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Office Depot Misses, Declares Merger

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Amid a sluggish economic environment, Office Depot Inc. (ODP - Free Report) posted breakeven earnings for the fourth quarter of 2012 that fell short of both the Zacks Consensus Estimate as well as the prior-year quarter earnings by 3 cents. Soft top-line performance muted the company’s cost containment efforts.

Including one-time items, Office Depot slumped to a loss of 6 cents a share compared with earnings of 4 cents registered in the year-ago quarter.

Office Depot’s total revenue of $2,622.8 million decreased 11.7% from the prior-year quarter and also came below the Zacks Consensus Estimate of $2,767 million. In constant currency, revenue slipped 11%.

Despite an 11.2% decline in cost of goods and occupancy costs during the quarter, adjusted gross profit dropped 12.9% to $783.8 million. Gross margin contracted 40 basis points to 29.9% in the quarter.

Office Depot reported adjusted operating income of $26 million down from $35.8 million in the year-ago quarter, whereas operating margin shriveled 20 basis points to 1%.

Concurrent with the earnings release, this Zacks Rank #5 (Sell) stock announced a merger deal with OfficeMax Incorporated , which has long been speculated. OfficeMax also came out with its fourth quarter results, delivering adjusted earnings of 16 cents a share that came a penny ahead of the Zacks Consensus Estimate but fell 5.9% year over year. Total sales tumbled 7.4% to $1,700.5 million.  

Segment Performance

During the quarter, North American Retail division revenue decreased 13% to $1,070.7 million, whereas comparable-store sales dropped 6%.  

Office Depot witnessed sales decline across notebook computers and software but registered sales increase across tablets, e-readers and desktop computers. Sales of Copy and Print, and cleaning and breakroom supplies rose but fell for office furniture and supplies. Management stated that customer transaction counts dropped 5%, while the average order value remained even.

The division reported an operating income of $10.6 million, substantially down from an operating income of $32.4 million in the prior-year quarter.

Total store count at the North America Retail division stood at 1,112 at the end of the quarter. During the quarter, the company opened 2, closed 4 and relocated 15 stores.

Revenue for North American Business Solutions decreased 8% to $763.4 million. Both direct and contract channels sales declined during the quarter. However, online sales increased on the back of higher traffic and increase in average order value but the direct channel witnessed fall in purchases from consumers who use catalogs while shopping and give orders via call centers.

The division posted operating income of $55.2 million up from $44.7 million in the year-ago quarter.

The International division’s revenue dipped 13% to $788.7 million, whereas it fell 11% in constant currency. The overall sales in European contract channel dropped in the mid-single digits as the growth witnessed in Germany and even sales in the UK were mitigated by soft sales in other parts of Europe. Asia contract channel sales remained flat compared with the prior-year quarter. European direct channel experienced a sales decline but the rate of fall decelerated sequentially. The retail channel sales slipped in Europe due to softness witnessed across Sweden and Hungary, partly offset by marginal sales increment in France, whereas in Asia, South Korean retail witnessed a marginal increase in sales.

The division posted an operating income of $23.4 million, down from $33 million in the year-ago quarter. At the end of the quarter, total store count at the International division stood at 123. During the quarter, the company closed 11 stores.

Other Financial Details

Office Depot generated cash flow of $95.2 million from operating activities and incurred capital expenditures of $31.5 million, resulting in free cash flow of $63.7 million.

The company ended the quarter with cash and cash equivalents of $670.8 million, long-term debt of $485.3 million and shareholders’ equity of $661.4 million, excluding non-controlling interest of $107,000.

About the Merger

Though the future remains unpredictable, efforts to combat the tough economy are obvious. Business budget remains tight, consumers are cautious than ever before and companies are trying hard to navigate through the challenging environment. Amid such a scenario, Office Depot and OfficeMax decided to unite to better compete with the industry bellwether, Staples Inc. and online rivals such as Inc. (AMZN - Free Report) .

The all-stock merger agreement, which involves 2.69 Office Depot shares for each share of OfficeMax, would result in cost synergies of $400 to $600 million yearly by the third year from the time of closing of the transaction. The transaction is expected to be concluded by the end of 2013. Management of both the companies are yet to decide on the name of newly formed company, the location of corporate headquarters and the CEO.

The consolidation augurs well for both the companies, who have been grappling with soft sales. The combined sales for the recently concluded year ended on Dec 29, 2012 stood at approximately $18 billion, whereas cash and cash equivalents together comes at $1.2 billion.

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