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

Office Depot Inc. (ODP) posted 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 the year-over-year gross margin improved for the fourth consecutive quarterly period. Its beaten-down stock, which was 27% lower year-to-date, was off 3 cents at $4.70 in recent trading after rising as much as 5.9% after the opening bell.

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 that it has had for 14 years and that is potentially valued at more than $500 million next year, citing "onerous" terms.

The office-product retailer reported a second-quarter 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 a share on revenue of $2.74 billion.

Gross margin rose to 28.4% from 27.1%, but its free cash flow, or cash flow from operations minus capital expenditures, was negative $62 million thanks to building inventory for the back-to-school season and the company's higher capital expenditures.

Sales were down 2% at its North American retail division, its largest unit by revenue, but swung to a small profit on improved product margins, and same-store sales fell 1%. On a conference call to discuss results, Office Depot said third-quarter sales would be flat versus a year earlier and operating profit could be lower due to increased marketing expense.

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, though the company said third-quarter sales and operating profits in the division should improve from last year. Adjusted earnings at its international division are expected to be flat with last year's third quarter.

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 valued at more than $500 million in 2011, and was $600 million, or 5%, 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 is now calling 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.

In a quarterly report filed with the Securities and Exchange Commission, Office Depot said Chairman and Chief Executive Steve Odland has reached proposed settlements with the SEC related to possible violations of fair-disclosure regulations. Odland will, if the settlements are approved, agree to remain in compliance with Regulation FD and agree to a civil penalty, without admitting or denying liability. The company said the settlement wouldn't affect Odland's position.

Office Depot itself, as previously disclosed, is also close to settling an SEC investigation into the accuracy of its books and records and its internal controls, and its communications with analysts and investors. Under the proposed settlement, Office Depot will also pay a civil penalty and eschew the admission or denial of liability.

No. 3 office-supply chain OfficeMax Inc. (OMX) reports its results next week, while industry titan Staples Inc. (SPLS) will report later in August.

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

(Tess Stynes and Kevin Kingsbury contributed to this article.)

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