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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 27, 1998
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OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________________ to _____________________
Commission file number 1-10948
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OFFICE DEPOT, INC.
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(Exact name of registrant as specified in its charter)
Delaware 59-2663954
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2200 Old Germantown Road; Delray Beach, Florida 33445
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(Address of principal executive offices) (Zip Code)
(561) 438-4800
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(Registrant's telephone number, including area code)
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(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
The registrant had 159,803,233 shares of common stock outstanding as of
August 7, 1998.
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OFFICE DEPOT, INC.
Form 10-Q - Quarter ended June 27, 1998
INDEX
Page
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Consolidated Statements of Earnings for the
13 and 26 Weeks Ended June 27, 1998 and
June 28, 1997 3
Consolidated Balance Sheets as of
June 27, 1998 and December 27, 1997 4
Consolidated Statements of Stockholders'
Equity for the 26 Weeks Ended June 27, 1998
and the Year Ended December 27, 1997 5
Consolidated Statements of Cash Flows for the
26 Weeks Ended June 27, 1998 and
June 28, 1997 6
Notes to Consolidated Financial Statements 7 - 9
ITEM 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 10 - 17
ITEM 3. Not Applicable
PART II. OTHER INFORMATION 18
SIGNATURE 19
INDEX TO EXHIBITS 20
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OFFICE DEPOT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(In thousands, except per share amounts)
(Unaudited)
13 Weeks 13 Weeks 26 Weeks 26 Weeks
Ended Ended Ended Ended
June 27, June 28, June 27, June 28,
1998 1997 1998 1997
----------- ----------- ----------- -----------
Sales $ 1,697,539 $ 1,531,825 $ 3,678,635 $ 3,304,269
Cost of goods sold and occupancy costs 1,275,663 1,171,291 2,794,301 2,544,194
----------- ----------- ----------- -----------
Gross profit 421,876 360,534 884,334 760,075
Store and warehouse operating
and selling expenses 285,973 247,904 592,684 522,521
Pre-opening expenses 2,839 792 4,013 1,583
General and administrative expenses 51,371 45,581 106,836 91,647
Amortization of goodwill 1,311 1,311 2,622 2,623
----------- ----------- ----------- -----------
341,494 295,588 706,155 618,374
----------- ----------- ----------- -----------
Operating profit 80,382 64,946 178,179 141,701
Other income (expense)
Interest expense, net (1,937) (4,306) (2,878) (9,059)
Equity in (losses) earnings
of investees, net (3,534) (728) (8,041) (1,973)
Merger costs -- (9,483) -- (16,094)
----------- ----------- ----------- -----------
Earnings before income taxes 74,911 50,429 167,260 114,575
Income taxes 29,197 19,955 65,723 45,314
----------- ----------- ----------- -----------
Net earnings $ 45,714 $ 30,474 $ 101,537 $ 69,261
=========== =========== =========== ===========
Earnings per common share:
Basic $ 0.29 $ 0.19 $ 0.64 $ 0.44
Diluted 0.27 0.19 0.60 0.43
The accompanying notes are an integral part of these statements.
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OFFICE DEPOT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
June 27, December 27,
1998 1997
----------- -----------
(Unaudited)
ASSETS
Current assets
Cash and cash equivalents $ 327,486 $ 199,637
Receivables, net of allowances 447,957 494,942
Merchandise inventories 1,162,002 1,273,753
Deferred income taxes 43,345 35,846
Prepaid expenses 15,962 16,409
----------- -----------
Total current assets 1,996,752 2,020,587
Property and equipment, net 716,671 700,663
Goodwill, net of amortization 182,348 184,711
Other assets 107,811 75,128
----------- -----------
$ 3,003,582 $ 2,981,089
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable $ 726,406 $ 868,725
Accrued expenses 240,362 245,915
Income taxes 28,836 20,669
Current maturities of long-term debt 2,532 2,473
----------- -----------
Total current liabilities 998,136 1,137,782
Long-term debt, less current maturities 36,313 29,406
Deferred taxes and other credits 91,466 67,382
Zero coupon, convertible subordinated notes 426,552 417,614
Stockholders' equity
Common stock - authorized 400,000,000 shares of
$.01 par value; issued 161,554,426 in 1998 and
160,466,708 in 1997 1,616 1,605
Additional paid-in capital 670,447 647,752
Accumulated other comprehensive income (7,536) (5,503)
Retained earnings 788,338 686,801
Less: 2,163,447 shares of treasury stock, at cost (1,750) (1,750)
----------- -----------
1,451,115 1,328,905
----------- -----------
$ 3,003,582 $ 2,981,089
=========== ===========
The accompanying notes are an integral part of these statements.
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OFFICE DEPOT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except share amounts)
COMMON COMMON ADDITIONAL
STOCK STOCK PAID-IN
SHARES AMOUNT CAPITAL
----------- ------------- -------------
Balance at December 29, 1996 159,417,089 $ 1,594 $ 630,049
----------- ------------- -------------
Comprehensive income:
Net earnings for the period
Foreign currency translation adjustment
Comprehensive income
Exercise of stock options (including tax benefits) 611,084 6 9,598
Issuance of stock under employee
purchase plan 286,410 3 5,286
401(k) plan matching contributions 151,190 2 2,800
Conversion of LYONs to common stock 935 -- 19
----------- ------------- -------------
Balance at December 27, 1997 160,466,708 1,605 647,752
(UNAUDITED):
Comprehensive Income:
Net earnings for the period
Foreign currency translation adjustment
Comprehensive income
Exercise of stock options (including tax benefits) 879,302 9 17,010
Issuance of stock under employee
purchase plan 106,493 1 2,860
401(k) and deferred compensation plans
matching contributions 86,364 1 2,482
Conversion of LYONs to common stock 15,559 -- 343
----------- ------------- -------------
Balance at June 27, 1998 161,554,426 $ 1,616 $ 670,447
=========== ============= =============
ACCUMULATED
OTHER
RETAINED TREASURY COMPREHENSIVE COMPREHENSIVE
EARNINGS STOCK INCOME INCOME
------------- ------------- ------------- -------------
Balance at December 29, 1996 $ 527,125 $ (1,750) $ (1,073)
------------- ------------- -------------
Comprehensive income:
Net earnings for the period 159,676 $ 159,676
Foreign currency translation adjustment (4,430) (4,430)
-------------
Comprehensive income $ 155,246
=============
Exercise of stock options (including tax benefits)
Issuance of stock under employee
purchase plan
401(k) plan matching contributions
Conversion of LYONs to common stock
------------- ------------- -------------
Balance at December 27, 1997 686,801 (1,750) (5,503)
(UNAUDITED):
Comprehensive Income:
Net earnings for the period 101,537 $ 101,537
Foreign currency translation adjustment (2,033) (2,033)
-------------
Comprehensive income $ 99,504
=============
Exercise of stock options (including tax benefits)
Issuance of stock under employee
purchase plan
401(k) and deferred compensation plans
matching contributions
Conversion of LYONs to common stock
------------- ------------- -------------
Balance at June 27, 1998 $ 788,338 $ (1,750) $ (7,536)
============= ============= =============
The accompanying notes are an integral part of these statements.
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OFFICE DEPOT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Change in Cash and Cash Equivalents
(In thousands)
(Unaudited)
26 Weeks Ended 26 Weeks Ended
June 27, June 28,
1998 1997
------------- --------------
Cash flows from operating activities
Cash received from customers $ 3,654,945 $ 3,279,285
Cash paid for merchandise inventories (2,639,377) (2,360,515)
Cash paid for store and warehouse operating,
selling and general and administrative expenses (789,376) (675,714)
Interest received 7,631 1,363
Interest paid (1,822) (1,955)
Income taxes paid (60,017) (47,260)
----------- -----------
Net cash provided by operating activities 171,984 195,204
----------- -----------
Cash flows from investing activities
Capital expenditures, net (58,054) (39,474)
----------- -----------
Net cash used in investing activities (58,054) (39,474)
----------- -----------
Cash flows from financing activities
Proceeds from exercise of stock options and sales
of stock under employee stock purchase plan 17,278 5,117
Foreign currency translation adjustment (2,033) (1,117)
Payments on long- and short-term borrowings (1,326) (141,223)
----------- -----------
Net cash provided by (used in) financing activities 13,919 (137,223)
----------- -----------
Net increase in cash and cash equivalents 127,849 18,507
Cash and cash equivalents at beginning of period 199,637 51,398
----------- -----------
Cash and cash equivalents at end of period $ 327,486 $ 69,905
=========== ===========
Reconciliation of net earnings to net cash
provided by operating activities
Net earnings $ 101,537 $ 69,261
----------- -----------
Adjustments to reconcile net earnings to net cash
provided by operating activities
Depreciation and amortization 54,286 47,898
Provision for losses on inventory and accounts receivable 23,759 21,019
Accreted interest on zero coupon, convertible
subordinated notes 9,281 9,027
Contributions of common stock to employee
benefit and stock purchase plans 2,783 1,617
Changes in assets and liabilities
Decrease in receivables 41,170 14,590
Decrease in merchandise inventories 93,807 153,311
Increase in prepaid expenses, deferred income
taxes and other assets (41,320) (13,136)
Decrease in accounts payable, accrued
expenses and deferred credits (113,319) (108,383)
----------- -----------
Total adjustments 70,447 125,943
----------- -----------
Net cash provided by operating activities $ 171,984 $ 195,204
=========== ===========
The accompanying notes are an integral part of these statements.
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OFFICE DEPOT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. The interim financial statements as of June 27, 1998 and for the 13 and 26
week periods ended June 27, 1998 and June 28, 1997 are unaudited; however,
in the opinion of management, such interim statements reflect all
adjustments (consisting only of normal recurring items) necessary for a
fair presentation of the financial position, results of operations and
cash flows of Office Depot, Inc. (the "Company") for the interim periods
presented. Interim results are not necessarily indicative of the results
to be expected for the full year. The interim financial statements should
be read in conjunction with the audited financial statements for the year
ended December 27, 1997.
The Company maintains licensing agreements for the operation of Office
Depot stores in Colombia, Hungary, Israel and Poland and joint venture
agreements to operate stores in Mexico, France, Thailand and Japan. In
April 1998, the Company increased its ownership share in its Thailand
joint venture from 20% to 80%. Accordingly, the Company's share of the
Thailand joint venture's financial position, results of operations and
cash flows have been included in the consolidated interim financial
statements. All other joint ventures are accounted for using the equity
method.
2. In September 1996, the Company entered into an agreement and plan of
merger with Staples, Inc. ("Staples"). In June 1997, the proposed merger
was blocked by a preliminary injunction granted by the Federal District
Court at the request of the Federal Trade Commission. In July 1997, the
Company and Staples announced that the merger agreement had been
terminated. The Company recorded costs of $9,483,000 and $16,094,000,
respectively, during the 13 and 26 week periods ended June 28, 1997 that
were directly related to the terminated merger. These costs consisted
primarily of legal fees, investment banker fees and personnel retention
costs.
3. On May 18, 1998, the Company entered into an agreement and plan of merger
with Viking Office Products, Inc. ("Viking"). Pursuant to the merger
agreement, (i) VK Acquisition Corp., a wholly owned subsidiary of the
Company, will be merged with and into Viking which, as the surviving
corporation in the merger, will become a wholly owned subsidiary of the
Company, and (ii) each issued and outstanding share of Viking common stock
will be converted into one share of Office Depot common stock, subject to
dissenters' rights, as defined by the California Commercial Code. Shares
of Office Depot common stock outstanding on the effective date of the
merger will remain outstanding and unaffected by the merger. The
consummation of the merger is subject to several conditions, most of which
have been met. A special meeting of Office Depot and Viking stockholders
will be held on August 26, 1998 to vote on the merger.
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The merger, if completed, will be accounted for as a pooling of interests.
Accordingly, the Company's prior period consolidated financial statements
will be restated and combined with the prior period consolidated financial
statements of Viking, as if the merger had taken place at the beginning of
the periods reported. The Company will expense all merger and integration
costs as they are incurred.
Upon consummation of the merger, each outstanding option to purchase
shares of Viking common stock will be converted into an option to purchase
an equal number of shares of Office Depot common stock at an exercise
price per share equal to the stated exercise price for the shares of
Viking common stock. All Viking stock options outstanding as of May 18,
1998 will become exercisable in full for Office Depot shares upon
consummation of the merger.
4. Basic earnings per common share is based upon the weighted average number
of shares outstanding during each period. Diluted earnings per common
share further assumes that the zero coupon, convertible subordinated notes
were converted as of the beginning of the period and that dilutive stock
options were exercised. Net earnings under this assumption have been
adjusted for interest on the notes, net of the related income tax effect.
The following information was used to compute basic and diluted earnings
per share:
13 Weeks 13 Weeks 26 Weeks 26 Weeks
Ended Ended Ended Ended
June 27, June 28, June 27, June 28,
1998 1997 1998 1997
-------- -------- -------- --------
(in thousands)
Basic:
Weighted average number of
common shares outstanding 159,137 157,583 158,820 157,471
======== ======== ======== ========
Diluted:
Net earnings $ 45,714 $ 30,474 $101,537 $ 69,261
Interest expense related to
convertible notes, net of tax 2,871 2,860 5,708 5,552
-------- -------- -------- --------
Adjusted net earnings $ 48,585 $ 33,334 $107,245 $ 74,813
======== ======== ======== ========
Weighted average number of
common shares outstanding 159,137 157,583 158,820 157,471
Shares issued upon assumed
conversion of convertible notes 16,553 16,565 16,558 16,565
Shares issued upon assumed
exercise of stock options 5,338 1,281 4,772 1,609
-------- -------- -------- --------
Shares used in computing diluted
earnings per common share 181,028 175,429 180,150 175,645
======== ======== ======== ========
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5. The Consolidated Statements of Cash Flows do not include the following
non-cash investing and financing transactions:
26 Weeks Ended 26 Weeks Ended
June 27, June 28,
1998 1997
------------- -------------
(in thousands)
Additional paid-in capital related
to tax benefits on stock options exercised $2,302 $ 957
Assets acquired under capital leases 8,292 --
Common stock issued upon conversion of debt 343 --
6. In June 1997, SFAS No. 131, "Disclosures About Segments of an Enterprise
and Related Information," was issued. SFAS No. 131 establishes standards
for the way that companies report selected information about operating
segments in annual financial statements and requires that such companies
report selected information about segments in interim financial reports
issued to stockholders. It also establishes standards for related
disclosures about products and services, geographic areas and major
customers. SFAS No. 131, which supersedes SFAS No. 14, "Financial
Reporting for Segments of a Business Enterprise," retains the requirement
to report information about major customers and requires that companies
report financial and descriptive information about their reportable
operating segments.
Operating segments are defined as those components of an enterprise about
which separate financial information is regularly evaluated by the chief
operating decision maker when allocating resources and assessing
performance. SFAS No. 131 requires that companies report a measure of
segment profit or loss, certain specific revenue and expense items, and
segment assets. SFAS No. 131 also requires that companies report
descriptive information about the manner in which the operating segments
were determined, the products and services provided by the operating
segments, differences between the measurements used in reporting segment
information and those used in the enterprise's general-purpose financial
statements, and changes in the measurement of segment amounts from period
to period.
SFAS No. 131 is effective for financial statements issued for periods
beginning after December 15, 1997, but is not required for interim
financial statements in the initial year of its application. The Company
has not yet determined the effects that SFAS No. 131 will have on the
disclosures in its consolidated financial statements.
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Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Sales increased 11% to $1.698 billion and $3.679 billion during the second
quarter and first six months of 1998, respectively, from $1.532 billion and
$3.304 billion during the comparable periods of 1997. Approximately one-third of
the increase in sales for the second quarter and the first half of 1998 were
attributed to the 55 new office supply stores opened subsequent to the second
quarter of 1997. The remainder of the increase results from the 7% growth for
the second quarter and 8% growth for the first six months of 1998 in comparable
sales for stores and delivery warehouses ("delivery centers") open for more than
one year at June 27, 1998. Sales of computers, business machines and related
supplies continued to rise as a percentage of total sales in the second quarter
and first six months of 1998 over the comparable 1997 periods, driven primarily
by the sales of machine supplies. The average unit sales prices and comparable
store sales of computers for the first six months of 1998 have decreased from
the comparable period in 1997, while the number of units sold has increased.
The Company opened 18 office supply stores and closed one store in the first
half of 1998, bringing the total number of office supply stores open at the end
of the second quarter to 619, compared with 565 stores open at the end of the
second quarter of 1997. During the second quarter, the Company substantially
completed consolidation of four California delivery centers into two newer,
larger facilities, reducing the number of delivery centers to 21 as of the end
of the second quarter of 1998 from 23 at the end of the second quarter of 1997.
In the past few years, the Company has replaced several of its other delivery
centers with newer, larger facilities as well. The Company has substantially
completed the integration and conversion of its contract stationer business and
uses standard systems and procedures throughout its network of facilities. As of
June 27, 1998, the Company also operated three Images(TM), two Office Depot
Express(TM) and five Furniture At Work(TM) stores.
Gross profit as a percentage of sales was 24.9% and 24.0% during the second
quarter and first half of 1998, respectively, as compared with 23.5% and 23.0%
during the comparable periods of 1997. Gross profit as a percentage of sales
continued to be positively impacted by purchasing leverage gained from vendor
discount and rebate programs. Furthermore, the downward pressure on overall
gross profit has lessened in the second quarter and first half of 1998 as
compared to the comparable periods in 1997 because of improved margins on
computers and a favorable shift in sales mix to business machine supplies, which
yield much higher margins. These improvements in margin on computers, business
machines and related supplies were partially offset by lower margins on paper
products. The Company's gross profit as a percentage of sales fluctuates as a
result of numerous factors, including competitive pricing pressures, changes in
product and customer mix, suppliers pricing changes,
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as well as the Company's ability to achieve purchasing leverage through growth
in total merchandise purchases. Additionally, occupancy costs can vary as the
Company adds new stores and delivery centers.
Store and warehouse operating and selling expenses as a percentage of sales were
16.8% and 16.1% in the second quarter and first six months of 1998,
respectively, as compared to 16.2% and 15.8% in the second quarter and first six
months of 1997, respectively. The three largest components of store and
warehouse operating and selling expenses are payroll, depreciation and
advertising expenses. Store and warehouse operating and selling expenses as a
percentage of sales are significantly higher in the Business Services Division
than in the Stores Division principally because of the need for a more
experienced and more highly compensated sales force. Management expects these
expenses to decline from current levels as a percentage of sales if and when the
Business Services Division, now fully integrated, generates additional sales in
each market. Store and warehouse operating and selling expenses as a percentage
of sales have increased overall in the Business Services Division for the second
quarter and first half of 1998 as compared to the same periods in 1997 primarily
because of the substantial completion of the consolidation of four delivery
centers into two larger and newer facilities. Expenses in the Stores Division
increased in the second quarter and first six months of 1998 over the comparable
1997 periods because of the completion of 129 store remodels in the first half
of 1998. The increase in expenses is expected to continue as the Company plans
to complete approximately 70 additional remodels by the end of 1998. Late in the
fourth quarter of 1997, the Company launched a new advertising campaign,
significantly increasing broadcast and cable television exposure. This campaign
resulted in increased costs in both divisions during the first half of 1998.
Pre-opening expenses increased to $2.8 million in the second quarter of 1998
from $0.8 million in the comparable quarter of 1997 and increased to $4.0
million in the first half of 1998 from $1.6 million in the comparable 1997
period. The Company added 18 new office supply stores and closed one in the
first half of 1998, 17 of which were added in the second quarter, as compared
with five new and one replacement store in the comparable 1997 period, four of
which were added in the second quarter of 1997. Prior year store openings were
lower because of the uncertainty surrounding the merger with Staples, Inc.
("Staples"). Pre-opening expenses in the first half of 1998 also include costs
incurred to significantly expand one delivery center and open another larger
delivery center to replace two existing facilities, while pre-opening expenses
in the second quarter of 1997 include costs associated with replacing one
existing customer service center with a larger, more functional facility.
Pre-opening expenses, which currently approximate $0.1 million per standard
office supply store, are predominately incurred during a six-week period prior
to the store opening. Pre-opening expenses for a new standard-sized delivery
center are approximately $0.5 million and pre-opening expenses for a new
larger-sized delivery center, such as the facilities opened in California during
the first half of 1998, are approximately $1.0 million; however, these expenses
may vary with the size and type of future customer service centers. These
expenses consist principally of amounts paid for salaries and property expenses.
Because the Company's policy is to expense these
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items during the period in which they occur, the amount of pre-opening expenses
in each period is generally proportional to the number of new stores or delivery
centers opened or in the process of being opened during the period.
General and administrative expenses were 3.0% of sales for the second quarters
of 1998 and 1997, while these expenses increased as a percentage of sales to
2.9% for the first six months of 1998 from 2.8% for the first six months of
1997. In the first half of 1997, staffing issues associated with the Staples
merger resulted, to some extent, in fewer corporate personnel. By the end of the
first half of 1998, the Company had restaffed most of the corporate positions
and had strengthened its management team with the addition of several new key
executives. The Company's continuing commitment to improving the efficiency of
its management information systems and expanding its information systems
programming staff has increased general and administrative expenses in the short
term. In addition, certain corporate expenses have increased in the first half
of 1998 primarily because of management's involvement in the consolidation and
integration of the Company's California delivery centers and in the store
remodeling initiative. While the Company has been able to decrease other general
and administrative expenses, there can be no assurance that the Company will be
able to continue to increase sales without a proportionate increase in corporate
expenditures.
In September 1996, the Company entered into an agreement and plan of merger with
Staples. In June 1997, the proposed merger was blocked by a preliminary
injunction granted by the Federal District Court at the request of the Federal
Trade Commission. In July 1997, the Company and Staples announced that the
merger agreement had been terminated. The Company recorded costs of $9.5 million
and $16.1 million during the 13 week and 26 week periods ended June 27, 1998
that were directly related to the terminated merger. These costs consisted
primarily of legal fees, investment banker fees and personnel retention costs.
On May 18, 1998, the Company entered into an agreement and plan of merger with
Viking Office Products, Inc. ("Viking"). Pursuant to the merger agreement, (i)
VK Acquisition Corp., a wholly owned subsidiary of the Company, will be merged
with and into Viking which, as the surviving corporation in the merger, will
become a wholly owned subsidiary of the Company, and (ii) each issued and
outstanding share of Viking common stock will be converted into one share of
Office Depot common stock, subject to dissenters' rights, as defined by the
California Commercial Code. Shares of Office Depot common stock outstanding on
the effective date of the merger will remain outstanding and unaffected by the
merger. The consummation of the merger is subject to several conditions, most of
which have been met. A special meeting of Office Depot and Viking stockholders
will be held on August 26, 1998 to vote on the merger.
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The merger, if completed, will be accounted for as a pooling of interests.
Accordingly, the Company's prior period consolidated financial statements will
be restated and combined with the prior period consolidated financial statements
of Viking, as if the merger had taken place at the beginning of the periods
reported. The Company will expense all merger and integration costs as they are
incurred.
LIQUIDITY AND CAPITAL RESOURCES
Since the Company's inception in March 1986, it has relied upon equity capital,
convertible debt, capital equipment leases and bank borrowings as the primary
sources of its funds. Because the majority of the Company's store sales are on a
cash and carry basis, cash flow generated from operating stores provides a
source of liquidity to the Company. The Company also uses private label credit
card programs administered and financed by financial services companies, which
allow the Company to expand its store sales without the burden of additional
receivables. Working capital requirements are reduced by vendor credit terms
that allow the Company to finance a portion of its inventory.
Sales made to larger customers through the Company's contract business are
generally made pursuant to regular commercial credit terms under which the
Company carries its own receivables, as opposed to sales made to smaller
customers, who generally pay in cash or by credit card. Therefore, as the
Company expands its contract business, management anticipates that the Company's
credit sales will continue to grow.
Receivables from vendors under rebate, cooperative advertising and marketing
programs, which comprise a significant percentage of total receivables, tend to
fluctuate seasonally, growing during the second half of the year and declining
during the first half. Industry practice dictates that under such programs, a
significant portion of the collections are made after an entire program year has
been completed.
In the first six months of 1998, the Company added 18 and closed one office
supply store, compared with five new and one replacement office supply store and
one new Furniture at Work(TM) store added in the comparable period of 1997. In
addition, the Company consolidated four delivery centers in its Business
Services Division into two newer, larger facilities during the first six months
of 1998, as compared to replacing one delivery center with a larger facility in
1997. Uncertainty and staffing issues associated with the Staples merger
negatively affected the Company's store opening program during 1997 and
continued to impact it through the first half of 1998. The Company has recently
hired several real estate personnel and regained its store opening momentum.
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Net cash provided by operating activities was $172 million in the first six
months of 1998, compared with $195 million provided in the comparable 1997
period. This decrease was driven primarily by increased expenditures for the
Company's store remodeling program and warehouse consolidations. Increases in
contract and commercial sales from existing delivery centers also leverage
assets employed and generate incremental working capital. Cash generated from
operations is also affected by fluctuations in the levels of receivables and
inventory. Capital expenditures are also affected by the number of stores and
warehouses opened, replaced or remodeled each year as well as the increase in
computer and other equipment at the corporate office required to support such
expansion. Cash used for capital expenditures was $58 million in the first six
months of 1998 and $39 million in the first six months of 1997.
During the 26 weeks ended June 27, 1998, the Company's cash balance increased by
$128 million and long- and short-term debt decreased by almost $2 million,
excluding $9 million in non-cash accretion of interest on the Company's zero
coupon, convertible subordinated debt and $8 million in debt created by the
acquisition of assets through capital leases.
The Company entered into a new credit agreement in February 1998 with a
syndicate of banks which provides for a working capital line and letters of
credit totaling $300 million. The new credit agreement replaced the Company's
previous credit agreement and provides that funds borrowed bear interest, at the
Company's option: at a rate based on a grid incorporating credit rating and
fixed charge coverage ratio factors that currently would result in .18 % over
LIBOR, at .5% over the Federal Funds rate, at a base rate linked to the prime
rate, or at a rate determined under a competitive bid facility. The Company must
also pay a facility fee at a rate based on a grid incorporating credit rating
and fixed charge coverage ratio factors that currently would result in a .095%
per annum charge on the total credit facility. The credit facility expires in
February 2003. The credit agreement contains certain restrictive covenants
relating to various financial statement ratios. As of June 27, 1998, the Company
had no outstanding borrowings under the credit facility and had outstanding
letters of credit totaling $9.5 million.
The Company currently plans to open approximately 70 additional stores in the
second half of 1998. Management estimates that the Company's cash requirements,
exclusive of pre-opening expenses, will be approximately $1.9 million for each
additional office supply store, which includes an average of approximately $1.1
million for leasehold improvements, fixtures, point-of-sale terminals and other
equipment in the stores, as well as approximately $0.8 million for the portion
of the store inventory that is not financed by vendors. In addition, management
estimates that each new store requires pre-opening expenses of approximately
$0.1 million. The cash requirements for a
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delivery center, exclusive of pre-opening expenses, are significantly more than
a store. Each new delivery center requires pre-opening expenses of approximately
$0.5 million to $1.0 million depending on the size of the facility.
IMPACT OF THE YEAR 2000
The Company has undertaken a comprehensive review of all computer hardware and
software and other operating equipment and systems to mitigate disruption of its
business as a result of the Year 2000. The project has a dedicated organization,
including outside consultants and suppliers, who have developed an overall
scope, approach, methodology and communication plan. The organization's goal is
to complete certification testing by the first quarter of 1999.
Many of the Company's computer systems have been developed over the past four
years, and management believes that they are already Year 2000 compliant. Any
required remediation for priority systems, defined as those systems that affect
customer service and product availability or that are critical to continued
operations, is scheduled for completion by the end of 1998. Additionally, the
Company is reviewing the Year 2000 issue with its suppliers, shippers, customers
and other external business partners. A survey developed to assess Year 2000
readiness was recently mailed to approximately 1,200 suppliers, and the
dedicated Year 2000 organization will work with key suppliers to follow their
progress and perform collaborative testing where appropriate.
The Company does not expect the costs associated with its Year 2000 compliance
program to have a material effect on its financial position or its results of
operations. There can be no assurance until 2000, however, that all of the
Company's systems, and the systems of its suppliers, shippers, customers and
other external business partners will function adequately. If any such systems
are not Year 2000 compliant, it could have a material adverse effect on the
Company.
NEW ACCOUNTING PRONOUNCEMENT
The Company will adopt the following Statement of Financial Accounting Standard
("SFAS") in the year ending December 26, 1998.
SFAS No. 131, "Disclosures About Segments of an Enterprise and Related
Information," establishes standards for reporting certain information about the
Company's operating segments. These disclosures should include the reported
segments' sales, operating profit, identifiable assets and other certain
information. This Statement is effective for fiscal years beginning after
December 15, 1997 and will require disclosure of prior period information, if
practicable. This statement is not required to be applied to interim financial
statements in the initial year of its application. The Company has not yet
determined the impact of adopting this pronouncement on its financial
statements.
FUTURE OPERATING RESULTS
With the exception of historical matters, the matters discussed in this
Quarterly Report on Form 10-Q are forward-looking statements that involve risks
and uncertainties, including those discussed below. The factors discussed below
could affect the Company's actual results and could cause the Company's actual
results during the remainder of 1998 and beyond to differ materially from those
expressed in any forward-looking statement made by the Company.
The Company currently plans to open approximately 70 additional stores in the
second half of 1998. There can be no assurance that the Company will be able to
find favorable store
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locations, negotiate favorable leases, hire and train employees and store
managers, and integrate the new stores in a manner that will allow it to meet
its expansion schedule. The failure to expand by opening new stores as planned
could have a material adverse effect on the Company's future sales growth and
profitability.
The Company competes with a variety of retailers, dealers and distributors in a
highly competitive marketplace. High-volume office supply chains, mass
merchandisers, warehouse clubs, computer stores and contract stationers that
compete directly with the Company operate in most of its geographic markets.
More recently, the Company began competing with internet-based merchandisers.
This competition is expected to increase in the future as both the Company and
these and other companies continue to expand their operations. There can be no
assurance that such competition will not have an adverse effect on the Company's
business in the future.
In addition, as the Company expands the number of its stores in existing
markets, sales of existing stores may suffer. New stores typically require
several months or longer to reach the levels of sales and profitability of the
Company's existing stores, and there can be no assurance that new stores will
ever be as profitable as existing stores because of competition from other store
chains and the tendency of existing stores to share sales as the Company opens
new stores in its more mature markets. The Company's comparable sales results
are affected by a number of factors, including the opening of additional Office
Depot stores; the expansion of the Company's contract stationer business in new
and existing markets; competition from other office supply chains, mass
merchandisers, warehouse clubs, computer stores and contract stationers; and
regional and national economic conditions. In addition, the Company's gross
margin and profitability could be adversely affected if its competitors were to
attempt to capture market share by reducing prices.
Fluctuations in the Company's quarterly operating results have occurred in the
past and may occur in the future. A variety of factors such as new store
openings with their concurrent pre-opening expenses, the extent to which new
stores are less profitable as they commence operations, the effect new stores
have on the sales of existing stores in more mature markets, the pricing
activity of competitors in the Company's markets, changes in the Company's
product mix, increases and decreases in advertising and promotional expenses,
the effects of seasonality, acquisitions of contract stationers and stores of
competitors or other events could contribute to this quarter to quarter
variability.
Costs related to the integration of acquired facilities in the Company's
delivery business and the remodeling of stores have contributed to increased
store and warehouse expenses, and these costs are expected to continue impacting
store and warehouse expenses at decreasing levels through 1998. The failure to
achieve the projected improvements in operating margins could result in a
significant impact on the Company's net income in the future. Furthermore, the
Company's growth, through both store openings and acquisitions, will continue to
require the expansion and upgrading of the Company's operational and financial
systems, as well as necessitate the hiring of new managers at the store and
supervisory level.
On May 18, 1998, the Company entered into an agreement and plan of merger with
Viking. Integrating the operations and management of Office Depot and Viking
will be a complex process, and there can be no assurance that this integration
will be completed rapidly or will result in the achievement of all of the
anticipated synergies and other benefits expected to be realized for the merger.
Moreover, the integration of the two companies will require significant
management attention, which may temporarily distract management from its usual
focus on the daily operations of their respective businesses. The ability of
management to integrate successfully the operations of Office Depot and Viking,
or any significant delay in achieving such integration, could have a material
adverse effect on the business and operating results of the combined company.
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The Company has entered a number of international markets using licensing and
joint venture agreements. The Company intends to enter other international
markets as attractive opportunities arise. In addition to the risks described
above arising from the Company's domestic store and delivery operations,
internationally, the Company also faces the risk of foreign currency
fluctuations, political and social conditions, obtaining adequate and
appropriate inventory and, because its foreign operations are not wholly-owned,
compromised operating control in certain countries.
The Company believes that its current cash and cash equivalents, lease financing
arrangements and funds available under its revolving credit facility should be
sufficient to fund its planned expansion and other operating cash needs,
including investments in international joint ventures, for at least the next
twelve months. However, there can be no assurance that additional sources of
financing will not be required during the next twelve months as a result of
unanticipated cash demands or opportunities for expansion or acquisition,
changes in growth strategy or adverse operating results. Also, alternative
financing will be considered if market conditions make it financially
attractive. There also can be no assurance that any additional funds required by
the Company, whether within the next twelve months or thereafter, will be
available to the Company on satisfactory terms.
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PART II. OTHER INFORMATION
ITEMS 1 LEGAL PROCEEDINGS
On May 21, 1998, a Viking stockholder filed a purported class action complaint
in Superior Court, State of California, County of Los Angeles for breach of
fiduciary duties against Viking. The complaint also names Office Depot as a
defendant, alleging that it aided and abetted Viking in the breach of its
fiduciary duties. The complaint seeks an injunction against the merger and the
certification as a class of all Viking stockholders.
The Company believes that this complaint is without merit and will aggressively
defend against the suit and will continue to pursue the merger with Viking.
ITEMS 2 - 4 Not applicable.
ITEM 5 OTHER INFORMATION
Details of a special meeting of stockholders to be held on August 26, 1998 and
the Joint Proxy Statement/Prospectus of Viking Office Products, Inc. and Office
Depot, Inc. are incorporated by reference to the Company's Registration
Statement on Form S-4 filed with the SEC on July 22, 1998.
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
a. 27.1 Financial Data Schedule (for SEC use only)
b. A Current Report on Form 8-K was filed on May 21, 1998 regarding the
proposed merger with Viking Office Products, Inc. and is incorporated
by reference herein.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
OFFICE DEPOT, INC.
------------------
(Registrant)
Date: August 11, 1998 By: /s/ BARRY J. GOLDSTEIN
-----------------------------------
Barry J. Goldstein
Executive Vice President-Finance
and Chief Financial Officer
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INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION PAGE NO.
27.1 Financial Data Schedule (for SEC use only)
20
5
1,000
6-MOS
DEC-26-1998
DEC-28-1997
JUN-27-1998
327,486
0
285,824
21,992
1,162,002
1,996,752
1,099,127
382,456
3,003,582
998,136
465,397
0
0
1,616
1,449,499
3,003,582
3,678,635
3,678,635
2,794,301
3,390,998
109,458
3,989
11,050
167,260
65,723
101,537
0
0
0
101,537
.64
.60
