Office Depot Misses Slightly

| About: Office Depot (ODP)

Office Depot Inc. (NYSE:ODP) recently posted lower-than-expected third-quarter 2011 results. The company reported a break-even that missed the Zacks Consensus Estimate by a couple of cents, but portrayed a marginal improvement from a loss of 2 cents a share delivered in the year-ago quarter.

On a reported basis, including one-time items, Office Depot’s quarterly earnings came in at 28 cents a share that more than doubled from 12 cents earned in the prior-year quarter.

Office Depot’s total revenue of $2,836.7 million fell short of the Zacks Consensus Estimate of $2,894 million, and also dropped 2.2% from the prior-year quarter’s revenue of $2,899.7 million.

Store and warehouse operating and selling expenses inched up 1%, while general and administrative expenses climbed 5.4%. However, cost of goods sold and occupancy declined 4.3%.

Gross profit rose 3.1% to $855 million, whereas gross margin expanded 150 basis points to 30.1%. Adjusted operating profit came in at $24.9 million compared with $8.3 million in the prior-year quarter, whereas operating margin increased 60 basis points to 0.9%.

Segment Performance

During the quarter, revenue for the North American Retail division slid 4% to $1,232.7 million. Same-store sales fell 2%. Office Depot witnessed comps decline in computers and related products, which were partially offset by comps growth in supplies, back-to-school necessities, Tech Depot Services and Copy and Print Depot.

However, sales across furniture remain flat. Customer transaction counts dropped 2% and the average order value fell marginally. The stores closed in Canada also lead to the decline in total sales for the quarter.

The division reported an operating profit of $41.9 million compared with $29.7 million in the prior-year quarter. The increase in profit was attributed to improved gross margin on account increase in sales mix of supplies and lower technology products, effective price and promotional management, and reduced property expenses.

Total store count at the North America Retail division stood at 1,132 at the end of the quarter. During the quarter, the company opened 3 stores and closed 2 stores.

Revenue for North American Business Solutions also dipped 2% to $820.9 million due to a decline in customer transaction counts. However, average order value remained flat. Direct channel sales remained flat, whereas contract channel sales decreased 3%. The division witnessed a decline in sales of supplies, including paper and ink and toner. These were partly offset by rise in sales across cleaning and break room categories.

Operating profit increased to $39.1 million from $25.1 in the year-ago quarter, reflecting effective cost management and increased gross margin.

The International division’s revenue inched up 1% to $783.2 million (in U.S. dollar terms) but dipped 7% in constant currency. The overall sales in contract channel rose witnessing growth in the U.K. and Germany, but partly offset by softness seen in sales in the public organization in other parts of Europe. Direct channel experienced a sales decline.

The division posted an operating profit of $19.5 million down from $29.7 million in the year-ago quarter due to a fall in constant currency sales and the divestment of business in Israel, which benefited the prior-year results.

At the end of the quarter, total store count at the International division stood at 132. During the quarter, the company 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 $139.3 million during the quarter compared with $109.9 million in the prior-year period.

The company ended the quarter with cash and cash equivalents of $452.7 million, long-term debt of $647.7 million (reflecting debt-to-capitalization ratio of 46.5%), and shareholders’ equity of $746.1 million, excluding non-controlling interest of $0.2 million. Capital expenditures for the quarter came in at $28.7 million.

Let’s Conclude

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 rating on the stock. Moreover, Office Depot, which competes with Staples Inc. (NASDAQ:SPLS) and OfficeMax Inc. (NYSE:OMX), holds a Zacks #3 Rank that translates into a short-term Hold rating and correlates with our long-term view.