are taking in 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 will provide some color on those line items. Our selling expenses in the third and fourth quarters of 2009 are projected to be $20 million to $30 million higher than the second quarter due to seasonally higher sales revenue.

Our third quarter G&A is forecast to be an increase of $20 million 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 accelerated vesting of certain employee stock options, and additional expenses related to changing control features in certain employment contracts. Our fourth quarter G&A is projected to be only about $10 million 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 will turn the call back over to Steve.

Thanks, Mike. In summary, although we're disappointed with the loss in the second quarter driven by the global macro economic impact on our businesses, the results were consist went 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 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 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 new platform in June as scheduled and without any disruption. This release included financial modules for AP, AR, credit and collections, cash manage, et cetera. We plan to launch additional finance and business function releases in coming months as we move forward to reaching our goals, 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, it's 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 will open up the call to questions.

Thank you very much. (Operator Instructions). Oliver Wintermantel with Morgan Stanley, your line is open.

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

Oliver, 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. I'm very pleased about that. Maybe each of the divisions could just give a little color on the SMB focus. Chuck, you want to start?

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. It's an incredibly important program. They shop more frequently, they spend more money than 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. We're pleased they've expanded, but to Steve's point, we did see them spending less than they have in the past.

Steve Schmidt?

Oliver, on the SMB side of the fence, we were pleased with the fact that during the latter half of second quarter, we started to grow our customer file. 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 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. We continue to work aggressively on acquisition of customers on a selective basis as we talked about during the call. All in all, we're seeing some competitive pricing with our large customers, but not seeing anything significantly different than we saw in the second quarter.

For the international division, again, I would echo some of the things that Steve has said in terms of SMB and the large accounts. We're seeing 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.

Okay. Thank you. (multiple speakers) That's very helpful. Could you also give us a little more detail about the trends within the quarter, April, May, June? Have you seen any pick-up in the businesses or has it stayed about the same during the whole quarter?

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

Yes, within retail, Oliver, to Steve's point, that hit us at retail for about 80 basis points. That happened in April. We saw things stabilize somewhat from there. On the consumables part of our business, it was especially stable, as the quarter unfolded.

As I 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. Consumables, we saw steady progress in things getting better on the -- minus the Easter shift. On the durables, on computers in particular, we saw that choppy a little bit more.

Chuck, you may want to mention, we've been trying to improve our profitability by cutting back on our computer promotions. You might want to mention the effect it's had on our top line. It's improved our margin significantly.

When you look at our comps, we published a minus 18. I said in my comments that the pull-back on promotions and big ticket technology was about 300 basis points. 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 to Steve's earlier point, did it help our overall mix and we think it's a healthier mix of our business as we move forward.

Thank you very much.

Our next question comes from Colin McGranahan with Bernstein.

Thank you. Good morning. First question just on the free cash flow outlook. Mike, it sounded like the entire change there from the $50 million 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. How does the sale leaseback of the facility fit into that definition?

I think the previous guidance was cash flow before financing of around $250 million. We've lowered that by about $40 million which is the sale leasebacks. The cash flow before financing, or excuse me, the free cash flow forecast is fairly consistent with what we've done previously. With that number consistent, the only change in the total cash flow before financing is driven by the fact that with the additional liquidity, we're walking away 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.

Mike, just a follow up on that. I'm looking at the first quarter conference call and it says, free cash flow -- expect free cash flow to be $50 million 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 of $30 million to $50 million. Am I correct --

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

Okay. And then secondly, just a broader question on G&A. I appreciate the guidance. That's helpful. That is a hard item for us to forecast, but I'm curious why G&A is going off 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 had sub $12 billion in total revenue, which looks like where you're heading this year, the total G&A at the corporate level was in '02, '03 at the 490 to 580 level. 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 one.

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. The first and second quarters, G&A is in the 160 range. 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 noncash. And then as we go into the fourth quarter, it's mostly about the increase I called out in my script, is mostly about simplified appreciation and some related IT costs, as were not working on the project any more and were depreciating it.

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 that we're bringing depreciation on. We just wanted to give you a little bit more color.

But on both operating expenses and G&A, we've done a hell of a job take 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 that we've done in labor and also in distribution and delivery costs internationally. We think that's a good story.

Mike, I think we also should point out that a year ago, we had some unusual favorables in UK pension pickup.

$30 million.

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. S I think comparable G&A quarter to quarter, Mike --

We're really down closer to $20 million. We've got some unusuals from last year in 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.

Okay. Thanks.

Chris Horvers with JPMorgan, your line is open for your question.

Thank you. Good morning. A couple of follow-up questions. Mike, first can you repeat what you said about store warehouse and selling expenses in the fourth quarter? Are you expecting positive earnings in the third quarter? And then finally on the sales side, can you talk about what the intra-quarter trend is -- in the BSD intra-quarter trend?

I'll get the first two and leave somebody for the last one. I will 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 million to $30 million, principally due to the higher seasonal sales level.

Okay. Then that line roughly flat third quarter and fourth quarter?

Quarter to quarter, yes, roughly flat. Probably a little higher in the third because it's a little stronger quarter.

Chris, we're talking sequentially now, not year-over-year, right?

Sequentially.

Right.

What was your second question again?

Are you expecting positive earnings in the third quarter?

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

Okay.

Chris, this is Steve Schmidt. Regarding BSD intra-quarter trends and 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. 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.

Maybe a 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 is happening right now in July and how we should think about the balance of the quarter.

Let me try to answer that in total for the whole division -- business. In the second quarter, we just told you the sales number is down $22 million in total. We're up against a minus 1 last year.

Third and fourth quarters, total business, we're up against respectively minus 7 and minus 15. It really started to step down late third quarter, then all of the fourth quarter. The other issue is that the currency impacts in the fourth quarter will start to get up against easier currency comparisons, whereas instead having the 1200 basis point impact like we did this quarter, it will almost be neutral in the fourth quarter.

Chris, the big step-down last year was really around September 15th in the Lehman bankruptcy when all the spending from our customers just dried up.

Thank you very much.

Okay.

Thank you, Chris.

Matt Fassler with Goldman Sachs, you may ask your question.

Thanks a lot. A couple 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 but I'm focused on retail in particular, the revenue declines are more or less hitting bottom and presumably as compares, will you 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 a year-on-year basis?

Matt, 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 look -- 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 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.

As sales start to stabilize, we do thinking that there's expansion in our margins, pleased with all the components underlying the margins. When you look at product margins, they continue to expand, and when you look at our expense manage. As sales stabilize, we think that we reverse our operating performance.

Matt, I'd just had add a little bit to that. This is the second quarter in a row on retail where gross margins were up year-over-year despite the deleveraging impact. I would expect that that would balance of the year to Chuck's point. Keep in mind, fourth quarter last year we were a little bit more promotional than we wanted to be so we're up against that. We will likely be out there, but not quite as promotional.

As we take a look at the long run, and I'm thinking much less about Q3, Q4, and more about when the sales levels stable year-on-year, it looks like of the four dollar numbers that that you identify that drove margins one way or another to profit in the second quarter, the one that might have some legs is the $6 million associated with retail margins. I would take it that it there's no ability to leverage your infrastructure or your fixed costs, your labor with anything other than a positive comp? Or am I missing something on the opportunity front?

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

I think, Matt, 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 attachment we want to get and so on and so forth. It gives away the 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 margins. This has been a tough balancing act here over the past few quarters.

To Steve's point, if you look at the computer market overall and there's a deflationary component that's going on in the computer business throughout most retailers where the average selling price is deflating -- forget year-over-year, deflating quarter by quarter. 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 of the computer that's going on, and the marketplace for computers has become far more competitive today than it was a year ago?

Understood. My second question is a simple one. It relates to the share count and thinking about the share count in the future and the context of BC's investment. Mike, if could you give us some guidance as to how you think that plays out and what the different scenarios are that will influence that calculation.

I don't know if this will answer your question or not, but from an EPS calculation we look at -- 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 calculations, 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 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 dilutive is the one you will see on the earnings page which happens to be the first calculation that I gave you because we're in a loss position.

Got you. As long as you're losing money on the year, I take that it will be -- or not making much money that will probably be the MO and then just test it every quarter?

Generally, yes.

Thanks so much.

Thanks, Matt.

Our next question comes from Michael Baker with Deutsche Bank. You may ask your question.

Hi, guys. Thanks. Two questions; I think both more related to the delivery business. First, you mentioned a couple times, aggressive pricing, 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?

Michael, 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.

Okay. It's really outside of the big three we're seeing the aggression?

There is some going on with the big three. I would just say it's more focused on one versus the other.

It's -- for international, we're seeing the same thing. It's not regional players. There's been a number of what I will call regional players in Europe that have actually gone out of business. It's really a fight for survival for some of these smaller players.

Understood. Thank you. Interesting. Then, Steve, again, could you just give us some color on what's going on with the government contracts? How big is that as a percent of your total delivery business? I think some large portion of that is made up through one buying consortium. How you think about that in the lack of diversity in customer base there?

Mike, we've talked in previous calls that we 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 into our profitability across the board, but we continue to cooperate with any discussions with any of the states and continue to be a part of the 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 communities relationship. That's really simply a group of thousands of customers who participate across the United States as part of that US communities relationship, and that continues to be a positive factor for us.

Steve, 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 into states, federal government, counties, military. And so I wouldn't think of it, Mike, as a monolith of a customer and even though US communities relationship is just a facilitator for thousands and thousands of other customers. I don't think of it -- we don't think of it as one concentrated customer base. It happens to be in the public sector versus in the private sector.

What I'm getting at -- the US communities is some large percentage, I think, of your BSE business, maybe 10% or 15%. Is there a concern that if there's 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 of it?

The way I would think about it is simply that it's simply a facilitation and that each of the agencies that participate as part of that contract make an independent decision. 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. 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.

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

I understand. Thank you.

Our next question comes from Kate McShane with Citigroup. Your line is open.

Good morning.

Hi, Kate.

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 about what you've seen so far this season that maybe differs from what you saw last year. Are there certain categories where people are being more aggressive than other categories?

Good morning, Kate. I think what we're seeing is what you're seeing as a customer. The range of players continues to be large, from drugstore 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 children, 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.

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 at who is out there selling computers. But you've also seen it into core supplies. 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 a little more seriously a little bit later than maybe they did last year. It will be a fight for those dollars.

Is this more aggressive than you were anticipating or basically in line with what you're anticipating for the season?

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 at the very beginning stage.

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?

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 bailout if will you that we have in our marketing program.

We think those things are contributing to 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 larger 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 for that smaller end business customer, to help work through -- to capture some additional sales.

Okay. Thanks very much.

I think we have time for one more question.

Thank you. Our final question comes from Mitch Kaiser with Piper Jaffray.

Thanks, guys. Good morning. Mike, I just want to make sure that we're clear on this. On the SG&A, the numbers that you gave, up $20 million to $30 million versus Q2 and Q4 being up $10 million 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.

Okay. In the second quarter, excluding charges, we had operating expenses of about $660 million. Our comment that going forward we would be $20 million to $30 million greater than in that Q3 and Q4, for what I called selling expenses, it's relatively the same in third and fourth. In G&A in the second quarter, excluding charges, we're at about 165-ish in G&A. And we called out that we would be $20 million to $30 million greater in Q3 because of one-timers and then our ERP depreciation. In Q4, we would be $10 million to $20 million in the second quarter because of the nonrecurrence of these one-timers.

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?

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

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

As I mentioned a minute ago, a 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.

Okay.

I think you just to have look at Wal-Mart, Mitch, as an example of the aggressiveness out there. 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. All of that, everybody is trying to grab the basket by footballing some of these categories. That's what we're seeing early and we also expect that the season will be a little later this year. I think that's what we're trying to characterize.

Then just my final question, have you seen the bid for contracts on the BSG side? Has there been any change with your improved liquidity position?

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. Obviously, the refinancing would help in that type of evaluation, but nothing specific that I would call out.

I don't think we saw in -- a big sensitivity to that from a contract standpoint. The cycle where we were having the most discussion is really coming from us 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. We're focused on how do we profitably build the business again, get our margins to recover and so forth.

Very good. Thanks, guys. Good luck.

Okay, Mitch. Thanks to everyone for joining us on the call, and this will conclude our call for this morning. Thank you very much.

Thank you all for joining. You may disconnect your lines at this time.