CORRECT: UPDATE: Office Depot 2Q Loss Narrows On Cost Cuts

Office Depot Inc. (ODP) calmed fears with a much narrower second-quarter loss than expected, as the No. 2 office-supply chain's operating cost cuts more than made up for weaker-than-expected revenue.

Revenue fell almost $50 million short of analysts' expectations in the traditionally softest quarter, but Office Depot said year-over-year gross margins improved for the fourth consecutive quarter. Its beaten-down stock, which was 27% lower year to date through Monday's close, rallied 5.5% to $4.99 in premarket trading.

Office-product retailers have been hurt by the soft economy, especially high unemployment among white-collar workers. Office Depot in April reported first-quarter earnings that missed analysts' estimates and said it expected continued weakness in California, where about 13% of its U.S. stores are located. More recently, the company walked away from a government contract in Los Angeles potentially valued at more than $500 million, citing "onerous" terms.

The office-product retailer reported a loss of $9.5 million, or 7 cents a share, compared with a prior-year loss of $82.1 million, or 31 cents a share, which included 9 cents of charges. Revenue decreased 4.4% to $2.7 billion.

Analysts polled by Thomson Reuters most recently forecast a loss of 17 cents on revenue of $2.74 billion.

Gross margin rose to 28.4% from 27.1%, but its free cash flow, or

Sales were down 2% at its North American retail division - its largest unit by revenue - but swung to a small profit amid improved product margins. Same-store sales fell 1%.

Revenue declined 6% at its North American business solutions unit on continued declines in transactions and 3% excluding currency changes at its international business. International earnings soared to $19 million from $3 million, but business solutions had a 39% drop.

Office Depot softened its language on why it pulled out of bidding on the Los Angeles County office-supply contract, which is then used as the standard for scores of government agencies nationwide as part of the U.S. Communities Government Purchasing Alliance, a nonprofit government purchasing cooperative. The contract could be worth more than $500 million a year, and was $600 million, or 6%, of Office Depot's 2009 sales.

U.S. Communities and L.A. County took issue with Office Depot saying the terms were onerous, arguing that they were largely unchanged from previous pacts. Office Depot in its results press release now called the terms "problematic" and said they could hurt its profitability, but said it will aggressively work to retain some of those government customers and can "manage costs as needed to mitigate the potential financial impact" of business it loses.

Industry titan Staples Inc. (SPLS) saw its shares rise 2.7% premarket to $20.85. Meanwhile, No. 3 OfficeMax Inc. (OMX), which has coupled its solid execution with Office Depot's recent weakness to nearly overtake Office Depot in terms of market value, was inactive in premarket trading. OfficeMax reports its quarterly results next week and Staples will report later in August.

-By Maxwell Murphy, Dow Jones Newswires; 212-416-2171; maxwell.murphy@dowjones.com

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