ODP Corp (ODP) 2011 Q2 法說會逐字稿

(Audio starts in progress) 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 are contained in the Company's filings with the SEC.

In addition, during the conference call we refer to certain non-GAAP or adjusted financial measures. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP financial measures as well as our press release and a Company webcast [live] for today's call are available on our website at www.OfficeDepot.com. Click on Investor Relations under Company Information.

Neil Austrian will now make a few opening comments and then summarize Office Depot's second quarter 2011 earnings. Neil?

Thanks Brian and good morning. Before I review our second quarter 2011 results, I would like to comment on the Board's decision to name me Chairman and CEO of Office Depot on May 23. And I will also comment on our recent organizational announcement.

In regard to the CEO search, the search committee met with many qualified candidates who were excited about the opportunity. But near the end of the process, the Board recognized that I had made measurable progress during my seven months as interim CEO and began to rethink the decision to introduce a new leader at this time. As a result, the Board decided that I was the best person to lead Office Depot's return to profitable growth and to attract talent and build bench strength for the future.

I am both flattered and humbled by the strong confidence expressed in me by the Board. And I have committed to all of our 40,000 associates that we'll work together to return this Company to the performance levels previously achieved.

Concerning the announcement made on July 13, we made organizational changes to drive profitable sales in all of our channels to better leverage our infrastructure and assets, and build our brand. These changes included the appointment of Kevin Peters as President, North America, a new position combining the Company's previous North American retail and North American Business Solutions division.

In his new role, Kevin will be responsible for all customer-facing sales channels including retail contract, direct and e-commerce, and the [PEL -- P&L] in North America. For the first time we are consolidating all of our North American operations under one leader, allowing us to break down silos, increase our productivity and improve the execution of our key initiatives. We are confident that this approach will help us to better serve our business customers and consumers.

In addition, we announced several other changes including Steve Schmidt being named the Executive Vice President of Corporate Strategy and New Business Development. Bob Moore was named Executive Vice President and Chief Marketing Officer, Farla Efros named interim Head of Merchandising and Michael Allison promoted to Executive Vice President, Human Resources.

I believe we now have the right priorities, the right people and the right structure in place to successfully execute our plans, accelerate our growth and make Office Depot a stronger competitor in the marketplace. We thank Daisy Vanderlinde, our previous head of human resources, and Monica Luechtefeld, our previous head of e-commerce and direct marketing for their many contributions to Office Depot and wish them well as they retire from the Company after many years of valuable service.

We also would like to thank Dave Fuente, who resigned as a member of the Board last week to pursue other professional interests. Dave has been a valuable member of our Board since 1987 and we wish him well.

Turning to Office Depot's second quarter 2011 results, sales totaled $2.7 billion -- essentially flat compared to our second quarter results in 2010. On a constant currency basis and excluding sales related to asset dispositions and de-consolidation in the fourth quarter 2010, then an acquisition in the first quarter of 2011, total Company sales in the second quarter of 2011 decreased about 2% versus prior year.

The Company reported a net loss after preferred stock dividends of $29 million or $0.11 a share in the second quarter of 2011, versus a net loss of $25 million or $0.09 in the same period a year ago. Second quarter 2011 results included charges primarily related to restructuring activities and actions to improve future operating performance. Excluding these charges, which totaled $20 million before tax, the net loss after preferred dividends was $17 million or $0.06 per share.

Total Company gross profit margin increased about 90 basis points in the second quarter of 2011 compared to the prior year. This was driven primarily by gross margin improvements in North America retail and BSD. Second quarter gross margin was relatively flat versus the prior year in the international division.

Total Company operating expenses adjusted for charges were down $4 million compared to the second quarter of 2010. EBIT adjusted for charges was $11 million in the second quarter of 2011, compared to an EBIT loss of $23 million in the prior period. The significant year-over-year improvement was primarily due to better results in North American retail and a strong quarter from the Business Solutions Division.

Mike will further review the second quarter financial details later in the call. I will now ask Kevin to review North American retail's second quarter 2011 performance.

Thanks Neil and good morning. In the North America retail division second quarter 2011 sales were $1.1 billion, down 2% versus one year ago. And same-store sales were down 1%.

You may recall that we previously reported that April same-store sales were positive, and anticipated that the second quarter would be slightly positive as well. However, May same-store sales were down 2%. And June, the highest sales volume month of the quarter, was down 3%.

The reversal in same-store sales trends during period were mainly driven by an expected significant decline in computer sales in the back half of the second quarter. Excluding sales of computers and related items, same-store sales in June would've been relatively flat.

It is interesting to note that although our overall notebook computer sales dollar volumes declined year-over-year in the second quarter, the NPD Group retail tracking service indicates that we gained dollar share in notebook computers within the office superstore channel.

As we look at average order value and customer transaction counts, AOV rose 1% during the second quarter versus the prior year while customer transaction counts declined about 2%.

Turning to our product categories, furniture comp sales were positive again in the second quarter as seating remained strong. Other key product groups showing year-over-year improvement in the second quarter included storage items, printers, writing instruments and cleaning and breakroom supplies.

Total peripheral sales count negatively again in the second quarter, which drove the overall division sales comp decline. The good news is that the peripheral sales decline improved sequentially and we continue to take actions to drive sales within that product group going forward.

Growing sales of our high-margin service offerings continued to be a great opportunity for our retail business. In the second quarter, Tech Depot services again reported double-digit sales gains versus the prior year. And Copy & Print Depot comped positively for the sixth consecutive quarter. We are encouraged that these value-added services are gaining awareness with our customers and we will continue to allocate resources to drive their growth.

Our goal to increase direct import of products continues to go well. Penetration in North America Retail was at a double-digit level in the second quarter and increased 300 basis points versus the same period last year. If we look at our second-quarter same-store sales on a regional basis, four regions showed flat to improving trends versus the prior year.

Unfortunately, California reversed the positive trend from earlier in the year and declined for the quarter. We believe this decline was due to state budget cuts and a relatively high unemployment rate, resulting in continued low consumer and small business confidence.

Our North American store count at the end of the second quarter was 1131 stores. During the quarter we opened 4 new stores and closed 14 stores. We closed our remaining 10 stores in Canada in the second quarter 2011, but we will continue to serve our Canadian customers through our BSD division.

We remodeled 5 stores and relocated 4 during the second quarter, successfully reducing the square footage in those nine locations by about 30% on average. North American Retail reported operating profit excluding the $12 million in charges for the Canadian store closures of $15 million in the second quarter of 2011 compared to $9 million in the same period of 2010. The charges primarily related to accrued lease costs as well as severance and other closures. The increase in operating profit reflects 80 basis points of gross margin improvement, including lower property costs.

Additionally, reduced advertising expenses and the division's portion of benefits that should not recur, including removing recourse provisions from Office Depot's private label credit card program, drove some of the improvement in operating profit. These benefits were partially offset by the negative flow-through effect of lower sales and investments in our key growth initiatives.

Earlier this year I outlined four initiatives for North American Retail to drive sales and reduce costs. I will now update you on the progress of those key initiatives.

First, we have moved into the second phase of our plan to improve the customer in-store shopping experience, which involved expanding the pilot to 28 stores in two districts in June, using two different transformation models. Once we determine which model provides the optimal solution to deliver results, we will begin rolling out the model to approximately 300 stores in the fourth quarter of 2011. The key here is to increase the customer conversion rate in our stores and turn dissatisfied shoppers into very loyal customers.

Second, we're investing in our Copy & Print Depot and Tech Depot services. These two solution-based businesses continued their strong year-over-year gains in revenue in the second quarter and provide Office Depot the opportunity to differentiate in the market.

In Copy & Print we have added incremental in-store and outside sales expertise as well as increased our marketing spend to drive awareness. To drive Technology Services, we are piloting a redesigned technology area with an optimized assortment and dedicated selling resources in two markets. We're encouraged with the results to date and our plan is to launch this model across a significant number of stores in 2012.

Third, we're focused on improving the sales productivity of our stores. This includes remodeling about 50 traditional stores into our M2 format in 2011 and reducing the average store size wherever possible. We have been making progress, as evidenced by the fact that we have reduced the average store size of our remodels and relocations by 20% to 30% over the past three quarters.

In addition, we continue to test our new smaller concept store. And although we continue to tweak the model, the results to date indicate that services can successfully drive profitable sales in the small store format.

And then lastly, we continue to pursue opportunities to improve margins, including increasing direct import penetration, pursuing the harmonization of rationalization of SKUs, and taking a much more disciplined approach to price and promotions and measuring their effectiveness.

We're extremely excited about these initiatives and believe that improving the in-store experience, reducing occupancy costs and promotional discipline could benefit North American Retail operating income in the range of $75 million to $100 million annually by 2013. We will have more to say about these initiatives and the projected benefits in the next few quarters.

Third quarter is back-to-school season and we plan on offering our customers the best value possible with new lower prices on over 75 top back-to-school supplies. We will bring this savings message to life in the store, online and in media, highlighting new and exciting fashion products and popular national brands.

And because business is built on relationships, we are committed to Worklife Rewards members and our Star Teachers special treatment throughout the year. And for back-to-school they will receive VIP offers during private events we're holding just for them.

In addition, we're excited about offering eight tablets in time for back-to-school this year. Our tablet offerings currently include the HP Touchpad, the Asus Transformer, the Blackberry PlayBook, the Toshiba Thrive, the Acer Iconia, the Lenovo IdeaPad, ViewSonic G-Tablet and the Velocity Micro Cruz. We're offering all of the accessories our customers need for these great new tablets as well.

Looking at the third quarter of 2011, we expect our year-over-year same-store sales trending to be consistent with the second quarter, which will be down versus the prior year. However, despite softer sales, we expect our operating profit to be up slightly as we continue to improve product margins and reduce occupancy costs while continuing to invest in our key initiatives.

Although Steve Schmidt is already transitioning into his new duties as Executive Vice President, Corporate Strategy and New Business Development, he will be double duty today and report on the second quarter results for the North American Business Solutions Division. Steve?

Thanks, Kevin, and good morning. I'm very excited about my new role, which will include the tactical development and implementation of our strategic plans, integrating our own brands across the globe while optimizing our direct import and global sourcing strategies and new business development.

I look forward to working with the executive team on driving change and profitable growth in this capacity.

Turning to the North American Business Solutions Division, second quarter 2011 sales were $803 million, down 2% versus the same period last year. The rate of sales decline was slightly better than the first quarter rate. And the entire sales decline is equivalent to the sales not retained during the transition to our new public sector purchasing consortiums.

Our sales results were lower than original expectations due to softness in the public sector overall and lower growth than expected with small to medium-size business customers.

Looking at our second-quarter sales by product category, we did see positive year-over-year sales growth again this quarter in seating and cleaning and breakroom supplies. We continue to gain traction in breakroom supplies, with the sales rate improving at a double-digit rate again in the second quarter. The paper group sales declined at a rate consistent with the division average, while ink and toner sales were lower.

I should note that cut size paper price increases were announced by the North American paper producers for June 2011. And we believe the impact on profitability will be neutral to slightly negative in the third quarter as we attempt to pass through the cost increases to our customers.

Geographically, the second quarter sales rate in Texas and Florida versus the prior year were better than the overall BSD rate, while California was slightly worse due to the continued macroeconomic weakness in the state, as Kevin had mentioned earlier. BSD's second quarter average order value was down to last year and customer transaction counts were lower as well. While discretionary spend appears to have stabilized, we still have not seen a significant change in discretionary purchases by our customers at this point in the economic recovery.

If we look at the direct channel, sales in the second quarter were down 1% versus one year ago due to increased competitiveness and paid Internet search and a concerted effort to reduce promotional support to better manage our bottom-line.

Turning to the contract channel, sales declined about 2% versus last year, which was equivalent to the sales not retained during the January 2011 transition to our new public sector purchasing consortiums. In addition, I'm pleased to report that we retained this business at an 86% rate in the second quarter, and we're beginning to see some customers previously lost to other providers returning to Office Depot because of our superior service model.

If we look at the other parts of our contract business, we achieved positive sales [growth sales] with our large national account customers again this quarter. In addition sales to small to medium-sized business customers, or SMB, in the second quarter grew slightly versus the prior year. This is the first quarter-over-quarter, year-over-year growth in SMB since 2008 and shows that we're beginning to get traction in this key customer group.

However, we continue to see weaknesses in the state government area and some volatility within the federal government business as these customers experience budgetary pressures.

Second quarter 2011 operating profit for BSD was $45 million, up significantly from the $14 million reported in the same period one year ago. The $31 million year-over-year increase in operating profit was driven by 150 basis point gross margin increase, operational improvements and some discrete items that will not occur in the future quarters.

On the operational side we were successful in reducing distribution, advertising and payroll expenses as part of the initiative to improve the Division's overall cost structure. These reductions were rooted in a greater level of fiscal discipline and involved the strategic implementation of low return or no return expenses. The discrete items that should not reoccur total approximately $10 million in the quarter and included benefits from removing resource provisions from the Office Depot private label credit card program and adjustments related to customer incentive programs.

In North America and BSD we continue to focus on three key initiatives to drive sales and improve margins in an environment that remains challenging. I will now update our progress with these initiatives for you.

First, we are determined to increase our customer mix of SMB customers. This initiative continues to be a priority and we feel that we are gaining traction as evidenced by our positive sales growth in the second quarter.

Second, we are continuing to grow our Copy & Print business with a year-over-year improvement in the second quarter. Copy & Print sales recorded in the retail channel continue to show strong growth, as we have successfully expanded this service to our contract customers in most markets using capabilities in both our retail stores and the nine regional print facilities in the US.

And third, we continue to look at every area to offset margin pressures and improve the bottom line. This would include reducing overhead and supply chain expenses and taking a more disciplined approach to promotions and measuring their effectiveness.

In summary, we continue to win new business and retain existing business in the contract channel. And our direct channel continues to perform well and maintain its competitive position in this market. We also feel that some of the actions taken around fiscal discipline and our cost structure in 2010 are taking hold and driving improved operational performance.

In regard to the third quarter 2011 outlook, we expect BSD sales to be flat to down slightly versus last year and operating profit to be flat versus the second quarter, excluding nonrecurring items, and up versus prior year as we continue to capture operational improvements.

I will now turn the call over to Charlie to discuss his second quarter 2011 results for the international business. Charlie?

Thanks, Steve, and good morning. The International Division reported second quarter 2011 sales of $827 million, an increase of 6% compared to the prior year in US dollars and a decrease of 5% in constant currency.

Excluding the revenue impact from our recent portfolio optimization activities, the constant currency sales were down 1% versus the same period a year ago. As a reminder, these activities include the negative impacts from divesting our businesses in Japan and Israel, and de-consolidating our joint venture in India late in 2010. And, of course, the positive sales impact from acquiring Svanstrms in Sweden during the first quarter of 2011.

As I speak to year-over-year sales comparisons, please note that I will do so in constant currency.

Geographically our sales were mixed across Europe. Sales in France were roughly flat compared to the prior year, while the UK and Germany reported small declines in sales. Our businesses in Asia reported high single digit growth in the second quarter, excluding the prior-year sales in both Japan and India.

In the contract channel our European business continued to report positive sales growth for the second quarter. The contract business performed well in France, Germany and the UK where we recently took a large contract with the Scottish government and further strengthened our leadership position in that region. In addition, our contract business in Asia again reported double-digit sales growth, excluding the divested businesses I mentioned earlier.

Second-quarter sales in the direct channel were lower than a year ago. We're not happy with this performance and are addressing it with some of the initiatives that I will discuss later.

For the retail channel sales in the second quarter grew at a low single-digit rate compared to prior year, excluding the 2010 sales from our divested business in Israel and our first quarter 2011 acquisition of Svanstrms.

France, our largest retail business in Europe, reported -- continue to report positive sales growth in the second quarter.

The International Division reported operating profit of $13 million for the second quarter of 2011 compared to $19 million reported in the same period last year. Excluding $6 million of charges related primarily to our business restructuring activities, adjusted operating profit was [$19 million] in the second quarter [year of] 2011, or flat to prior year.

Both gross profit and operating profit margins were roughly flat versus the year before. The negative flow-through impact of lower sales was offset by the improvement in operating expenses in the second quarter. Excluding the impact of our portfolio actions, operating expenses for our existing businesses were down year-over-year.

The benefits we are realizing from our restructuring activities have allowed us to invest in expanding our sales force and rebranding Viking in Europe without increasing our cost base.

Although the results for Office Depot de Mexico are currently not consolidated, it's important that we provide an update on the joint venture's performance. In the second quarter of 2011, Office Depot de Mexico reported sales of $272 million and net income of just over $14 million. Our share of the net income is approximately $7 million and is reported in [this year's] income in our income statement.

During the second quarter of 2011 we also received a cash dividend from a joint venture partner totaling approximately $25 million. We remain extremely pleased with the performance of this joint venture and continue to view it as potential platform for additional growth in Latin America.

On the first-quarter earnings call in April, I mentioned that one region in Europe was less successful in passing along higher paper costs in a timely manner. And that region accounted for more than the total year-over-year operating profit decline. We took decisive action in that region to increase the level of resources and modified our strategies in order to improve its performance going forward.

Although this region continued to negatively impact the division's operating profit by over $10 million in the second quarter versus prior year, we're encouraged that we're making progress and expect to show improvement by the fourth quarter of this year.

Turning to our initiatives, we continue to concentrate our efforts on implementing our strategic plan to enhance sales and drive overall profitability in the international business. Let me update you on three of these initiatives.

First, the portfolio optimization strategy we discussed over the past few quarters is producing the results we projected and achieved 2011 benefits to date of $8 million. We believe we have additional opportunities to strengthen the international portfolio, such as an expansion into Latin America, and we will continue to review our options.

Secondly, we're making progress on the business restructuring and continuous improvement process initiated in Europe during the fourth quarter of 2010. These initiatives reduced SG&A costs in the second quarter by $10 million and we continue to find opportunities to enhance our current processes and leverage our resources, enabling us to further reduce our overall cost structure.

And finally, we remain focused on [really] new small to medium-sized business customers or SMB. We announced the rebranding of Viking in May in the UK and Germany to drive SMB growth and improve our competitive positioning within the direct channel. The Viking marketing effort to drive traffic was successful. But we experienced (inaudible) transitional difficulties in the UK and are working to resolve those at the moment.

So in summary, the international contract and retail channels continue to perform well in the second quarter. We are pursuing opportunities to profitably grow our direct channel. As we look forward, we will continue to carry out our strategic initiatives to profitably increase sales and reduce our costs.

In regard to our third-quarter outlook, we expect our sales in constant currency to be down slightly on a like-for-like basis versus the prior year, and operating profit excluding charges to be flat versus prior year.

I will now turn the call over to Mike, who will review the Company's second quarter 2011 financial results in more detail.

Thanks Charlie. I would first like to give you an update on our restructuring actions and benefits.

In the second quarter of 2011 we reported $20 million of restructuring-related charges and other costs intended to improve efficiency and benefit operations in future periods. These charges included $12 million related to the store closures in Canada, $6 million for European process improvements and $2 million for business process improvements at the corporate level.

Looking at the remainder of 2011 we anticipate an additional $30 million in charges primarily related to global process improvements and cost reductions. By quarter, we're projecting approximately $15 million in both the third and fourth quarters. The full year 2011 charges should total approximately $60 million.

And the negative cash impact from these charges could be in the $50 million to $60 million range, and relate mostly to severance and facility closure costs.

I will now review the benefits from both the restructuring actions and our previously announced business process improvement activities. In the second quarter of 2011, we realized about $20 million in gross benefits mostly from International Division restructuring activities. After some reinvestment in our business, net P&L benefits in the second quarter were approximately $8 million.

As a reminder, we anticipate reinvesting about $40 million to $50 million of the $80 million to $90 million in projected gross benefits back into the business in 2011.

Although the net benefits did not significantly impact our second-quarter EBIT, we still anticipate the full-year 2011 that benefits to be more second-half weighted and in the neighborhood of $40 million to $50 million.

By quarter we're projecting approximately $15 million in the third quarter and $20 million in the fourth quarter. As previously mentioned, the P&L benefits expected from the business reinvestment are not built into the projected benefit stream.

Turning to our second-quarter results, the effective tax rate for the second quarter of 2011 on a reported basis was 27%. And it is likely that the effective tax rate on a reported basis could exhibit significant variability throughout the course of the year due to changes in income projections and the mix of income across jurisdictions.

The effective tax rate on our earnings adjusted for charges dropped to 4% for the second quarter. The adjusted rate is lower than the reported rate because it removes charges without tax benefits that are in the GAAP calculation.

For the third quarter we project about $5 million in cash taxes. I should also note that we may have a non-cash tax benefit in the third quarter.

As background, in past years the Company has entered into statute extension agreements with certain taxing authorities to facilitate resolution of disputed items. The extension expired on June 30, 2011 for certain open years and accrued [uncertain] tax positions and related interest costs.

We're assessing this expiration and recently enacted legislation. And depending on the results of this assessment, [we may reverse] as much as $96 million of combined tax and interest accruals during the third quarter.

For the full year we still estimate that we will pay a total of $15 million to $20 million in taxes on both a book and cash tax basis, excluding any discrete items.

Taking a look at cash flow, we're seeing an atypical profile of free cash flow by quarter in 2011. We ended the second quarter and first half of 2011 with an $85 million and $208 million use of free cash flow respectively. I will explain the dynamics of this cash used in the first half and then explain the drivers of cash generation in the second half of 2011.

During the first half of 2011, cash used by operating activities totaled $148 million. This use of cash primarily reflects changes in working capital including an increase in inventory, the normal cash flow timing of bonuses and other long-term incentive payments and other expenses accrued in prior periods. And less of a decrease in receivables in the first half of 2011 compared to the same period last year.

The increase in inventory reflects an early buildup of direct import inventory for back-to-school, heavier inventory of notebook computers and forward buys of products to provide a cushion for supply chain challenges in Japan. The build of direct import inventory is impactful because it generally requires payment earlier in the shipping process.

The slowdown in computer sales in North America Retail Division that occurred late in the second quarter also resulted in an increase in inventory that was not offset by corresponding increases in accounts payable.

If we look at the second half of 2011, we anticipate nearly $120 million of working capital improvements as we sell through the direct import and forward buy inventories and trade payables return to normal levels.

Additionally, we expect to see $115 million to $120 million of cash generation in the second half from non-trade payables and other accrued expenses reflecting the normal invoicing cadence of non-trade payables, and an increase in accruals related to bonus and long-term incentive accruals.

If we look at full-year 2011, we continue to expect to generate $25 million to $35 million in free cash flow. The relevant flow components are as follows.

A full-year EBIT projection in the $100 million to $110 million range; a negative cash impact from restructuring charges of $50 million to $60 million; interest expense of $70 million; cash taxes of about $20 million. And we expect to pick up $50 million to $60 million in cash with 2011 capital expenditures in the $150 million to $160 million range, netted against depreciation and amortization in the range of $210 million to $215 million.

And finally, a working capital benefit for the total year of $25 million resulting from the second half improvements I just outlined.

Turning to our liquidity, we ended the second quarter with $374 million in cash and $766 million available from our amended credit agreement, for a total liquidity of over $1.1 billion. We did have borrowings of about $45 million in Europe under the amended credit agreement at the end of the second quarter. And this was related to our acquisition of Svanstrms in Sweden in the first quarter.

During the second quarter we recorded a dividend on our convertible preferred stock of approximately $9 million, which was paid in cash in July. On June 20, we entered into an amended merchant service agreement with Citibank, the bank that previously provided and administered our private label credit card program. The agreement extends the arrangement for 5 years through September 2016, eliminates recourse to the company for losses, obtains portfolio rights at termination, lowers the overall fees and modifies other terms and conditions. As a result of this amendment, a previously established unfunded bad debt accrual of approximately $8 million was reversed during the second quarter of 2011.

The reversal was included in the discrete items impacting operating profit for both North American Retail and BSD as described by Kevin and Steve. From a business perspective, extending this agreement was very important given that both individuals and small businesses that have the private label credit card for multiple years are some of our very best customers.

Looking at the outlook for the third quarter, we expect total Company sales to be roughly flat versus the prior year, and EBIT excluding charges to be up compared to last year.

With that, I will now turn the call back over to Neil.

Thank you. In closing, I have witnessed a renewed energy and excitement at all levels within the Company, and I'm confident that we have begun the process of returning to the profitability of prior years. We have focused the Company on a few key initiatives, some of which will begin paying of this year while others will reap benefits in 2012 and 2013.

What has given me encouragement is the fact that our associates have all signed up for this focused approach, and we will continue to make the changes needed to create opportunities for improved financial performance. We understand that we are on a journey, the benefits of which will take time to fully realize.

Before we start the Q&A, I wanted to mention that the back-to-school season also marks the most active time for the Office Depot Foundation's Backpack Program. The Foundation will hold 25 events across the US during back to school and give children over 350,000 backpacks filled with school supplies to help them start school with the tools they need to succeed.

Since 2001, the Office Depot Foundation has helped over 2.5 million children begin the school year with confidence. And I'm very proud of the great work they do and the many lives they touch.

Thanks Neil. Operator, we are ready to take questions.

(Operator Instructions) Colin McGranahan.

Good morning. It is Colin McGranahan at Sanford Bernstein. Firstly, I just wanted to ask about gross margin. Obviously a pretty good performance in North America.

Can you give us a little bit more color and insight as to what some of the discrete drivers were there, both in retail and in BSD?

Sure. This is Kevin. On the gross margin side for retail it really was a couple of things. One was being less promotional than we historically have been with regards to rebates and coupons.

I think the second piece was really doing a much better job in adding lower levels of clearance and things like supplies, tech and peripherals. Those were the two principal drivers in retail.

Steve. On the BSD side, it was similar to what Kevin talked about. On the direct side it was really taking a hard look at promotional spending in addition to mix of what we were selling by channel.

And then on the contract side, we talked in 2010 about really focusing on productivity and taking a number of expenses out of the base of a contract business. Those have proved to be good decisions and we are starting to see the fruits of that, those initiatives in 2010, in the 2011 business results.

Okay. And if I could just follow up on that, it sounds like last quarter there was some concern about competitive intensity, inability to pass through price increases, not just in paper but in other products. Given this gross margin performance, can you just comment on what you are seeing competitively both in retail, and I think more importantly, in the contract business as you're going out to retain and win new contracts?

Yes, let me start off on the BSD side of the fence. First of all, the price increases and those issues you talked about I believe are on the International side, not in North America. But relative to the competition that we are seeing out there at this point, I would say that -- nothing abnormal.

I think it continues to be highly competitive with all of the players in this space. But I would say at this point there is nothing abnormal to call out. We continue to see some irrational behavior from time to time.

But this is a tough market, very competitive and we're all fighting for market share.

And then a final follow-up on gross margin, just in terms -- in Retail, on the negative side, how should we think about the excess laptop inventory in terms of clearance going into Q3?

And then it sounds like you have made a lot of progress on direct sourcing. I think it was up 300 bips in Q2. It sounds like it is even growing given the fuller buy of direct sourcing for back-to-school. Can you talk about how those two dynamics might work themselves out going forward?

Yes. I think we were pleased with penetration improvement both in direct importing as well as private brand. We saw big changes in year-over-year penetration levels in both of those categories, and certainly contributed positively to the margin improvement in Q2.

So our expectation, as we have talked in the past, is that we will continue to step on that pedal and see if we can't drive further levels of penetration in both private brand and direct import.

With regard to the laptop, again, we picked up share in laptop in OSS, but it was really the tale of two sides of a quarter. The laptop business drove comps in the first part of the quarter and got softer than we have ever seen in the tail end of the quarter. So we did carry inventory over.

Our expectation is, though, and just looking at sales here over the last few weeks, is that the carryover of laptops will not put any pressure on us in Q3 though.

Hey, Mike Newman. The guidance I gave in the second half of $120 million of working capital improvements, about $40 million of that is inventory. So, while that is not a small amount, on a year-end balance for the Company of $1.2 billion to Kevin's point, we should be able to work through that pretty easily.

That is very helpful. Thanks. I will turn it over to someone else.

Christopher Horvers, JPMorgan.

Good morning guys. So, just some clarification questions on the guidance. So you said EBIT of $100 million to $110 million for the year; I'm assuming that is GAAP. So, if we adjust for the charges in the first half --

No, that is excluding charges.

Because all of the charges are noncash?

Well, there are some cash charges. But we gave EBIT ex-charges of $100 million to $110 million, and we had cash restructuring of $50 million to $60 million.

Right. So year-to-date -- you were talking like what, $70 million to $80 million of EBIT in the back half of the year then?

Including charges? Yes, based on those two sets of numbers you're going to be on the low end, $50 million on the high end. (multiple speakers) Yes, close to that.

Right, because it would be $100 million to $110 million and you've got $30 million so far, right? So that is $70 million to $80 million.

Okay. Right, right, right. And so as you think about the tax rate for the year, I understand that $15 million to $20 million in cash taxes for the year. But the tax rate in Q3, maybe you could clarify how you were thinking about what the GAAP tax rate might be in the third quarter?

Yes, it is real difficult because of both earnings mix as we said in the script. I think the best thing to do is that -- we said that for the year we expected cash taxes to be about [20]. And I think through the first half cash taxes are probably a little bit less than that.

So I would model cash taxes for the year -- it is really going to be hard, especially if we have this throwback of the deferred tax assets that we talked about in the script of $90 million to $100 million. It is impossible to talk about a GAAP tax rate with any certainty.

Okay, fair enough. And then so you -- Kevin mentioned in the PC category you gained share in a -- if that category was down in the back half, it seems like the industry was just overall -- still tough PC sales.

Was there anything discrete that drove the drop-off in PC sales in the back half of the quarter? Did you pull back on promotions? Was it -- tablets come in? What exactly was the driver?

This is Kevin. To be perfectly honest with you, if we knew that answer we would feel a lot better. But we picked up share in OSS.

I think there is some indication that in retail in general that there was a kind of a remixing of share, but nothing significantly detrimental to us. We did not change our promotional cadence. We did not change our mix. There just seems to be a drop-off in overall demand for laptops.

I think there was some evidence of that as you look at the chipmakers when they announced earnings. I think there was some softness particularly in US-based sales versus global sales. So I think it ended up just working itself through our channel and specifically with Office Depot.

But the other thing I would add is, even if you adjust for tablets, not only the tablets that are carried in our offering but the tablets that are carried by -- or that are produced by Apple and even the MacBooks, it still doesn't explain the drop-off in sales.

Okay, fair enough. One final question for Neil, I want to follow-up on the Board departure. I know you mentioned it was just going to a different opportunity. But he has been around the Company for such a long period of time, and it does seem [like it's] an abrupt departure from one perspective.

Then from the other perspective, do you think that is departure is a loss of guidance from the Board?

Basically what happened is Dave decided to be a senior adviser to Peter J. Solomon Company, an investment banking firm with whom our Company has done and probably will do business. And given all the new reasons in terms of corporate governance, Dave actually resigned also from all his public boards -- Ryder, Dick's Sporting Goods and Office Depot.

Given that Dave and I have become very good friends, I fully expect to be able to tap into his expertise going forward and I don't see that really changing.

Fair enough. Thanks very much.

Matt Fassler, Goldman Sachs.

This is actually [Ryan Brinkman] for Matt Fassler, Goldman Sachs. Can you speak to the impact of changing mix on gross margin improvement versus potential various other factors, such as a change in markdown activity?

I will jump in. This is Mike Newman. In addition to the things that we mentioned in North American Retail and BSD in the second quarter, we still -- we have seen nice mix improvements from our services. It's particularly as our Tech Depot dismisses start to grow, we have seen nice mix impacts there.

So, I won't quantify how much of the margin improvement in each business was mix driven and how much was promotions, but we got very nice contributions from both.

Okay, that's great. Thanks. And then could you also maybe talk about the trend of higher inventories, lower payables and the consequent increase in net owned inventories?

Yes, as I said on the script, it is an atypical profile of cash flow use for us. And we ended the first half in inventories probably about $50 million, round numbers, higher than we would have liked.

And that was direct import inventories. It was laptop inventories. We had some pre-buys on some Japan supply chain issues. We actually had a couple of pre-buys with vendors that took advantage of some prices.

We didn't get any support on the AP side because we ended up with this excess inventory, DI because of the pipeline, Tech because the terms tend to be more rapid. We got a real interesting double whammy dislocation on cash flow which I expect to right itself by year-end.

If you look at our balance sheet and you look at our AP to inventory ratio, for the end of the second quarter we were in the mid-70%s -- 76%. Now, this business has run in either the mid-80%s to the 90%s for the last year.

We have not had any changes with vendors term-wise. That has been constant. So that is where you really see this.

And in addition to taking the inventories down by year-end, as Kevin mentioned, we expect to see a more reasonable mix in the AP inventory and get back into that mid-80% range. And so when we talk about the working capital guidance for the second half of $120 million, about $40 million to $50 million of that is inventory. And the balance is really seeing the payables go back to normal levels and get the support at year-end from payables that we normally see.

So we see we've studied this a lot. We're confident that is what is going to happen. And it's a very unusual occurrence for us to see that kind of mix at the end of the first half.

Okay, that's great. Thank you for answering my question.

Brian Nagel, Oppenheimer.

A couple questions, first on gross margin, recognizing others have already asked about it. But just to be clear, as we look at the income statement you had about a 90 basis point improvement year over year. How much of that is a true improvement versus an effect of one-time factors?

I would say most of it is operational. We might have had a small amount that was one timers, but most of it is operational for all the reasons we just articulated in the last two questions.

Okay. And then on the computer issued you talked about the weakness late in the second quarter. Have you seen a change in trend here early in Q3?

This is Kevin. I think the way to answer that is, the first part of July continued to exhibit the softness that we saw in June. Part of that was the July 4th holiday lapping over the July 4th holiday, which I think added some softness at least on the retail side.

That being said, the second half of July has exhibited signs of returning the laptop sales to more traditional levels.

Okay. And then finally, you called out in your press release and then you alluded to it in your prepared remarks as well, maybe a better trend in the North American BSD division excluding government. Did you see a significant turn of business there with some of the customer activity? Or was that just more of a stabilization as you have talked about before?

Yes, I would say it is really more stabilization, as we talked about discretionary spending by our key customers. We aren't seeing a significant improvement, but more of a stabilization trend that we have seen over the last few quarters.

We continue to manage mix. The fact that we actually grew SMB slightly obviously helps from a margin perspective. But that would be the majority of what is driving that.

Okay, thank you very much.

Kate McShane, Citi Investment Research.

You had mentioned that one of your initiatives in the delivery business was to reduce overhead and supply chain expenses. I just wondered if you could walk us through what there is left to do there.

Steve. As we look at supply chain there is numerous opportunities as we look at AOV and MOV. You look at things like route density and you look at sourcing of goods and services from a direct import standpoint, and how we manage the overall mix of business.

So, like everyone, we're always looking for productivity. And we believe there is significant room yet still to improve our overall cost structure.

Okay. And if I could switch gears a little bit. Last quarter there seemed to be a significant amount of price competition in the international market. Can you just comment on the promotional environment internationally currently?

This is Charlie. The issue last quarter was we were still playing catch up on some of the price increases that we saw late last year. This quarter, we were on top of [it, fought] our way back. Our gross margins in the International Division were essentially flat year-over-year, which was an improvement versus Q4 last year and Q1 this year.

So it still is quite competitive. But I think it was really more of an issue of us getting on top of the price increases as they came from particularly the paper suppliers.

Okay, thank you.

Brad Thomas.

Yes. This is actually [Jason Campbell] standing in for Brad at KeyBanc Capital Markets. You said the small and midsize business was up, I believe you said for the first time 2008.

I was just wondering if you can give us some of the drivers. Was it more ticket or customer acquisition with that?

Yes. I mean SMB continues to be a focus for the Company, and we continue to improve in a number of areas. First of all from a sales standpoint, a coverage standpoint, we continue to add efficiency and effectiveness through our TDMs and TDRs, the people that are primarily calling on the SMB segment.

We continue to focus on our TAM organization, our telephone account management which deals with our smaller customers in the SMB space, to improve the efficiency of that operation. So we continue to make progress there.

In addition to that, from a marketing standpoint, as we think about our contact strategy and how we market into the SMB segment, we have made improvement there also. So those are probably the three main drivers as we look at SMB.

Great. And then the only follow-up I had was, you have been talking recently about reducing your store size. You said you have, I believe, remodeled a handful of stores and reduced by 20% to 30%. How is that in terms of where you plan to be? Are you kind of ahead and are you finding landlords willing to work with you?

I think, Jason, as we have talked about in the past, we have about 100 leases or so that come up for renewal each year. We view those each as an opportunity to downsize and remodel the stores. We have a plan that takes us out through 2013 to get after that, and we are on track with the plan right now.

But you can see it in the property cost, occupancy cost improvements that we have had already this year and a little bit last year.

All right, thanks.

Dan Binder, Jefferies.

Good morning. It's Dan Binder with Jefferies. A couple of questions for you. First on this position to be more disciplined on promotion, as well as reduced advertising, obviously is generating some profit improvement here in the short run.

I guess how do you view the risk of those two actions potentially having a tail on it that results in slower sales growth?

This is Kevin. I think the actions that we have taken this year have been deliberate. I don't know that we necessarily think of them as short-term.

I think essentially we've been much more strategic and thoughtful about our promotional activity in the business, particularly around products that don't exhibit a relationship between price and volume. So those that are probably are more inelastic in their demand patterns than elastic.

So we have really tried to be smart about where we invest our promotional dollars in terms of acquiring and retaining customers using that promotion leverage. So I think we certainly reduced the level of promotional activity that we're doing, particularly on items that we don't think we're getting the volume lift.

With regard to advertising, we have also taken I think a more thoughtful approach. And we have looked at our advertising spend across all the vehicles that we have, and where we have a vehicle we think give us a reasonable return on investment, we repurpose those dollars into other activities. An example would be in some of our strategic initiatives.

So again, we think that is a positive. That is not a negative.

And then if you could give us an update on where you are -- in absolute terms where your private label and direct import penetration is today, and what the opportunity may be over the course of the next year or two?

Sure. We saw about a 300 basis point improvement in North American Retail and direct import penetration, and close to a [450] basis point improvement in private brand penetration year over year. That certainly had a part to do with our margin improvement in North American Retail.

And as we mentioned in the past, we think there are continued opportunities to drive further penetration in both direct import and private brand. I think the same would be true on the BSD side of the house.

So in absolute terms, can you give us an idea of where that level is today?

We'll just leave it at that.

Okay. Finally if you could, you talked a lot about restructuring and business process improvement. I was wondering if you can give us maybe a couple of examples on the business process improvement side in terms of -- maybe pick a couple of the big items that you think are making a big contribution to the change in the profit profile.

This is Mike Newman. I think you know the story. The things we have worked on today to date that we're having good success on -- indirect expenses; we have looked at some financial processes inside of finance. We've had this business process improvement team in place for over a year now. They're becoming part of our fabric.

We're starting to work on -- the things [where we are] reinvesting the savings into this year, the $40 million to $50 million. We're looking at a number of different initiatives. We're looking at pricing effectiveness. We're looking at promotional effectiveness.

We're looking at parts of our business. We're looking at our direct import supply chain. As we become more penetrated there, where you can see some of the pressures that is creating on cash flow, we're looking at opportunities there.

We've got a list of 10 to 15 items internally in the business. We've talked to you externally about some of them. And in the next few quarters we'll be talking more with some more concrete examples.

But Kevin mentioned in-store customer experience, he [mentioned] occupancy and he talked about the benefits from those. We're starting to really get our heads around some significant numbers from these initiatives.

So I'm encouraged that we will continue to see the margin expansion that you saw, that you are seeing today not been short-lived, not being one-timers, not being promotional for the sake of short-term results. But we'll be able to sustain this going forward.

Great, thank you.

Mike Baker, Deutsche Bank.

So, two questions, one, you have seen some improvement in sales here. How much of that do you think is starting to see some of the year-over-year growth in employment level, particularly white-collar employment level starting to flow through into your business versus how much you think is marketshare gains?

And then my second question is on store closures. Kevin, you alluded to having a plan in place through 2013. Can you remind us -- have you talked about or could you now talk about what you expect total square footage to be in 2013 versus where it is now? Thanks.

This is Neil. On the employment issue, we haven't seen any change at all. In fact, it is still going down and the number of white-collar people in terms of employment who have been out of work for more than six months continues to increase. So that has not been a positive impact on our business at all at this point.

Can I interrupt? Isn't the year over year number of white-collar employed people up year over year when we look at the monthly data that has come up?

We have not seen that in the SMB sector, which is our key.

Okay.

You'll see it manufacturing and you've seen it in some of the large financial institutions. We don't see it in terms of the key customer base that we're focused on.

Okay, fair enough.

I think Mike on your first question, again, it goes back to the 100 or so leases that come up for renewal each year. We try to action as many of those as we can to reduce the size of the store footprint.

Today our average store footprint sits at about 24,000 square feet. When we are successful in downsizing, we can reduce that square footage by about 30%. And depending on the terms of the deal, get some flow through benefit in terms of reduced rent, not always proportional to the downsize of the actual store square footage.

And then where we can't get a downsize and a remodel, we're actively involved in trying to just to reduce the overall rent even though the square footage might be the same. So our real goal is to get as many stores remodeled as we can and flow through that benefit. And where we can't, go through the benefit of reduced occupancy cost on the balance of the stores.

We really haven't called out a net number in terms of our goal, in terms of total square footage of our store base.

This is Steve. I would just add regarding marketshare where we sit, particularly on the contract side of the business, we're actually retaining our medium to large customers right now at very high levels that we haven't seen. So I'm very pleased with that and we are gaining share.

We have won a lot of new business and we continue to retain our existing customers at very high rates. So those are really contributing to some of the momentum that you are seeing.

Okay, so it sounds more like share gains than anything else in your view?

Yes.

Thank you.

Joe Feldman, Telsey Advisory Group.

Thanks guys. Just kind of some longer-term questions for you, Neil. The first is, I was just kind of curious what you have been spending most of your time lately and maybe which business unit is getting most of your attention.

And then also, if you guys as maybe a team could share your vision for the longer-term operating margin potential. I know in the past we have talked about getting back to that 3%, 4% where you had been. I'm sure that is still the goal. But any sense of timing, how soon you would like to be there and just how you're thinking about the longer-term?

Sure. I've been spending my time primarily in North America because we have been doing extremely well internationally. And a large part of that has been thinking through organizational changes and people changes that we needed to make.

I think I will continue to be spending a larger part of my time thinking about and working with Steve and Mike and Kevin on the corporate strategy in terms of where we go domestically. I still see us getting to that 3% to 4% plus by the end of 2013. And that is the goal we have set and everybody in the Company is clearly aware of it.

The initiatives are all focused on that. And it's not -- that goal does not have to have significant revenue increases for us to get there.

Got it. That's helpful. Thanks guys. Good luck with this quarter.

Sorry to go into overtime here, but this concludes our webcast and conference call this morning. Thank you very much for participating and I will be available to take your calls later today. Have a great day.

That does conclude today's conference. Thank you for participating. You may disconnect at this time.