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Office Depot Beats on Bottom-Line

Zacks Equity Research

Amid sluggish economic environment, Office Depot Inc. (ODP) posted third-quarter 2012 earnings of 6 cents a share compared with a breakeven in the year-ago quarter, and way ahead of the Zacks Consensus Estimate of 1 cent. Effective cost management facilitated this office supply retailer to deliver better-than-expected bottom-line results.

Including one-time items, Office Depot slumped to a loss of 25 cents a share compared with an earnings of 28 cents registered in the prior-year quarter.

Office Depot’s total revenue of $2,692.9 million decreased 5% from the prior-year quarter and also fell short of the Zacks Consensus Estimate of $2,724 million. In constant currency, revenue slipped 3%.

Despite a 6% decline in cost of goods sold and occupancy costs during the quarter, gross profit dropped 2% to $834.7 million. However, gross margin expanded 90 basis points to 31% in the quarter.

Office Depot reported adjusted operating profit of $40.5 million up from $24.9 million in the year-ago quarter, whereas operating margin increased 60 basis points to 1.5%.

Segment Performance

During the quarter, North American Retail division revenue decreased 5% to $1,173.7 million, whereas comparable-store sales dropped 4%.  

Office Depot witnessed sharp sales decline across computers and other related products but registered sales increase across tablets and e-readers. Sales of Copy and Print rose while fell for office furniture. Sales in the supplies category remained even, whereas sales of ink and toner rose marginally. Management stated that customer transaction counts dropped 4%, while the average order value was marginally negative.

The division reported an operating loss of $21.3 million compared with an operating profit of $41.9 million in the prior-year quarter.

Total store count at the North America Retail division stood at 1,114 at the end of the quarter. During the quarter, the company opened 1, closed 4 and relocated 5 stores.

Revenue for North American Business Solutions inched up 1% to $827.4 million. Direct channel sales decreased, whereas contract channel sales rose. The division witnessed improved sales in Copy and Print, furniture and cleaning and breaks room supplies. Sales remained soft to federal and state government due to budget constraint but were higher to customers related to education sector.

The division posted operating profit of $54.8 million up from $39.1 million in the year-ago quarter.

The International division’s revenue dipped 12% in U.S. dollars to $691.9 million, whereas it fell 4% in constant currency. The overall sales in European contract channel dropped in the low single-digits as the growth witnessed in Germany and even sales in the U.K. were mitigated by soft sales in other parts of Europe. Asia contract channel sales rose in the high single-digits.

European direct channel experienced a sales decline but the rate of fall decelerated sequentially. The retail channel sales slipped in low single-digits in Europe, whereas in Asia, South Korean retail witnessed sales increase in high single-digits.

The division posted an operating profit of $1 million, drastically down from $19.5 million in the year-ago quarter. At the end of the quarter, total store count at the International division stood at 134. During the quarter, the company opened 1 and closed 1 store.

Other Financial Details

Office Depot, the operator of office supply stores under brand names such as Office Depot, Foray, Ativa, Break Escapes, Worklife and Christopher Lowell, generated free cash flow of $189.7 million and incurred capital expenditures of $26.2 million.

The company ended the quarter with cash and cash equivalents of $619.5 million, long-term debt of $486 million and shareholders’ equity of $676.9 million, excluding non-controlling interest of $95,000.

Closing Comment

No one can predict the future but efforts to combat the tough economy are obvious. Business budget remains tight, consumers remain more cautious than ever before and companies are trying hard to navigate through the challenging environment. Consumers and small businesses remain frugal about big ticket spending on items such as business machines and other durable products.

We believe that the demand for office products is closely tied to the health of the economy. Going by the pulse of the economy we prefer to have a long-term Neutral recommendation on the stock. However, Office Depot, which competes with OfficeMax Inc. (OMX) and Staples Inc. (SPLS), holds a Zacks #5 Rank that translates into a short-term Strong Sell rating.

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