Office Depot Inc. (ODP) recently posted improved second-quarter 2010 results. The quarterly loss of 7 cents a share portrayed a substantial improvement from a loss of 22 cents witnessed in the prior-year quarter, and also fared far better than the Zacks Consensus Estimate of a loss of 17 cents.
Despite a mid-single digit decline in the top-line, the office supplies retailer was able to narrow its bottom-line loss on the heels of cost containment. Cost of goods sold and occupancy costs fell 6.2%, store and warehouse operating and selling expenses tumbled 7.1%, whereas general and administrative expenses slipped 10.9% during the quarter.
The effective cost control helped deliver a gross profit growth of 0.3% to $766.7 million, whereas gross profit margin expanded 130 basis points to 28.4%. This reflects the fourth successive quarter of margin improvement.
Office Depot’s total revenue of $2,699.5 million missed the Zacks Consensus Revenue Estimate of $2,740 million, and dropped 4.4% from the prior-year quarter due to sluggish demand.
Segment Performance
During the quarter, North American Retail division’s revenue slid 2.2% to $1,100.9 million. Same-store sales fell 1% in the quarter. Office Depot hinted that the average order value climbed in the quarter, but customer transaction counts dropped compared with the year-ago quarter. The division reported an operating profit of $8.7 million compared with an operating loss of $13.1 million in the prior-year quarter.
Total store count at North America Retail division stood at 1,152 at the end of the quarter. The company during the quarter opened 7 stores and closed 4 stores.
North American Business Solutions’ revenue also dipped 5.5% to $820.2 million due to a decline in the number of consumer transactions. Operating profit fell 37.3% to $14.1 million on account of sluggish sales.
The International division’s revenue declined 6.2% to $778.3 million (in U.S. dollar terms). The division posted an operating profit of $18.9 million compared with $3.1 million delivered in the prior-year quarter. Better pricing management, and lower distribution costs and general and administrative expenses, helped boost operating profit results.
International division ended the quarter with 140 company-owned stores. The company opened one store and closed one 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 a negative free cash flow of $62.2 million during the quarter.
The company ended the quarter with cash and cash equivalents of $577.8 million, total long-term debt of $723.2 million (reflecting debt-to-capitalization ratio of 50.1%), and shareholders’ equity of $721.5 million. Capital expenditures for the quarter were $41.8 million.
Our View
Office Depot has been repositioning itself to keep afloat in a difficult consumer environment. It is containing costs, closing underperforming stores, managing inventory, and focusing on providing innovative products and services, which should all contribute to margin improvement. However, with sluggish sales as well as competition, we do not see any near-term positive catalyst.
We have a Neutral rating on Office Depot. However, ODP rates a Zacks #4 Rank, which translates into a short-term Sell recommendation on account of the company’s decision of not participating in the bid to renew the Los Angeles County office supplies contract. The company cited the terms of the new general office supplies agreement as its reason for not bidding for the new contract, which may adversely impact its profitability.
We believe that the loss of contract may hamper the company’s financial status. However, Office Depot notified that it would manage its infrastructure costs to alleviate the negative impact of the lost business. Moreover, the weakening Euro vis-à-vis dollar may adversely affect the company’s top and bottom lines.
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