Item 2: Amendment of Our Long-Term Equity Incentive Plan to Increase the Number of Shares Authorized for Issuance under the Plan by 15,000,000 Shares to 62,068,750 Shares of Our Company’s Stock

Purpose of the Plan

Our Long-Term Equity Incentive Plan (the “Plan”) exists to provide one important component of compensation for our officers, directors and certain key employees. The Plan has been adopted and previously approved by our shareholders (including amendments to the Plan from time to time) for the purpose of attracting, retaining and rewarding the best available persons for positions of substantial responsibility in our Company. In addition, the Plan serves to align the interests of our officers, directors and key employees with the interests of our shareholders, since the benefits of the Plan are realized generally only if the market price of our stock increases in the marketplace. The Plan permits issuance of stock options (both Incentive Stock Options and non-qualified stock options), Stock Appreciation Rights (“SARs”) and Restricted Shares of our stock. Grants are made at the discretion of the Compensation Committee of our Board of Directors, which consists solely of independent directors of our Company.

Reasons for Proposed Amendment

For several reasons, the Compensation Committee has recommended to our Board, and our Board now recommends to our shareholders, that the number of shares authorized and available for issuance under the Plan be increased by 15 million shares of stock, from 47,068,750 shares of our stock to 62,068,750 shares. Of this total number (i.e. 47,068,750 total authorized shares), we had shares available for issue as of our fiscal year-end 2003 of 6,319,192 (or only approximately 13% of the currently authorized total shares under the Plan). Also at our fiscal year-end, we had issued but unexercised options outstanding of 29,452,938. The balance of shares originally approved for issuance under the Plan have been exercised, and the resulting shares of our stock are either being held or have been sold.

In October 1998, our shareholders approved an amendment to the Plan to increase the number of shares which may be granted as awards under the Plan to 20,712,500. Pursuant to the terms of the Plan, this number automatically increased to 31,068,750 as a result of the three for two stock split which became effective April 1, 1999. In April 2000, our shareholders voted in favor of a Plan amendment to increase the number of shares with respect to which awards may be granted under the Plan to the current level of 47,068,750 shares.

In April 2002, our shareholders voted to amend the Plan to provide for certain changes in the Plan that included allowing for the grant to our executive officers and members of our Board, as an alternative to traditional stock options (“TSO’s”), certain performance-accelerated stock options (“PSO’s”), which have a longer vesting period and a shorter term than TSO’s, but as to which the vesting may be accelerated upon the occurrence of certain positive performance achievements by our Company. The creation of PSO’s by our Board (and approval by our shareholders) was, in part, a response to the fact that in recent years, a number of companies have implemented various types of performance-based stock options. Some of these plans utilize stock options granted at exercise prices that are at a fixed amount or a fixed percentage above the market price of the issuer’s stock on the date of grant. Others use so-called performance-contingent options, where the stock option is forfeited if a certain level of stock price performance is not achieved. Yet others use what are referred to as performance-accelerated stock options. These stock options are issued at the market price on the date of grant, but have a significantly longer vesting schedule than traditional stock options. Vesting may be accelerated, however, if specified company performance criteria are met.

Our Compensation Committee and Board determined, and our shareholders approved, Plan amendments to utilize the third of these alternatives, or performance-accelerated stock options, as a component of the stock option grants to our Chairman and Chief Executive Officer, our Division Presidents, our Executive Vice Presidents and our Directors.

Why do we need an increase in the number of shares available for awards under the Plan?

Our Company has enjoyed considerable growth in the period since 2000, when we last requested an increase in the number of authorized shares under the Plan. For example, in 2003, we substantially expanded our operations in Europe through the acquisition of Guilbert, S.A., virtually doubling the size of our business in Europe and establishing the Company as the leading reseller in the office supplies business in many key countries in Europe. In the same four-year period, our e-commerce business worldwide has enjoyed spectacular growth to over $2.6 billion in annual sales in 2003. With these expansions of our business, we have added a number of key personnel, including new country management leadership in Europe, e-commerce management, and we anticipate continuing to add personnel, particularly in Europe and in technical areas, such as our IT organization and our rapidly expanding e-commerce business. In addition, our contract business continues to grow, and we expect to continue to add key managers in this area.

This dramatic increase in our overall business size, coupled with ambitious plans for the future growth of our Company, requires that we have sufficient shares authorized for issuance to new key managers and other employees. If we do not add sufficient capacity to the Plan, we may be unable to attract the right caliber of personnel to our Company or to retain the services of key managers currently with our Company, including key executives in recently- acquired businesses, which could jeopardize the future growth prospects of our Company.

As a result of these factors, we have determined that we do not currently have available a sufficient number of shares authorized under the Plan to cover normally anticipated needs. We believe at this time that an increase of 15 million shares, from 47,068,750 shares to 62,068,750 authorized shares under the Plan will be sufficient to cover our anticipated needs under the Plan for the next several years, possibly until 2008. This is consistent with our commitment to shareholders in 2000 that the increase approved at that time would be sufficient for at least three (3) years, which has turned out to be the case.

Steps Taken to Counter Dilution

Our Company is aware of the potential for dilution under the Plan, as more shares are issued. To help counter this dilutive effect, our Board has authorized in recent years a series of stock repurchase plans, of approximately $50 million annually, to offset dilution due to issuance of shares under the Plan. In 2001-2002, we repurchased 3,154,031 of our shares for this purpose, and in 2003, we repurchased 3,222,635 of our shares for the same purpose. While future repurchases are in the discretion of our Board of Directors, they have authorized an additional $50 million in repurchases in 2004, to counter dilution by additional awards under the Plan.

Description of the Plan

General. The Plan, which our shareholders first approved effective October 1, 1997, allows us to grant stock options, stock appreciation rights (“SARs”) in tandem with options, restricted stock, performance awards and any combination of the foregoing to directors, officers, key employees, and certain other key individuals who perform services for our Company. Stock options, as discussed above, now include either TSO’s or PSO’s. The original purpose of adopting the Plan was to incentivize eligible individuals to maximize shareholder value and otherwise contribute to the success of our Company. The Plan also enables us to attract, retain and reward the best available persons for positions of substantial responsibility.

The Plan is administered by the Compensation Committee of our Board. Because grants awarded under the Plan are made entirely at the discretion of this Committee, the recipients, amounts and values of future benefits to be received pursuant to the Plan are not determinable. The shares of our Common stock reserved for issuance pursuant to the Plan are subject to adjustment in the event of a reorganization, recapitalization, stock split, stock dividend or similar change in our corporate structure or the outstanding shares of our common stock. Such shares may be authorized and unissued or reacquired and held as treasury shares.

Eligibility. Our directors (whether or not employees), officers and key employees, including those of our subsidiaries, who are selected by our Compensation Committee are eligible to receive grants pursuant to the Plan. However only our domestic employees may receive grants of incentive stock options. As of February 29, 2004, approximately 3,592 employees were eligible to participate in the Plan.

Stock Options. Pursuant to the Plan, our Compensation Committee may award grants of incentive stock options (“incentive options”) conforming to the provisions of Section 422 of the Internal Revenue Code (the “Code”, and other stock options (“non-qualified options”). However, the number of shares of our common stock underlying grants of options and/or SARs made to any participant in any one-year shall not exceed 2,000,000 shares. The exercise price of any option is determined by our Compensation Committee in its discretion at the time of the grant, but may not be less than 100% of the fair market value of a share of our stock on the grant date. The exercise price of an incentive option awarded to a person who owns stock constituting more than 10% of the voting power of our Company may not be less than 110% of such fair market value on such date. The Plan also provides that no option or SAR may be granted in substitution for a previously granted option or SAR if the new award would have a lower option exercise price or SAR appreciation base than the award it replaces. In other words, stock option ‘repricing’ is not allowed under the Plan.

The term of each option also is established by our Compensation Committee, subject to a maximum term of ten years from the date of grant (or five years from the grant date in the case of an incentive option granted to a person who owns stock constituting more than 10% of the voting power of Office Depot). In addition, the Plan provides generally that all options cease vesting on, and terminate 90 days after, the date on which a grantee ceases to be a director, officer or employee of, or to otherwise perform services for, Office Depot or its subsidiaries, except for certain provisions applicable to Section 16 Officers and members of our Board of Directors, for whom a longer period is allowed under certain circumstances, due to such persons having restricted periods of time when they can exercise stock options during their tenure with the Company.

The Plan also provides that unless our Compensation Committee decides otherwise:

(a)

 

Upon a Plan grantee’s death while still an employee of our Company, all of the grantee’s options become fully vested and exercisable and remain so for 24 months after the date of death, provided that all incentive options must be exercised within twelve months of the grantee’s death or they will be treated as non-qualified stock options under the plan;

 

 

 

 (b)

 

Upon the retirement of a grantee, non-qualified stock options vested as of the date of retirement will remain exercisable for a period of 18 months after retirement;

 

(c)

 

Upon a grantee’s termination for cause (as defined in the Plan), all options terminate immediately;

 

 

 

(d)

 

Upon the voluntary separation of a Section 16 officer or a member of the Board of Directors of the Company, all non-qualified stock options granted to such person which are vested at the date of such voluntary separation will remain exercisable for a period of 18 months after such voluntary separation; provided that the Section 16 officer or director has had a period of service of five (5) years or longer as an employee or director of the Company as of the date of such voluntary separation (but in no event beyond the termination date of the stock option pursuant to the terms of its original grant);

 

 

 

(e)

 

Upon the involuntary separation (including a termination for good reason, as defined in the Plan) of a Section 16 officer or a member of the Board of Directors, other than for cause (as defined in the Plan), all non-qualified stock options granted to such person which are vested at the date of such involuntary separation will remain exercisable for a period of 18 months after such involuntary separation, regardless of the period of service of such Section 16 officer or director of the Company (but in no event beyond the termination date of the stock option pursuant to the terms of its original grant); and

 

 

 

(f)

 

Upon a change in control of Office Depot, all options become fully vested and exercisable.

 

 

Upon exercise of a SAR, the grantee will receive an amount in cash and/or shares of our common stock equal to the difference between the fair market value of a share of our common stock on the date of exercise and the exercise price of the SAR, multiplied by the number of shares as to which the SAR is exercised.

Restricted Stock. Under the Plan, our Compensation Committee also may award restricted stock subject to conditions and restrictions, and for such duration (which shall be at least twelve months except as other described below), as determined by the Committee in its discretion. Except as otherwise provided by our Compensation Committee, all restrictions on a grantee’s restricted stock will lapse immediately prior to a change in control of our Company or at such time as the grantee ceases to be a director, officer or employee of, or otherwise perform services for us or one of our subsidiaries due to death or retirement. Unless our Compensation Committee decides otherwise, if a grantee ceases to serve as a director, officer or employee of, or otherwise perform services for, our Company, all of his or her restricted stock as to which the applicable restrictions have not lapsed will be forfeited immediately.

Performance Awards. Our Compensation Committee may grant performance awards contingent upon achievement of set goals and objectives with respect to specified performance criteria, such as return on equity, over a specified performance cycle, as designated by the Committee. Performance awards may include specific dollar-value target awards, performance units, (the value of which is established by our Compensation Committee at the time of grant) and/or performance shares, the value of which is equal to the fair market value of a share of our common stock on the date of grant. The value of a performance award may be fixed or may fluctuate on the basis of specified performance criteria. The number of shares of our common stock or the amount of cash that can be granted to a participant to satisfy a performance award in any one year cannot exceed 100,000 shares or $2.0 million, respectively.

Except as otherwise provided by our Compensation Committee, in the event of a change in control of our company, or if a grantee ceases to be a director, officer or employee of, or otherwise perform services for, Office Depot or its subsidiaries due to death, or retirement, prior to completion of a performance cycle, the grantee will receive the portion of the performance award payable to him or her based upon the achievement of the applicable performance criteria over the elapsed portion of the performance cycle. If a grantee ceases to be a director, officer or employee of, or otherwise perform services for us or one of our subsidiaries for any other reason prior to completion of a performance cycle, the grantee will become ineligible to receive any portion of a performance award.

Vesting. The terms and conditions of each award made under the Plan, including vesting requirements, will be set forth, consistent with the Plan, in a written document provided to each grantee. Unless our Compensation Committee determines otherwise, no award under the Plan may vest and become exercisable within twelve months of the date of grant; other than immediately prior to a change in control of our Company and in certain other circumstances upon a participant’s termination of employment or performance of services as described above.

Transferability. Unless our Compensation Committee determines otherwise, no award made pursuant to the Plan will be transferable otherwise than by will or the laws of descent and distribution, and each award may be exercised only by the grantee or his or her guardian or legal representative.

Amendment and Termination of the Plan. No options may be granted under the Plan after the close of business on September 30, 2007 and the Plan may be terminated by our Board at any time. Our Compensation Committee, with concurrence of the Board, may amend the Plan in its discretion, except that no amendment will become effective without the approval of our shareholders if such approval is necessary for continued compliance with the performance-based compensation exception of Section 162(m) of the Code or any stock exchange listing requirements.

Certain Federal Income Tax Consequences of the Plan

The following discussion is intended only as a brief summary of the federal income tax rules relevant to options or shares issued under the Plan, as based upon the Code as currently in effect. These rules are highly technical and subject to change in the future. Because federal income tax consequences will vary as a result of individual circumstances, grantees should consult their personal tax advisors with respect to the tax consequences associated with stock options. Moreover, the following summary relates only to grantees’ United States federal income tax treatment, and the state, local and foreign tax consequences may be substantially different. Certain Plan participants are residents of foreign countries. These grantees are provided country-specific tax summary information at the time they receive grants under the Plan.

Non-Qualified Options. A grantee does not recognize any taxable income, and we are not entitled to a tax deduction, upon the grant of a non-qualified option. Upon the exercise of a non-qualified option, the grantee recognizes ordinary income (subject to wage and employment tax withholding) equal to the excess of the fair market value of our common stock acquired over the option exercise price. A grantee’s basis in the stock received is equal to such stock’s fair market value on the date of exercise. We are entitled to a tax deduction equal to the compensation taxable to the grantee.

If a grantee sells our common stock acquired pursuant to the exercise of a non-qualified option, the grantee will recognize capital gain or loss equal to the difference between the selling price of the stock and the grantee’s basis in the stock. Capital gains are currently taxed at a maximum rate of 15% in the case of stock held for more than 12 months, and 35% in the case of stock held for not more than 12 months. The capital gain holding period will begin on the exercise date. We are not entitled to any tax deduction with respect to any capital gain recognized by the grantee.

Capital losses on the sale of stock may be used to offset capital gains. If capital losses exceed capital gains, then up to $3,000 of the excess losses may be deducted from ordinary income. Remaining capital losses may be carried forward to future tax years.

Incentive Options. An optionee does not recognize taxable income on the grant or exercise of an incentive option. However, the excess of the stock’s fair market value on the exercise date over the option exercise price will be included in the grantee’s alternative minimum taxable income and thereby may subject the grantee to an alternative minimum tax. Such alternative minimum tax may be payable even though the grantee receives no cash upon the exercise of his or her incentive option with which to pay such tax.

Upon the disposition of shares of our common stock acquired pursuant to the exercise of an incentive option, if such shares are held for (i) more than one year after the date of exercise, and (ii) more than two years after the grant date (the “Required Holding Periods”), the grantee recognizes capital gain or loss, as the case may be, measured by the difference between the stock’s selling price and the exercise price. We are not entitled to any tax deduction by reason of the grant or exercise of an incentive option, or a disposition of stock received upon the exercise of an incentive option after the Required Holding Periods have been satisfied.

If a grantee disposes of shares of our common stock acquired pursuant to the exercise of an incentive option before the expiration of the Required Holding Periods (a “Disqualifying Disposition”), the difference between the exercise price of such shares and the lesser of (i) the fair market value of such shares upon the date of exercise or (ii) the selling price, will constitute compensation taxable to the grantee as ordinary income. We would be allowed a corresponding tax deduction equal to the amount of compensation taxable to the grantee. If the selling price of the stock exceeds the fair market value on the exercise date, the excess will be taxable to the grantee as capital gain. We are not allowed a tax deduction with respect to any such capital gain recognized by the grantee.

At the present time, it is the intention of our Compensation Committee not to award any further incentive stock options after February 19, 2004 and instead to award only non-qualified stock options.

One Million Dollar Compensation Limit. If a covered employee’s total compensation from our Company (including compensation related to options) exceeds $1 million in any given year, such compensation in excess of $1 million may not be tax deductible by us under Section 162(m) of the Code. The “covered employees” for any given taxable year of Office Depot are our Chief Executive Officer and the four other most highly compensated executive officers at the end of the taxable year. Excluded from the calculation of total compensation for this purpose is compensation that is “performance-based” within the meaning of Section 162(m) of the Code. We intend that compensation realized upon the exercise of an option, SAR or a performance award granted under the Plan be regarded as “performance-based” under Section 162(m) of the Code and that such compensation be deductible without regard to the limits of Section 162(m) of the Code.

Vote Required for the Plan Amendment

The affirmative vote of a majority of the votes cast by the holders of shares of Office Depot Common stock represented in person or by proxy at our Annual Meeting is required for approval of the Plan Amendment.

Text of Proposed Plan Amendment

The Amendment to the Plan submitted for your approval is as follows: The first sentence of Section 4 of the Long-Term Equity Incentive Plan is hereby amended as follows:

Subject to adjustments as provided in Section 15, as of any date the total number of shares of Common stock with respect to which awards may be granted under the Plan (the “Shares”) shall equal the excess (if any) of 62,068,750 over (i) the number of shares of Common stock subject to outstanding awards under the Plan or the Prior Plans, (ii) the number of shares of Common stock in respect of which options and stock appreciate rights have been exercised under the Plan or the Prior Plans, and (iii) the number of shares of Common stock issued pursuant to performance awards or issued subject to forfeiture restrictions which have lapsed under the Plan or the Prior Plans.