Office Depot's 2Q Results
August 1, 2007
Office Depot, Inc. (NYSE:ODP) announced second quarter results for the fiscal period ended June 30, 2007.
Second Quarter ResultsTotal Company Second quarter sales grew 4% to $3.6 billion compared to the second quarter of 2006. Sales growth in North America was flat in the second quarter, down from 3% in the first quarter, reflecting a continuation of the macro economic conditions in the U.S. North American Retail sales grew 1% with comparable store sales down 5% for the quarter. International sales increased 14% in U.S. dollars and 7% in local currencies.
Net earnings for the quarter on a GAAP basis were $109 million compared to $118 million in the same quarter of the prior year. GAAP earnings per share on a diluted basis were $0.40 in the second quarter of 2007 versus $0.41 in the same period a year ago. Excluding Charges, diluted earnings per share as adjusted were $0.43 in the second quarter of 2007, consistent with the second quarter last year(1). Net earnings, as adjusted, were $118 million in the second quarter of 2007 from $125 million in 2006.
"For eight straight quarters, we've executed the initiatives in our strategic plan to consistently deliver double digit EPS growth to our shareholders, averaging 32% growth in EPS, as adjusted, over the period," said Steve Odland, Office Depot's Chairman and CEO. "Unfortunately, this streak came to a halt this quarter. As previously discussed, we knew we were facing significant headwinds as we entered the second quarter this year, a quarter which also is seasonally our lowest point for sales. While we are frustrated that we weren't able to grow earnings at the same rate as in the previous two years, we are pleased that in this challenging sales environment we delivered earnings per share consistent with the prior year and were able to invest in our global business for the future. In North America we maintained our focus on pursuing only those sales which would yield profitable growth. This approach allowed us to somewhat mitigate the effects of a softening economy in North America while continuing to position us for margin expansion when economic conditions improve. We remain positive on the long term growth and margin expansion opportunities for Office Depot."
EBIT, as adjusted, was $176 million for the quarter or 4.9% as a percentage of sales, versus $186 million or 5.3% as a percentage of sales in the comparable prior year period(1).
Gross margin declined 50 basis points due principally to a shift in mix and increased property costs associated with new stores, which was partially offset by higher private brand sales. Operating expenses increased as a percentage of sales by approximately 10 basis points, reflecting investments made which more than offset benefits from cost management initiatives.
Year to date, share repurchases are approximately 5.7 million shares of Office Depot common stock for $200 million.
Return on Invested Capital (ROIC) for the trailing four quarters, as adjusted, improved 160 basis points to 15.5% compared to 13.9% in the prior year. Return on Equity (ROE), as adjusted, increased 460 basis points to 22.2% compared to 17.6% for the previous four quarters.
Second Quarter Division Results
North American Retail Division
Second quarter sales increased 1% to $1.5 billion, down from 3% growth in the first quarter. Comparable store sales in the 1,063 stores in the U.S. and Canada that have been open for more than one year decreased 5% for the second quarter. Comps were negatively impacted during the quarter by the continued softness in the economy. Office Depot's retail customers are predominantly small and home office businesses, as well as non-business consumers. The Company experienced softer sales in furniture and supplies, and, to a lesser extent, technology during the quarter as customers adjusted their spending in reaction to macroeconomic conditions such as changes in the housing market and higher fuel costs. Despite these soft market conditions, data from The NPD Group indicates that Office Depot's retail revenue share among office supply stores increased sequentially in the second quarter.
As U.S. new home construction continued to decline during the second quarter, the pace slowed to a rate of 24% below that of a year ago, underlining a persistent slump in the broader housing market. This trend significantly impacted Office Depot's furniture business which continued to experience soft sales and accounted for approximately 160 basis points of impact to the overall comp sales decrease. In addition, it is believed that the impact of this housing slump has adversely affected a broad range of small businesses and resulted in a reduction in customers overall spending patterns. Combined with rising fuel prices, these macroeconomic conditions have negatively impacted sales. Other drivers of the negative comps include new store build out (70 basis points), increases in private brand penetration (10 basis points), and costs associated with changes in mail-in rebate programs (40 basis points).
The Company chose not to repeat certain promotions that generated increased sales in the second quarter of 2006 because they did not generate an acceptable profit margin. The discontinuation of these promotions negatively impacted comps by approximately 70 basis points in the second quarter.
Although comparable store sales were disappointing, the North American Retail Division successfully delivered a 7% increase in operating profit to $104 million for the second quarter of 2007, compared to $96 million in the same period of the prior year.
Higher product margins and cost management initiatives more than offset the impact of the negative comps and increased property costs associated with new stores. Operating profit margins expanded to 6.8%, an increase of 40 basis points from 6.4% in the prior year period.
Average ticket size increased slightly. The comp decline was entirely driven by a reduction in the number of transactions.
Comparable average sales per square foot were $219 for the quarter.
Inventory per store was $965 thousand as of the end of the second quarter of 2007, 3% lower than the same period last year. On an average basis, inventory per store was $1,017 thousand for the second quarter of 2007, 4% higher than the same period last year.
North American Business Solutions DivisionNorth American Business Solutions Division sales were unchanged compared to the second quarter of last year, down from 3% growth in the first quarter. Second quarter 2007 revenue reflects growth in the contract channel of 4%, which was offset by expected declines in the direct channel from the continued effects of brand consolidation in the prior year. As previously discussed, this was a deliberate action geared toward reducing unprofitable business from our portfolio. As with Retail, sales in this division are being impacted by a soft macroeconomic environment, especially with small-sized businesses.
Offsetting softer sales in small-sized businesses is strong momentum in large and national segments, especially in the government and education customer verticals. These are profitable customers for the division and carry higher average total sales, although at lower margins.
The North American Business Solutions Division had an operating profit of $80 million for the second quarter of 2007 compared to $105 million for the same period of the prior year. On a sequential basis, operating margins improved 80 basis points from Q1, despite lower sales volume. On a comparable basis however, operating margins declined as expected versus second quarter 2006, reflecting a continuation of the temporarily higher expense levels associated with the investment in the expansion of both the contract sales force as well as the implementation costs associated with a new furniture delivery program coupled with the impact of changes in sales mix. Operating margins are anticipated to continue to improve sequentially during the second half of the year.
International DivisionAt almost $1.0 billion, the International Division reported increased revenues of $124 million, or an increase of 14% compared to the prior year. Sales in local currency increased 7% over the prior year. This marks the sixth consecutive quarter of sales growth in local currencies. In particular, the focus on expanding the contract sales force and new account acquisition continues to drive the top-line with sales in the contract channel growing by double digits in local currency versus the same period last year.
Division operating profit of $42 million for the quarter, compares to $48 million in the same period of 2006. Operating profit margin at 4.3% is 130 basis points lower when compared to the same period last year.
During the quarter, the International Division made a number of investments that resulted in short-term operating margin compression of approximately 100 basis points but positioned the Division to deliver longer term operating margin expansion. For example, the Division added almost 200 sales reps in Europe and Asia, expanded its global sourcing office in China and expanded its regional offices in Asia and Latin America. The Division also re-branded its Korean business from Best Office to Office Depot, which introduces the benefits of a global brand to that market. A similar re-branding in China was completed last year. These investments during the quarter more than offset the benefits from a continued focus on reducing ongoing operating costs. The International Division's efforts here are focused on investing in strategies that provide long term growth potential.
Acquisitions in the second half of 2006 also resulted in approximately 30 basis points of operating margin compression compared to the second quarter last year. However, collectively, the companies acquired in the prior year have grown revenues by over 50% on an annualized basis. We see these smaller acquisitions as opportunities to seed emerging market growth.
It is expected that these investments will begin to expand operating margin starting next year.v
