Office Depot Beats Estimates, Turns to Profit

| About: Office Depot (ODP)

Office Depot Inc. (ODP) recently posted better-than-expected third-quarter 2010 results. The quarterly earnings of 3 cents a share portrayed a substantial improvement from a loss of 8 cents in the prior-year quarter, and also fared better than the Zacks Consensus Estimate of a one-cent loss. The Zacks Consensus Estimate had been improving prior to the earnings announcement.

On a reported basis, including one-time items, earnings came in at 18 cents a share, as against a loss of $1.51 in the year-ago quarter.

Despite a mid-single digit decline in the top-line, the office supplies retailer was able to earn a profit on the heels of cost containment. Cost of goods sold and occupancy fell 4.5%, store and warehouse operating and selling expenses tumbled 6.9%, whereas general and administrative expenses slipped 12.7% during the quarter.

Office Depot’s total revenue of $2,899.7 million missed the Zacks Consensus Revenue Estimate of $2,954 million, and dropped 4.3% from the prior-year quarter due to soft demand for office supplies in a sluggish economy.

The improvement in the bottom-line overshadowed the fall in the top-line, which resulted in the rise of 2.7% or 13 cents for Office Depot’s shares to $4.90 in pre-market trading. Following this, a positive sentiment may be palpable among the analysts covering the stock, and we could witness a rise in the Zacks Consensus Estimates in the coming days.

Segment Performance

During the quarter, North American Retail division’s revenue slid 0.6% to $1,280.1 million. Same-store sales remained flat versus the prior-year quarter. Office Depot hinted that customer transaction counts rose compared with the year-ago quarter but the average order value fell in the quarter. The division reported an operating profit of $29.7 million, down 15.4% from the prior-year quarter.

Total store count at North America Retail division stood at 1,150 at the end of the quarter. The company during the quarter opened 3 stores, closed 5 stores and relocated 2 stores.

North American Business Solutions' revenue also dipped 4.4% to $841.8 million due to a decline in customer transaction counts. However, average order value grew marginally. To our surprise, operating profit climbed 17.8% to $25.1 million, reflecting a better sales mix.

The International division’s revenue declined 9.6% to $777.8 million (in U.S. dollar terms). The division posted an operating profit of $29.7 million, down 13.2% from the prior-year quarter, reflecting reduced sales volume, partially offset by better pricing management, and lower distribution costs and general and administrative expenses.

International division ended the quarter with 141 company-owned stores. The company opened 2 stores and closed 1 store during the quarter.

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 flows of $109 million during the quarter compared to $140.5 million in the prior-year period.

The company ended the quarter with cash and cash equivalents of $678.7 million, total long-term debt of $657.2 million (reflecting debt-to-capitalization ratio of 44.8%), and shareholders’ equity of $809.7 million. Capital expenditures for the quarter were $37.3 million.

Our View

Office Depot is repositioning itself to keep afloat in a difficult consumer environment. The company is containing costs, closing underperforming stores, reducing exposure to higher dollar-value inventory items, shuttering non-critical distribution facilities and focusing on providing innovative products and services, which should all contribute to margin improvement.

Furthermore, the company has always been looking for accretive opportunities to enhance its global footprint. Office Depot is reviewing capital-efficient opportunities to expand its reach in Eastern Europe, Asia and South America. The company believes that India and China will provide significant growth opportunities.

However, the company’s decision of not participating in the bid to renew the Los Angeles County office supplies contract, which is set to expire on January 1, 2011, may hamper its financial condition and keep the stock under pressure.

Moreover, we remain cautious about the macro-economic environment and sluggish job market. The recovery in the economy still lacks luster. As a result, consumers and small businesses still remain watchful about their spending on big-ticket items such as business machines and other durable products. We observe that the demand for office products is closely tied to the health of the economy.

We remain Neutral on the stock. Office Depot, which competes with Staples Inc. (SPLS) and OfficeMax Inc. (OMX), holds a Zacks #3 Rank, which translates into a short-term ‘Hold’ recommendation, and correlates with our view.

In a separate story, Office Depot declared that Steve Odland, who has been the Chairman and Chief Executive Officer of the company since 2005, has resigned effective November 1, 2010.