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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 26, 1998
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 1-10948
OFFICE DEPOT, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 59-2663954
(State or other jurisdiction of incorporation (I.R.S. Employer Identification No.)
or organization)
2200 OLD GERMANTOWN ROAD, 33445
DELRAY BEACH, FLORIDA (Zip Code)
(Address of principal executive offices)
</TABLE>
Registrant's telephone number, including area code: 561/438-4800
Securities registered pursuant to Section 12(b) of the Act:
<TABLE>
<CAPTION>
NAME OF EACH EXCHANGE ON
TITLE OF EACH CLASS WHICH REGISTERED
------------------- ------------------------
<S> <C>
Common Stock, par value $0.01 per share..................... New York Stock Exchange
Preferred Share Purchase Rights............................. New York Stock Exchange
Liquid Yield Option Notes due 2007 convertible into Common
Stock..................................................... New York Stock Exchange
Liquid Yield Option Notes due 2008 convertible into Common
Stock..................................................... New York Stock Exchange
</TABLE>
Securities registered pursuant to Section 12(g) of the Act: None
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of voting stock held by non-affiliates of the
registrant as of March 5, 1999 was approximately $8,413,828,062.
As of March 5, 1999, the Registrant had 248,983,334 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Annual Report to Stockholders for the fiscal
year ended December 26, 1998 are incorporated by reference in Part II, and the
Proxy Statement to be mailed to stockholders on or about March 19, 1999 for the
Annual Meeting to be held on April 21, 1999 is incorporated by reference in Part
III.
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PART I
ITEM 1. BUSINESS.
GENERAL
Office Depot, Inc. ("Office Depot" or the "Company") is the largest
supplier of office products and services in the world. The Company sells to
consumers and businesses of all sizes through three business segments -- Stores,
Business Services and International. The Company operates on a 52 or 53 week
fiscal year ending on the last Saturday in December.
Stock Split
On February 24, 1999, the Company's Board of Directors declared a
three-for-two stock split in the form of a 50% stock dividend payable on April
1, 1999 to stockholders of record on March 11, 1999. With the exception of pro
forma earnings per share, share and per share information in this Form 10-K does
not reflect this stock split.
Stores
Office Depot began its operations by opening its first retail office supply
store in Florida in October 1986. Through its Stores Division, as of March 12,
1999, it operated 706 retail office supply stores in 41 states, the District of
Columbia and 5 Canadian provinces.
The Company's stores use a warehouse format. This method of retailing
involves the display of merchandise using low-profile fixtures, pallets, bins
and industrial steel shelving that permit the bulk stacking of inventory and
quick and efficient restocking. Shelving is positioned to form aisles large
enough to comfortably accommodate customer traffic and merchandise movement. The
stores carry a wide selection of merchandise, including brand name office
supplies, business machines and computers, computer software, office furniture
and other business-related products. The stores sell primarily to small
offices/home offices and individual consumers. Each Office Depot store also
contains a multipurpose print and copy center offering printing, copying and a
wide assortment of other services. The stores' sales staff includes specialists
who are trained to answer customer questions regarding a wide variety of
technology-oriented products.
The Company's expansion program is carried out either by leasing existing
retail space and renovating it according to Office Depot's specifications or by
constructing new space. Prior to selecting a new store site, the Company obtains
detailed demographic information indicating business concentrations, traffic
counts, population, income levels and future growth prospects. The Company's
stores are located primarily in suburban strip shopping centers on major
commercial roadways where the cost of space is generally lower than at urban
locations. These suburban locations are generally more accessible to the
Company's primary customers, have convenient parking and readily receive
inventory on a daily basis.
The Company's retail stores average 27,500 square feet and conform to a
model designed to achieve cost efficiency by minimizing rent and eliminating the
need for a central warehouse. Each store displays virtually all of its inventory
on the sales floor according to a uniform store layout plan. This plan is
intended to display merchandise effectively, use merchandising space efficiently
and provide customers with a consistent and appealing store layout. In 1998, the
Company accelerated its store remodeling program and remodeled approximately 200
of its stores to a newer and more appealing store layout.
Prior to being displayed on the sales floor, inventory is labeled for
automatic processing. Sales are processed through sophisticated registers
located at the front of the store. In the retailing business, different products
are managed and referred to using unique alpha-numeric codes known as
stock-keeping-units, or "SKUs." Each day, sales and inventory information are
transmitted by SKU to the Company's central computer system, and pricing
information is transmitted from the central computer system to the stores.
Rather than individually price marking each product, a master sign for each
product displays its price. As price changes occur, new master signs are
automatically generated for the product display and the new prices are reflected
in the register, allowing the Company to avoid labor costs associated with price
remarking.
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The Company's overall business strategy for its Stores Division is to
increase the sales and profitability of existing stores and to add new stores in
locations where the Company can establish a significant market presence. Store
opening activity for the last five years is summarized as follows:
<TABLE>
<CAPTION>
OPEN AT
BEGINNING OPEN AT END
OF YEAR OPENED CLOSED RELOCATED OF YEAR
------------ ------ ------ --------- -----------
<S> <C> <C> <C> <C> <C>
1994.................................... 351 71 2 1 420
1995.................................... 420 82 1 6 501
1996.................................... 501 60 -- 3 561
1997.................................... 561 42 1 2 602
1998.................................... 602 101 1 5 702
</TABLE>
The rate of new store openings during 1997 and the first nine months of
1998 was reduced because of uncertainty associated with the proposed merger with
Staples, Inc. ("Staples"), which was terminated in July 1997. By the fourth
quarter of 1998, however, the Company restaffed its real estate department and
significantly increased the pace of store openings. The Company currently plans
to open at least 105 stores in the United States and Canada during 1999.
Business Services
In the early 1990's, Office Depot expanded its delivery business and began
offering contract stationer services. Through its contract stationer operations,
the Company provides a wide variety of office products to medium and large
business customers who have continuing relationships with the Company, often
through contractual agreements. The customer relationship is typically managed
by a dedicated sales organization.
The Company's Business Services Group offers delivery and contract services
to individuals, small and home office businesses, larger businesses, educational
institutions and government agencies through catalogs, contract and public web
sites and a dedicated sales force.
The Company provides its contract and commercial customers access to a
broad selection of stocked office products and office furniture, as well as
special order items. In addition, the Company provides its contract customers
with specialized services designed to aid them in achieving improved
efficiencies and a significant reduction in their overall office products and
office furniture costs. These services include electronic ordering, stockless
office procurement, desktop delivery and comprehensive product usage reports.
Office Depot currently operates customer service centers ("CSCs") in 18
states. CSCs, which range in size from 51,000 to 662,000 square feet, serve as
warehouse and delivery facilities. Many also house sales offices, call centers
and administrative offices. Most of the Company's delivery business is handled
through these facilities. The Company believes that its CSCs, along with their
surrounding satellite facilities, provide cost effective and efficient delivery
services to its customers in the 48 contiguous states. In 1998, the Company
merged with Viking Office Products, Inc. ("Viking"), a global direct marketing
office products company, significantly increasing the customer base and
marketing expertise of the Business Services Group.
In 1998, prior to the merger with Viking, the Company completed the
integration of its Office Depot CSCs into a national delivery network. This
integration included replacing and significantly expanding a number of existing
facilities with larger, more efficient CSCs and installing uniform order entry,
warehouse management and routing systems. Customers place orders by phone, fax,
electronic data interchange ("EDI") and e-commerce (Internet/intranet). Orders
are routed to the appropriate CSC for delivery. If an item is not in stock, the
order is automatically routed to a wholesaler. Wholesaler orders are generally
delivered to the CSC the same day, enabling Office Depot to deliver complete
orders to its customers the next day.
With the addition of 10 facilities through its merger with Viking, the
Company currently operates 30 CSCs. In formulating its strategy for integrating
the two companies, the Company has announced plans to close several facilities
by the end of 2000. See MERGERS AND ACQUISITIONS for further discussion of the
merger.
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In January 1998, the Company introduced the Office Depot Internet site
(www.officedepot.com), expanding its e-commerce capabilities beyond the existing
contract web site. The Company's web site provides customers with the same
assortment of products offered to its catalog customers with the convenience of
electronic ordering. It also provides news articles that would be of interest to
small office/home office businesses as well as pertinent information about
Office Depot.
The Company's strategies for growing its Business Services Group include
continuing to build and expand upon its integrated national network to provide
efficient and effective delivery services to customers. During 1998, the Company
completed the consolidation of its five Office Depot CSCs in California into two
larger facilities. The Company will begin integrating the Viking order entry,
warehouse management and routing systems into its national network in 1999.
Additionally, the Business Services Group plans to increase its penetration into
new and existing markets by expanding the coverage of its contract sales force,
which currently exceeds 900 account executives, and by increasing the frequency
and variety of its direct mail catalogs.
International
The Viking brand launched its international expansion in 1990 with the
opening of its United Kingdom operations. The first Office Depot store outside
of the United States and Canada opened in Colombia in late 1993. Today, the
Company's International Division has expanded its international retail and
catalog business to include operations in 17 countries outside of the United
States and Canada.
The International Division operates retail office supply stores and
provides catalog and delivery services to customers in Australia, Austria,
Belgium, Colombia, France, Germany, Hungary, Ireland, Israel, Italy, Japan,
Luxembourg, Mexico, The Netherlands, Poland, Thailand and United Kingdom. In
addition to delivery warehouses, certain of the Company's international CSCs
house call centers and administrative offices. While most of the International
Group's operations are wholly-owned, certain countries operate under license and
joint venture agreements. Stores, call centers, and CSCs open as of December 26,
1998 were located in the following countries:
<TABLE>
<CAPTION>
COUNTRY STORES CALL CENTERS CUSTOMER SERVICE CENTERS
- ------- ------ ------------ ------------------------
<S> <C> <C> <C>
Australia(4)................................... -- 1 2
Austria........................................ -- 1 --
Colombia(1).................................... 4 -- --
France(3)(4)................................... 15 1 2
Germany........................................ -- -- 2
Hungary(1)..................................... 3 -- --
Ireland(4)..................................... -- 1 1
Israel(2)...................................... 15 -- 1
Italy.......................................... -- 1 1
Japan(2)....................................... 3 -- 2
Mexico(2)...................................... 34 -- 2
The Netherlands................................ -- 1 1
Poland(1)...................................... 11 -- --
Thailand(2).................................... 2 -- --
United Kingdom(4).............................. -- 3 3
--- --- ---
Total................................ 87 9 17
=== === ===
</TABLE>
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(1) Operated under license agreements.
(2) Operated under joint venture agreements.
(3) In November 1998, the Company purchased its joint venture partner's 50%
ownership share in its French operations, making France a wholly-owned
operation. See MERGERS AND ACQUISITIONS.
(4) The call centers are housed inside the customer service centers.
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MERGERS AND ACQUISITIONS
On August 26, 1998, the Company completed its merger with Viking. In
conjunction with the merger, each outstanding share of Viking common stock was
converted into one share of Office Depot common stock. The merger was accounted
for as a pooling of interests. Accordingly, all financial data, statistical
data, financial statements and discussions of financial and other information
have been restated to include Viking's information as if the merger had taken
place at the beginning of the periods reported.
In September 1998, in formulating its strategy for integrating Office Depot
and Viking, management announced plans to close several facilities by the end of
2000. The facilities to be closed are either redundant or handle business that
can be more efficiently handled by other existing facilities. The Company
recorded costs of $108.1 million during the year ended December 26, 1998 that
were directly related to the Viking merger. These costs consisted of legal fees,
investment banker fees, asset impairment associated with the closure of
identified facilities, write-off of software applications to be abandoned,
personnel costs and other facility exit and integration costs. For additional
information regarding the restructuring, refer to Management's Discussion and
Analysis incorporated by reference in Item 7 of this report.
In November 1998, the Company increased its ownership position in its
operations in France from 50% to 100% by purchasing for $27.7 million its joint
venture partner's ownership share. As a result of the purchase, the Company
recorded goodwill of $20.2 million.
RESTRUCTURING
In addition to the Company's core office products retail and delivery
businesses, the Company has also operated the following concepts:
Images(TM) and Office Depot Express(TM) -- Retail stores located in South
Florida that provide graphics design, printing, copying, shipping and
fulfillment services as well as a limited assortment of office supplies.
Furniture At Work(TM) -- Retail office furniture stores offering a broad
line of office furniture, office accessories and design services.
In November 1998, the Company decided to focus its attention on more
rapidly expanding its core businesses, both domestically and internationally. In
conjunction with this decision, the Company plans to close its five Furniture at
Work(TM) and four Images(TM)/Office Depot Express(TM) stores. In 1998, the
Company recorded restructuring costs of $11.0 million in conjunction with this
restructuring. These costs consist primarily of estimated lease commitments
subsequent to the closing of the stores and the write-off of certain fixed
assets. For additional information regarding the restructuring, please refer to
Management's Discussion and Analysis incorporated by reference in Item 7 of this
report.
OFFICE PRODUCTS INDUSTRY
The office products industry is comprised of three broad categories of
merchandise: general office supplies, technology products and office furniture.
Office products distributors include contract stationers (selling at significant
discounts from list prices to their contract customers), mail order companies
(selling through catalogs) and retailers (including office superstores such as
those operated by Office Depot). More recently, Internet companies have emerged
as a new force in the industry.
Although the industry has changed in recent years, a significant portion of
the market is still served by small dealers. These dealers purchase a
significant portion of their merchandise from national or regional office supply
distributors who, in turn, purchase merchandise from manufacturers. Dealers
often employ a commissioned sales force that use the distributor's catalog,
showing products at retail list prices, for selection and price negotiation with
the customer. The Company believes that these dealers generally sell their
products at prices higher than those offered by the Company.
Over the past decade, high-volume office supply superstores have emerged
throughout the United States. These stores offer a wide selection of products,
strong customer service and low prices. High-volume office products retailers
typically offer substantial price savings to individuals and small- to
medium-sized
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businesses, which traditionally have had limited opportunities to buy at
significant discounts from retail list prices. Recently, other retailers,
including mass merchandisers and warehouse clubs, have begun offering a wide
variety of similar products at low prices and have become increasingly
competitive with office supply superstores. Direct mail and Internet-based
companies are also gaining wide acceptance in the office products industry.
Larger customers have been, and continue to be, served primarily by full
service contract stationers offering contract bids at discounts equivalent to or
greater than those offered by the Company's retail stores and catalogs. These
stationers, including the Company's contract stationer business, traditionally
serve larger businesses through a commissioned sales force, purchase in large
quantities primarily from manufacturers, and offer competitive pricing and
customized services to their customers.
COMPETITION
Office Depot operates in a highly competitive environment. Historically,
its markets were served by traditional office products dealers and contract
stationers. The Company believes it competes favorably against dealers on the
basis of price because these dealers typically purchase their products from
distributors and generally sell their products at prices higher than those
offered by Office Depot. The Company competes against other full service
contract stationers on the basis of price, service and value-added technology.
The Company also competes with other office supply superstores, wholesale clubs
selling general merchandise, discount stores, mass merchandisers, conventional
retail stores, catalog showrooms and direct mail companies. These companies, in
varying degrees, compete with Office Depot on both price and selection. The
Company's ability to buy in large quantities directly from manufacturers affords
a competitive advantage against competitors who buy from distributors.
Several high-volume office supply chains that are similar in concept to
Office Depot in terms of store format, pricing strategy and product selection
and availability also operate in the United States. The Company competes with
these chains and other competitors described above in substantially all of its
current markets. The Company anticipates that in the future it will face
increased competition from these chains.
The Company's Business Services Group principally competes against national
and regional full service contract stationers, national and regional office
furniture dealers, independent office product distributors, discount superstores
and, to a lesser extent, direct mail order houses, stationery retail outlets and
Internet-based merchandisers. Other office supply superstore chains also operate
contract stationer businesses. The Company competes with these businesses in
substantially all of its current markets. In the future, the Company may face
increased competition from Internet-based merchandisers who dedicate a larger
portion of their resources to e-commerce than does Office Depot.
MERCHANDISING AND PRODUCT STRATEGY
Office Depot's merchandising strategy uses two brands, Office Depot and
Viking, to offer a broad selection of brand-name office products which provide
customers with the most compelling combination of quality, assortment, price and
service. The Company offers a comprehensive selection of office products,
including general office supplies, computers, software and computer supplies,
business machines and related supplies, and office furniture. Each of the
Company's office supply stores stocks approximately 7,000 SKUs, including
variations in color and size; and the Company's CSCs stock approximately 18,000
SKUs, including the 7,000 SKUs stocked at the office supply stores. During the
integration process, the Company will evaluate and reduce the number of SKUs to
the most efficient level, while retaining a broad assortment of products for its
customers.
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The table below shows sales of each major product group as a percentage of
total merchandise sales for 1996, 1997 and 1998:
<TABLE>
<CAPTION>
1996 1997 1998
----- ----- -----
<S> <C> <C> <C>
General office supplies(1).................................. 42.73% 42.65% 42.85%
Computers, business machines and related supplies(2)........ 45.65% 45.69% 46.02%
Office furniture(3)......................................... 11.62% 11.66% 11.13%
----- ----- -----
100.0% 100.0% 100.0%
===== ===== =====
</TABLE>
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(1) Includes paper, filing supplies, organizers, business cases, writing
instruments, mailing supplies, desktop accessories, calendars, business
forms, binders, tape, post-it notes, staplers, fasteners, art supplies,
school supplies, engineering, food and janitorial supplies, and revenues
from the print and copy center located in each store.
(2) Includes calculators, typewriters, projectors, telephones, cameras and film,
cash registers, copiers, facsimile machines, tape recorders, computers,
printers, computer diskettes, ribbons, cartridges, software and books.
(3) Includes chairs, desks, tables, partitions, bookcases, filing and storage
cabinets, and furniture accessories such as chairmats, lamps and clocks.
The Company buys substantially all of its merchandise directly from
manufacturers and other primary source suppliers. Products are delivered by
manufacturers either directly to the stores or CSCs or to the Company's ten
cross-dock facilities. Office Depot's supply chain operations, including the
cross-docks, employ a customized system that manages the inbound flow of
merchandise with the goal of achieving optimal in-stock positions at the lowest
possible cost. This system maintains optimal in-stock positions by allowing for
a shorter delivery cycle to the stores and CSCs, while still meeting the minimum
ordering requirements of the vendors. The use of cross-docks also reduces the
Company's freight costs by centralizing the receiving function.
While the Business Services Group is party to several multi-year contracts
with certain of its contract customers and anticipates increasing this business
in the future, the Company has no material long-term contracts or commitments
with any vendor or customer, the loss of which would have a material adverse
effect on the Company. The Company has not experienced any difficulty in
obtaining desired quantities of merchandise for sale and does not foresee any
significant difficulties in the future.
Buyers at the Company's corporate headquarters are responsible for
selecting and purchasing merchandise. For merchandise offered to retail, direct
mail and Internet customers, corporate buyers also determine pricing. The
pricing of merchandise sold to contract customers is determined by the contract
sales force in the Business Services Group. Replenishment buyers, or rebuyers,
located both centrally and in the field, monitor inventory levels and initiate
product reorders with the assistance of the Company's customized replenishment
system. This system allows buyers to devote more time to selecting products,
developing new product lines, analyzing competitive developments and negotiating
with vendors to obtain more favorable prices and product availability.
The Company currently transmits purchase orders by EDI and receives Advance
Shipment Notices and invoices electronically from vendors that account for a
significant portion of its purchases. This method of electronic ordering
expedites orders and promotes accuracy and efficiency. The Company plans to
expand this program to the remainder of its vendors.
CATALOG PRODUCTION
The Company uses its catalogs and Internet sites to market directly to both
existing and prospective customers. Separate catalog assortments promote both
the Office Depot and Viking brands. Each catalog is printed in full color with
pictures and narrative descriptions that emphasize key product benefits and
features. The Company has developed a consistent and distinctive style for its
catalogs, most of which are produced in-house by its designers, writers and
production artists, using a computer-based catalog creation system.
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The Company's Viking brand catalog mailings include monthly sale catalogs
which are mailed to all active customers and contain the items most popular with
Viking customers. A complete "Buyers' Guide" containing all of the products
offered at regular discount prices is delivered to catalog customers every six
months. The Buyers' Guides for international customers are somewhat smaller than
those circulated domestically and vary between countries. Prospecting catalogs
with special offers designed to acquire new customers are mailed frequently.
Both Office Depot and Viking offer several different specialty catalogs,
including catalogs dedicated to office furniture, computer supplies, custom
printed business forms and stationery, pager products, shipping and warehouse
supplies (including cleaning and janitorial products) and presentation supplies
(including transparencies and overhead slides). Other specialty catalogs are
being considered and may be introduced in the future. The Company mailed
approximately 242 million, 225 million and 184 million copies of over 100
different Office Depot and Viking brand catalogs during 1998, 1997 and 1996,
respectively.
MARKETING AND SALES
The Company is able to maintain its competitive pricing policy primarily as
a result of the significant cost efficiencies achieved through its operating
format and purchasing power.
Marketing. The Company's marketing programs are designed to attract new
customers and to induce existing customers to make additional purchases. The
Company advertises in the major local newspapers in each of its markets. These
advertisements are supplemented with local and national radio and television
advertising and direct marketing efforts. The Company continuously acquires new
customers by selectively mailing specially designed catalogs to prospective
customers. The Company sometimes obtains the names of prospective customers in
new and existing markets through the use of selected mailing lists from outside
marketing information services and other sources. The Company uses a database
marketing system for its Viking catalogs and other promotional mailings. The
Company plans to use this same technology to increase the effectiveness of its
Office Depot brand catalogs in the future. Catalogs are also distributed through
the Company's contract sales force and are available in each of the Company's
stores.
The Company has a low price guarantee policy for its Office Depot brand.
Under this policy, the Company will match any comparable competitor's lower
price. In addition, the guarantee gives the customer a credit of 55% of the
difference, up to $55. This program assures customers of always receiving low
prices from the Company even during periodic sales promotions by competitors.
Monthly competitive pricing analyses are performed to monitor each market, and
prices are adjusted as necessary to adhere to this pricing philosophy and ensure
competitive positioning.
Sales. In addition to the sales associates at each of its stores and the
customer service representatives at its call centers, the Company has a
dedicated sales force serving its contract customers in the Business Services
Group. The Company's dedicated sales force operates out of its 68 regional sales
offices. All members of the Company's sales force are employees of the Company.
In early 1998, the Company introduced an Internet site enabling customers
to order directly from the Company. The Company's customers nationwide can place
orders over the Internet or by telephone or fax using toll-free telephone
numbers that route the calls through the Company's call centers located in South
Florida, Atlanta, Texas, Ohio, Connecticut, Kansas, and California. Orders
received by the call centers or via the Internet are transmitted electronically
to the store or CSC nearest the customer for pick-up or delivery at a nominal
delivery fee (free with a minimum order size). Orders are packaged, invoiced and
shipped for next-day delivery or same-day delivery as is the case for Viking
orders in selected markets.
The Company, through its Business Services Group, provides its contract
customers with a wide range of services designed to improve efficiencies and
reduce costs, including electronic ordering, stockless office procurement,
business forms management services and comprehensive product usage reports. The
Business Services Group provides certain of its customers with desktop delivery,
wherein merchandise is delivered to individual departments within a customer's
facilities, rather than being delivered to one central receiving point. The
Company also provides electronic ordering to its contract customers through
customized intranet sites
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developed in tandem with these customers. Customer orders placed through an
intranet site are sent to the Company over the Internet.
Terms. The Company offers its contract and qualified commercial customers
credit through open accounts, although the payment options available to retail
customers are also available to all contract and commercial customers. The
Company also offers revolving credit terms to Office Depot brand customers
through the use of private label credit cards. These credit cards are issued
without charge to credit-qualified customers. Sales transactions using the
private label credit cards are transmitted electronically to financial services
companies, which credit Office Depot's bank account with the net proceeds within
two days. The Company offers its contract customers a store purchasing card
which allows these customers to purchase office supplies at one of the Company's
office supply stores under the terms of their contracts. No single customer
accounts for more than one percent of the Company's sales.
MANAGEMENT INFORMATION SYSTEMS
Inventory is received and stocked in each facility using an automated
inventory tracking system. Prior to the merger with Viking, Office Depot
completed the conversion of its warehouse and order entry systems to a new
common platform. The Company has begun the integration of Viking's delivery and
warehouse systems with Office Depot's. See MERGERS AND ACQUISITIONS. Customer
orders placed via telephone, fax or electronically are filled by the appropriate
CSC or office supply store, usually for next-day delivery. The appropriate
delivery location is determined by the Company's automated routing systems, and
the order is filled using both in-stock and wholesaler-supplied inventory.
The Company uses IBM ES9000 mainframes, IBM System AS/400 computers and
client/server technologies that primarily run on Microsoft Windows in operating
its business. The Company's information systems include advanced software
packages that have been customized for the Company's specific business
operations. By integrating these technologies, the Company is able to
efficiently manage inventories, order processing, replenishment and marketing
efforts.
Inventory data is entered into the Company's information system upon its
receipt, and sales data is entered through the use of either the Company's
point-of-sale or its telemarketing order entry system. The point-of-sale system
permits the entry of sales data through the use of bar code laser scanning. The
system also has a price "look-up" capability that permits immediate price
verification and efficient movement of customers through the check-out process.
Information is centrally processed at the end of each day, permitting a
perpetual daily inventory and the calculation of average unit cost by SKU for
each store and CSC. Daily compilation of sales and gross margin data allows the
Company to monitor profitability and inventory by item and product line, as well
as the success of sales promotions. For all SKUs, management has immediate
access to on-hand daily unit inventory, units on order, current and past rates
of sale and other information pertinent to the management of its inventory.
All of the Company's computer operations are managed internally in
state-of-the-art facilities that use automated systems management tools, a help
desk which is manned 24 hours per day/7 days per week, and off-site disaster
recovery facilities. The Company's fully redundant network is managed internally
using advanced technologies throughout the system. These operations result in
industry leading system availability and reliability.
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The Company's public Internet site -- www.officedepot.com -- is a
state-of-the-art electronic commerce site that has won a number of Internet
honors. The Company's business-to-business e-commerce site has sophisticated
work-flow components that help customers electronically manage their ordering
process for office supplies, with thousands of customer orders processed on a
daily basis. Internet-enabled applications allow our suppliers to directly
interact with our systems, improving order flow and supply chain management. The
Company's corporate personnel make use of an internally developed and managed
intranet to greatly increase productivity and customer responsiveness and to
reduce internal costs.
EMPLOYEES, STORE MANAGEMENT AND TRAINING
As of March 12, 1999, the Company employed approximately 44,000 persons.
Additional employees will be added as needed to support the Company's expansion
program. The Company is committed to the development and promotion of its
employees. However, the Company's rapid growth will require continued management
recruitment from outside the Company.
The Company hires and trains new employees well in advance of new store and
CSC openings. In general, store managers have extensive experience in retailing,
particularly with warehouse store chains or discount stores that generate high
sales volumes. Each of the Company's new retail store managers usually spends
two to four months in an apprenticeship position at an existing Office Depot
store prior to being assigned to a new store. Typically, the Company's CSC
managers have extensive experience in distribution operations.
The Company's retail sales associates view product knowledge videos and
complete written training programs relating to certain products before being
allowed to assist customers. The Company creates some of these videos and
training programs internally. New product information is transmitted to
associates via satellite broadcasts on a routine basis. The satellite broadcasts
are also used for associate training.
The Company grants stock options and offers bonus programs to certain of
its employees as an incentive to attract and retain such employees.
The Company has never experienced a strike or any other work stoppage among
its domestic employees, and management believes that its relations with all of
its employees are good. There are no collective bargaining agreements covering
any of the Company's employees. However, certain of its international employees
are covered by various labor arrangements as dictated by government regulation
or local custom.
9
<PAGE> 11
ITEM 2. PROPERTIES.
As of March 12, 1999, Office Depot operates 675 office product stores in 41
states and the District of Columbia (including 666 office supply stores, four
Images(TM)/Office Depot Express(TM) stores, and five Furniture At Work(TM)
stores), 40 office supply stores in five Canadian provinces and 92 office supply
stores (including those operated under licensing and joint venture agreements)
in 8 countries outside of the United States and Canada. The Company also
operates 30 CSCs in 18 U.S. states and 17 CSCs in 10 foreign countries. The
following table sets forth the locations of these facilities.
<TABLE>
<CAPTION>
STORES CSCS
- ------------------------------------------------------------------- --------------------------------
LOCATION # LOCATION # LOCATION #
- -------- --- -------- --- -------- ---
<S> <C> <C> <C> <C> <C>
UNITED STATES: North Dakota 1 UNITED STATES:
Alabama 14 Ohio 25 Arizona 1
Arizona 8 Oklahoma 7 California 4
Arkansas 7 Oregon 14 Colorado 2
California 109 Pennsylvania 7 Connecticut 1
Colorado 19 South Carolina 11 Florida 3
District of Columbia 2 Tennessee 13 Georgia 1
Florida 78 Texas 80 Illinois 1
Georgia 31 Utah 4 Louisiana 1
Hawaii 3 Virginia 15 Maryland 2
Idaho 1 Washington 22 Massachusetts 1
Illinois 30 West Virginia 3 Michigan 1
Indiana 12 Wisconsin 11 Minnesota 2
Iowa 5 Wyoming 1 New Jersey 1
Kansas 7 CANADA: North Carolina 1
Kentucky 7 Alberta 8 Ohio 2
Louisiana 21 British Columbia 8 Texas 3
Maryland 11 Manitoba 4 Utah 1
Michigan 20 Ontario 18 Washington 2
Minnesota 8 Saskatchewan 2 AUSTRALIA 2
Mississippi 5 COLOMBIA 4 FRANCE 2
Missouri 13 FRANCE 17 ISRAEL 1
Montana 1 HUNGARY 3 GERMANY 2
Nebraska 3 ISRAEL 17 IRELAND 1
Nevada 8 JAPAN 3 ITALY 1
New Jersey 4 MEXICO 35 JAPAN 2
New Mexico 4 POLAND 11 MEXICO 2
New York 9 THAILAND 2 THE NETHERLANDS 1
North Carolina 21 UNITED KINGDOM 3
</TABLE>
Most of the Company's facilities are leased or subleased, with lease terms
(excluding renewal options) expiring between 1999 and 2020, except for 60
facilities, excluding corporate facilities, that are owned by Office Depot. The
owned facilities are located in 17 states, primarily Florida and Texas, three
Canadian provinces, the United Kingdom, Australia, Thailand, Mexico and France.
The Company operates its office supply stores under the names Office Depot, The
Office Place (in Ontario, Canada) and Office Depot Express (internationally).
The Business Services Group operates under the names Office Depot, Viking Office
Products and a number of variations of those names.
The Company's corporate offices in Delray Beach, Florida consist of
approximately 575,000 square feet in three adjacent buildings, two of which are
owned and one leased. The corporate office building in Torrance, California,
which the Company owns, consists of approximately 180,000 square feet.
ITEM 3. LEGAL PROCEEDINGS.
The Company is involved in litigation arising in the normal course of its
business. The Company believes that these matters will not materially affect its
financial position or the results of its operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None
10
<PAGE> 12
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER
MATTERS.
Office Depot's common stock is listed on the New York Stock Exchange (NYSE)
under the symbol ODP. As of March 5, 1999, there were 3,484 holders of record of
common stock. The last reported sale price of the common stock on the NYSE on
March 5, 1999 was $34.6875.
The following table sets forth, for the periods indicated, the high and low
sale prices of the common stock quoted on the NYSE Composite Tape. These prices
do not include retail mark-ups, mark-downs or commissions.
<TABLE>
<CAPTION>
1997 HIGH LOW
- ---- ------- -------
<S> <C> <C>
First Quarter............................................... $23.250 $16.375
Second Quarter.............................................. 21.250 12.000
Third Quarter............................................... 21.563 14.500
Fourth Quarter.............................................. 23.688 18.750
</TABLE>
<TABLE>
<CAPTION>
1998 HIGH LOW
- ---- ------- -------
<S> <C> <C>
First Quarter............................................... $30.063 $21.750
Second Quarter.............................................. 34.750 28.063
Third Quarter............................................... 37.250 20.000
Fourth Quarter.............................................. 36.625 15.875
</TABLE>
The Company has never declared or paid cash dividends on its common stock
and does not currently intend to pay cash dividends in the foreseeable future.
Earnings and other cash resources of the Company will be used to continue the
expansion of the Company's business.
On February 24, 1999, the Company's Board of Directors declared a
three-for-two stock split in the form of a 50% stock dividend payable on April
1, 1999 to stockholders of record on March 11, 1999. In conjunction with the
stock split, approximately 125 million additional shares will be issued on April
1, 1999.
ITEM 6. SELECTED FINANCIAL DATA.
The information required by this Item is set forth in Exhibit 13 under the
heading "Financial Highlights" as of and for the fiscal years ended December 26,
1998, December 27, 1997, December 28, 1996, December 30, 1995 and December 31,
1994. This information is set forth in our Annual Report to Stockholders for the
fiscal year ended December 26, 1998 (on page 1) and is incorporated herein by
this reference and made a part hereof.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
CAUTIONARY STATEMENTS FOR PURPOSES OF THE "SAFE HABOR" PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995
The information required by this item is set forth in Exhibit 13 under the
heading "Management's Discussion and Analysis of Financial Condition and Results
of Operations." This information is set forth in the Company's Annual Report to
Stockholders for the fiscal year ended December 26, 1998 (on pages 33-44) and is
incorporated herein by reference and made a part hereof. The following
Cautionary Statements are in addition to those contained in the Company's Annual
Report.
In December 1995, the Private Securities Litigation Reform Act of 1995 (the
"Act") was enacted by the United States Congress. The Act contains certain
amendments to the Securities Act of 1933 and the Securities Exchange Act of
1934. These amendments provide protection from liability in private lawsuits for
"forward-looking" statements made by public companies and other persons
specified in the Act. The Company desires to take advantage of the "safe harbor"
provisions of the Act. In order to do so, these cautionary statements are
provided.
11
<PAGE> 13
This Annual Report on Form 10-K contains both information which is
historical in nature and other information which looks towards the future
performance of the Company. Examples of historical information include the 1998
financial statements and the commentary on past performance contained in
Management's Discussion and Analysis ("MD&A"), which are incorporated herein by
reference to the respective information in the Company's Annual Report to
Stockholders for the fiscal year ended December 26, 1998. The Company cautions
readers that, with the exception of information which clearly deals with
historical matters, the information contained in this Annual Report on Form 10-K
should be considered to be "forward-looking statements" as referred to in the
Act. Without limiting the generality of the preceding sentence, any time the
words "estimate," "project," "intend," "expect" and similar expressions are
used, these are intended to clearly express that the information deals with
possible future events and is forward-looking in nature.
Forward-looking information involves risks and uncertainties, including
certain matters which are discussed in more detail below. This information is
based on various factors and important assumptions about future events that may
or may not actually come true. As a result, the Company's operations in the
future and its financial results could differ materially and substantially from
those discussed in the forward-looking statements in this Annual Report on Form
10-K. In particular, the factors discussed below could affect the Company's
actual results and could cause the Company's actual results during 1999 and in
future years beyond 1999 to differ materially from those expressed in any
forward-looking statement made by or on behalf of the Company in this Annual
Report on Form 10-K.
COMPETITION: 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. Well-established mass merchant retailers have the financial
and distribution ability to compete very effectively with the Company should
they choose to enter the office superstore retail category, Internet office
supply or contract stationer business. This could have a material adverse effect
on the Company's business and results of operations.
INTERNET: More recently, Internet-based merchandisers have begun competing
with the Company. This competition is expected to increase in the future as both
the Company and these and other companies continue to expand their operations.
Many startup operations focused exclusively on Internet sales may be able to
effectively compete with the Company in the areas of price and selection. While
most of them cannot offer the levels of service and stability of supply provided
by the Company, they nevertheless may be formidable competitors, particularly
for customers who are willing to look for the absolute lowest price without
regard to other attributes of the business. Some of these competitors may be
willing to substantially sacrifice their profitability in order to gain a
foothold in the marketplace, and the stock market success of certain Internet
retailers may enable such operations to raise capital in the public markets
without regard to profitability for the near future. In addition, certain
manufacturers of computer hardware, software and peripherals, including
suppliers of the Company, have expanded their own direct marketing of products,
particularly over the Internet. Even as the Company expands its own Internet
sales, its ability to anticipate and adapt to the developing Internet sales
market and to Internet competition will be key factors in its success.
Additionally, the capabilities of the Company's network infrastructure
(including its server, hardware and software) to efficiently handle the
Company's rapidly expanding operations, including its Internet traffic, is of
critical importance. Failure to execute in any of these key areas could have a
material adverse effects on the Company's future sales growth, profitability and
operating results.
EXECUTION OF EXPANSION PLANS: The Company plans to open approximately 105
stores in 1999, and the Company considers its expansion program to be an
integral part of its plan to achieve anticipated operating results in future
years. However, there can be no assurance that the Company will be able to find
favorable store locations, negotiate favorable leases, hire and train store and
account managers, and integrate the new stores in a manner that will allow the
Company to meet its expansion program. Conditions outside the Company's control,
such as adverse weather conditions affecting construction schedules,
unavailability of materials, labor disputes and similar issues also could impact
anticipated store openings. The failure to expand by opening new stores as
planned could have a material adverse effect on the Company's future sales
growth, profitability and operating results.
12
<PAGE> 14
CANNIBALIZATION OF SALES IN EXISTING OFFICE DEPOT BUSINESS LOCATIONS: In
addition, as the Company expands the number of its stores in existing markets,
sales of existing stores may suffer. New stores typically require an extended
period of time, generally exceeding a year, 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
other contract stationers as well as Internet-based businesses; and regional,
national and international economic conditions. In addition, the Company's gross
margin and profitability would be adversely affected if its competitors were to
attempt to capture market share by reducing prices.
COSTS OF REMODELING, UPDATING STORES: The remodeling of stores has
contributed to increased store expenses, and these costs are expected to
continue impacting store expenses throughout 1999 and beyond. While a necessary
aspect of keeping existing stores up to date both from a technology and
merchandising point of view, the expenses associated with such activities could
result in a significant impact on the Company's operating results 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
informational, operational and financial systems, as well as necessitate the
hiring of new managers at the store and supervisory level.
HISTORICAL FLUCTUATIONS IN PERFORMANCE: 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 than
existing stores as they commence operations; the effect new stores have on the
sales of existing stores in more mature markets; warehouse integration; the
pricing activity of competitors in the Company's markets, including the
Internet; changes in the Company's product mix; increases and decreases in
advertising and promotional expenses; the effects of seasonality; acquisitions
of competitors' contract stationers and stores; or other events could contribute
to this quarter to quarter variability.
VIKING MERGER; INTEGRATION; INTERNATIONAL ACTIVITY: On August 26, 1998,
the Company merged with Viking Office Products, Inc. ("Viking"). Costs related
to the integration of Viking's facilities into the Company's business will
contribute to increased operating expenses in 1999 and possibly beyond.
Moreover, integrating the operations and management of Office Depot and Viking
is a complex process. There can be no assurance that this integration process
will be completed as rapidly as management anticipates or, even if achieved as
anticipated, that it will result in all of the anticipated synergies and other
benefits expected to be realized. The integration of the two companies will
require significant management attention, which may temporarily distract
management from other matters. The inability of management to integrate
successfully the operations of Office Depot and Viking could have a material
adverse effect on the future revenues and sales growth, profitability, and
operating results of the Company.
The Company has operations in several international markets, including in
particular those markets in which Viking has operated prior to the merger. The
Company intends to enter other international markets as attractive opportunities
arise. Such entry could be in the form of acquisitions of stock or assets or by
the formation of joint venture or licensing agreements. In addition to the risks
described above arising from the Company's domestic store, delivery, contract,
and Internet operations, internationally, the Company also faces such additional
risks as foreign currency fluctuations, unstable political and economic
conditions, obtaining adequate and appropriate inventory and, because some of
its foreign operations are not wholly-owned, compromised operating control in
certain countries. Moreover, the Company does not have a large group of managers
experienced in international operations and will have to recruit additional
management resources to successfully compete in many foreign markets. All of
these risks could have a material adverse effect on the Company's financial
position and results of operations.
13
<PAGE> 15
CONTRACT AND COMMERCIAL SALES: The Company competes with a number of
contract stationers who supply office products and services to large and small
businesses both nationally and internationally. In order to achieve and maintain
expected profitability levels, the Company must continue to grow this segment of
the business. There can be no assurance the Company will be able to continue
expanding its contract and commercial business while retaining its base of
existing customers, and any failure to do so could have a material adverse
effect on the Company's profitability and operating results.
SOURCES AND USES OF CASH; FINANCING: The Company believes that its current
cash and cash equivalents, future operating cash flows, lease financing
arrangements and funds available under its revolving credit facility should be
sufficient to fund its planned expansion, integration and other operating cash
needs, for at least the next year. 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, opportunities for expansion or
acquisition, changes in growth strategy or adverse operating results. The
Company could attempt to meet its financial needs through the capital markets in
the form of either equity (for example, the issuance of more stock) or debt (for
example, new borrowings) financing. Alternative financing will be considered if
market conditions make it financially attractive. There 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,
either in the equity or debt markets. The inability of the Company to access
needed financial resources could have a material adverse effect on the Company's
financial position and its results of operations.
Y2K ISSUES: While the Company has worked diligently to bring its own
systems into compliance with Year 2000 issues and has endeavored to ensure that
its suppliers, vendors and major customers are also Y2K compliant (see pages
40-41 of Management's Discussion and Analysis), there can be no assurance that
the Company and all of its suppliers, vendors and major customers will in fact
become Year 2000 compliant. Any significant failure by the Company's suppliers,
vendors or major customers, or indeed, any unanticipated failure by the Company
to become fully Y2K compliant could have a material adverse effect on the
Company's financial position and results of operations. In addition to the
business risks inherent in the Y2K issues, there is also the possibility of
litigation from customers and other parties claiming to have been damaged by
failures of products and/or services provided to them by the Company. While the
Company fully expects to rely on indemnifications from suppliers of various
products, there is a possibility that certain claims might not be the subject of
indemnification and that the results of such litigation could have a material
adverse effect on the Company and its businesses.
DISCLAIMER OF OBLIGATION TO UPDATE: The Company assumes no obligation (and
specifically disclaims any obligation) to update these Cautionary Statements or
any other forward-looking statements contained in this Annual Report on Form
10-K to reflect actual results, changes in assumptions or other factors
affecting such forward-looking statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Interest Rate Risks
The Company's short-term investment portfolio generates interest income
which is affected by changes in interest rates. As of December 26, 1998,
assuming the investment portfolio was held constant, management estimates that a
ten percent change in short-term interest rates would result in an after-tax
increase or decrease of approximately $2 million in investment income on an
annual basis. The Company's zero coupon, convertible, subordinated notes offer
stated yields to maturity which are not subject to interest rate risks.
Borrowings under the Company's bank credit agreement would be subject to
variable interest rates; however, there were no such borrowings at December 26,
1998.
Foreign Exchange Rate Risks
The Company conducts business in various countries outside of the United
States, and does, from time to time, enter into forward or option contracts to
minimize the exposure to foreign exchange rate risk related to
14
<PAGE> 16
specific transactions. During 1998, a maximum of $13.1 million in foreign
exchange forward contracts was outstanding at any one time. As of December 26,
1998, there were no forward or option contracts outstanding.
Foreign currency transaction exposure arises when an operating unit
transacts business denominated in a currency that is not its own functional
currency. The Company's transaction risks are attributable primarily to
inventory purchases from third party vendors. The introduction of the euro has
significantly reduced such risks, and transaction exposures on an overall basis
are not significant.
The Company also has foreign exchange translation exposures resulting from
the translation of foreign currency-denominated earnings into U.S. dollars in
the Company's consolidated financial statements. Management estimates that, as
of December 26, 1998, a ten percent change in applicable foreign exchange rates
would have raised or lowered the Company's after-tax earnings by approximately
$3.5 million on an annual basis.
ITEM 8. FINANCIAL STATEMENTS.
The information required by this Item is set forth in Exhibit 13 under the
headings "Consolidated Balance Sheets," "Consolidated Statements of Earnings,"
"Consolidated Statements of Stockholders' Equity," "Consolidated Statements of
Cash Flows" and "Notes to Consolidated Financial Statements" as of December 26,
1998 and December 27, 1997 and for the fiscal years ended December 26, 1998,
December 27, 1997 and December 28, 1996. This information is set forth in our
Annual Report to Stockholders for the fiscal year ended December 26, 1998 (on
pages 46-63) and is incorporated herein by this reference and made a part
hereof.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
15
<PAGE> 17
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Information with respect to directors and executive officers of the Company
is incorporated herein by reference to the information under the caption
"Directors & Management" in the Company's Proxy Statement for the 1999 Annual
Meeting of Stockholders.
ITEM 11. EXECUTIVE COMPENSATION.
Information with respect to executive compensation is incorporated herein
by reference to the information under the caption "Executive Compensation" in
the Company's Proxy Statement for the 1999 Annual Meeting of Stockholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Information with respect to security ownership of certain beneficial owners
and management is incorporated herein by reference to the information under the
caption "Stock Ownership" in the Company's Proxy Statement for the 1999 Annual
Meeting of Stockholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Information with respect to certain relationships and related transactions
is incorporated herein by reference to the information under the caption
"Certain Relationships and Related Transactions" in the Company's Proxy
Statement for the 1999 Annual Meeting of Stockholders.
16
<PAGE> 18
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) The following documents are filed as a part of this report:
1. The financial statements listed in the "Index to Financial
Statements."
2. The financial statement schedule listed in "Index to Financial
Statement Schedule."
3. The exhibits listed in the "Index to Exhibits."
(b) Reports on Form 8-K.
The Company did not file any Reports on Form 8-K during the fourth
quarter of fiscal 1998.
17
<PAGE> 19
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 on this 22nd day of
March, 1999.
OFFICE DEPOT, INC.
By: /s/ DAVID I. FUENTE
------------------------------------
David I. Fuente, Chairman and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant in the capacities indicated on March 22, 1999.
<TABLE>
<CAPTION>
SIGNATURE CAPACITY
--------- --------
<C> <S>
/s/ DAVID I. FUENTE Chairman of the Board and Chief Executive
- ----------------------------------------------------- Officer (Principal Executive Officer)
David I. Fuente
/s/ IRWIN HELFORD Vice Chairman and Director
- -----------------------------------------------------
Irwin Helford
/s/ JOHN C. MACATEE Director, President and Chief Operating
- ----------------------------------------------------- Officer
John C. Macatee
/s/ M. BRUCE NELSON Corporate Executive Officer and Director
- -----------------------------------------------------
M. Bruce Nelson
/s/ BARRY J. GOLDSTEIN Executive Vice President -- Finance, Chief
- ----------------------------------------------------- Financial Officer and Treasurer
Barry J. Goldstein
/s/ CHARLES E. BROWN Senior Vice President -- Finance and
- ----------------------------------------------------- Controller (Principal Accounting Officer)
Charles E. Brown
/s/ LEE A. AULT, III Director
- -----------------------------------------------------
Lee A. Ault, III
/s/ NEIL R. AUSTRIAN Director
- -----------------------------------------------------
Neil R. Austrian
/s/ CYNTHIA R. COHEN Director
- -----------------------------------------------------
Cynthia R. Cohen
/s/ W. SCOTT HEDRICK Director
- -----------------------------------------------------
W. Scott Hedrick
/s/ JAMES L. HESKETT Director
- -----------------------------------------------------
James L. Heskett
/s/ MICHAEL J. MYERS Director
- -----------------------------------------------------
Michael J. Myers
/s/ FRANK P. SCRUGGS, JR. Director
- -----------------------------------------------------
Frank P. Scruggs, Jr.
/s/ PETER J. SOLOMON Director
- -----------------------------------------------------
Peter J. Solomon
</TABLE>
18
<PAGE> 20
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report of Deloitte & Touche LLP on
Consolidated Financial Statements......................... *
Consolidated Balance Sheets................................. *
Consolidated Statements of Earnings......................... *
Consolidated Statements of Stockholders' Equity............. *
Consolidated Statements of Cash Flows....................... *
Notes to Consolidated Financial Statements.................. *
Independent Auditors' Report of Deloitte & Touche LLP on
Financial Statement Schedule.............................. F-2
</TABLE>
- ---------------
* Incorporated herein by reference to the respective information in the
Company's Annual Report to Stockholders for the fiscal year ended December 26,
1998.
F-1
<PAGE> 21
INDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULE
To the Board of Directors of Office Depot, Inc.:
We have audited the consolidated financial statements of Office Depot, Inc.
and Subsidiaries as of December 26, 1998 and December 27, 1997 and for each of
the three years in the period ended December 26, 1998, and have issued our
report thereon dated February 17, 1999 (February 24, 1999 as to the stock split
described in Note A); such consolidated financial statements and reports are
included in the Company's Annual Report to Stockholders for the fiscal year
ended December 26, 1998 and are incorporated herein by reference. Our audits
also included the financial statement schedule of Office Depot, Inc. and
Subsidiaries listed in the Index to Financial Statement Schedule. The financial
statement schedule is the responsibility of the Company's management. Our
responsibility is to express an opinion based on our audits. In our opinion,
such financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
DELOITTE & TOUCHE LLP
Certified Public Accountants
Miami, Florida
February 17, 1999, (February 24, 1999 as to the stock split described in Note A)
F-2
<PAGE> 22
INDEX TO FINANCIAL STATEMENT SCHEDULE
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Schedule II -- Valuation and Qualifying Accounts and
Reserves.................................................. II-1
</TABLE>
All other schedules have been omitted because they are inapplicable, not
required or the information is included elsewhere herein.
<PAGE> 23
SCHEDULE II
OFFICE DEPOT, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS(1)
(IN THOUSANDS)
<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
-------- ---------- ----------------------- ------------- --------------
ADDITIONS
-----------------------
BALANCE AT CHARGED TO CHARGED TO
BEGINNING COSTS AND OTHER DEDUCTIONS -- BALANCE AT END
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS WRITE-OFFS OF PERIOD
----------- ---------- ---------- ---------- ------------- --------------
<S> <C> <C> <C> <C> <C>
Allowance for Doubtful Accounts:
1998.................................... $25,587 $23,702 -- $23,362 $25,927
1997.................................... 17,662 25,254 -- 17,329 25,587
1996.................................... 8,694 19,763 600 11,395 17,662
</TABLE>
- ---------------
(1) Amounts for 1997 and 1996 have been restated to reflect the merger with
Viking Office Products, Inc. on a pooling of interests basis.
II-1
<PAGE> 24
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT
------- -------
<S> <C>
3.1 Restated Certificate of Incorporation, as amended to
date(13)
3.2 Bylaws(2)
4.1 Form of certificate representing shares of Common Stock(3)
4.2 Form of Indenture (including form of LYON) between the
Company and The Bank of New York, as Trustee(4)
4.3 Form of Indenture (including form of LYON) between the
Company and Bankers Trust Company, as Trustee(5)
4.4 Rights Agreement dated as of September 4, 1996 between
Office Depot, Inc. and ChaseMellon Shareholder Services,
L.L.C., as Rights Agent, including the form of Certificate
of Designation, Preferences and Rights of Junior
Participating Preferred Stock, Series A attached thereto as
Exhibit A, the form of Rights Certificate attached thereto
as Exhibit B and the Summary of Rights attached thereto as
Exhibit C(6)
10.1 Stock Purchase Agreement, dated as of June 21, 1989, between
the Company and Carrefour S.A. (3)
10.2 Agreement and Plan of Reorganization, dated December 19,
1990, among the Company, The Office Club, Inc. and OD Sub
Corp. (3)
10.3 Stock Purchase Agreement, dated as of April 24, 1991,
between the Company, Carrefour S.A. and Carrefour Nederland
B.V. (7)
10.4 Revolving Credit and Line of Credit Agreement dated as of
February 20, 1998 by and among the Company and SunTrust
Bank, Central Florida, National Association, individually
and as Administrative Agent; Bank of America National Trust
and Savings Association, individually and as Syndication
Agent; NationsBank, National Association, individually and
as Documentation Agent; Royal Bank of Canada, individually
and as Co-Agent; Citibank, N.A., individually and as
Co-Agent; The First National Bank of Chicago, individually
and as Co-Agent; The First National Bank of Chicago,
individually and as Co-Agent; CoreStates Bank, N.A.; PNC
Bank, National Association; Fifth Third Bank; and Hibernia
National Bank. (Exhibits to the Revolving Credit and Line of
Credit Agreement have been omitted, but a copy may be
obtained free of charge upon request to the Company)(12)
10.5 Office Depot, Inc. Long-Term Equity Incentive Plan*(8)
10.6 Amended and Restated Agreement and Plan of Merger dated as
of July 12, 1993 and amended and restated as of August 30,
1993 by and among the Company, Eastman Office Products
Corporation, EOPC Acquisition Corp. and certain investors(9)
10.7 1997-2001 Office Depot, Inc. Designated Executive Incentive
Plan*(12)
10.8 Partnership Agreement, dated as of June 10, 1995, between
the Company and Carrefour, a joint stock company
incorporated under French law(10)
10.9 Form of Employment Agreement, dated as of September 4, 1996,
by and between Office Depot, Inc. and each of F. Terry Bean,
Thomas Kroeger and William P. Seltzer(11)
10.10 Form of Employment Agreement, dated as of September 4, 1996,
by and between Office Depot, Inc. and each of David I.
Fuente, John C. Macatee, Barry J. Goldstein and Richard M.
Bennington(11)
10.11 Form of Indemnification Agreement, dated as of September 4,
1996, by and between Office Depot, Inc. and each of David I.
Fuente, Cynthia R. Cohen, W. Scott Hedrick, James L.
Heskett, Michael J. Myers, Peter J. Solomon, Barry J.
Goldstein, F. Terry Bean, Richard M. Bennington, William P.
Seltzer, John C. Macatee, Thomas Kroeger and R. John
Schmidt, Jr.(11)
</TABLE>
<PAGE> 25
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT
------- -------
<S> <C>
10.12 Form of Employment Agreement, dated as of October 21, 1997,
by and between Office Depot, Inc. and each of Richard M.
Bennington, Barry J. Goldstein, John C. Macatee and William
P. Seltzer(12)
13.1 Annual Report to Securityholders
21.1 List of the Company's subsidiaries
23.1 Consent of Deloitte & Touche LLP
27.1 Financial Data Schedule
</TABLE>
- ---------------
+ This information appears only in the manually signed original copies of
this report.
* Management contract or compensatory plan or arrangement.
(1) Incorporated by reference to the respective exhibit to the Company's Proxy
Statement for its 1995 Annual Meeting of Stockholders.
(2) Incorporated by reference to the Company's Quarterly Report on Form 10-Q,
filed with the Commission on August 12, 1996.
(3) Incorporated by reference to the respective exhibit to the Company's
Registration Statement No. 33-39473.
(4) Incorporated by reference to the respective exhibit to the Company's
Registration Statement No. 33-54574.
(5) Incorporated by reference to the respective exhibit to the Company's
Registration Statement No. 33-70378.
(6) Incorporated by reference to the Company's Current Report on Form 8-K,
filed with the Commission on September 6, 1996.
(7) Incorporated by reference to the respective exhibit to the Company's
Quarterly Report on Form 10-Q for the quarterly period ended June 29, 1991.
(8) Incorporated by reference to the respective exhibit to the Company's Proxy
Statement for its 1997 Annual Meeting of Stockholders.
(9) Incorporated by reference to the respective exhibit to the Company's
Registration Statement No. 33-51409.
(10) Incorporated by reference to the respective exhibit to the Company's Annual
Report on Form 10-K for the year ended December 30, 1995.
(11) Incorporated by reference to the respective exhibit to the Company's Annual
Report on Form 10-K for the year ended December 28, 1996.
(12) Incorporated by reference to the respective exhibit to the Company's Annual
Report on Form 10-K for the year ended December 27, 1997.
(13) Incorporated by reference to the respective exhibit to the Company's
Quarterly Report on Form 10-Q for the quarterly period ended September 26,
1998.
Upon request, the Company will furnish a copy of any exhibit to this report
upon the payment of reasonable copying and mailing expenses.
<PAGE> 1
EXHIBIT 13.1
ANNUAL REPORT TO SECURITYHOLDERS
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
Statements of Earnings Data 1998(1) 1997(1) 1996(1) 1995(1) 1994(1)
(In thousands, except per share amounts and
statistical data)
===================================================================================================================================
<S> <C> <C> <C> <C> <C>
Sales $ 8,997,738 $ 8,100,319 $ 7,250,931 $ 6,233,985 $ 4,939,857
Cost of goods sold and occupancy costs 6,484,464 5,963,521 5,395,223 4,650,240 3,671,516
- -----------------------------------------------------------------------------------------------------------------------------------
Gross profit 2,513,274 2,136,798 1,855,708 1,583,745 1,268,341
Store and warehouse operating
and selling expenses 1,642,042 1,443,192 1,280,107 1,041,514 838,418
Pre-opening expenses 17,150 6,609 9,827 17,746 11,990
General and administrative expenses 330,194 272,022 222,714 195,816 158,809
Amortization of goodwill 6,174 6,146 6,147 6,113 6,224
Merger and restructuring costs 119,129 16,094 -- -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Operating profit 398,585 392,735 336,913 322,556 252,900
Interest income 25,309 7,570 3,726 4,004 5,328
Interest expense (22,356) (21,680) (26,378) (22,741) (18,268)
Equity in earnings (losses) of investees, net (12,811) (7,034) (2,178) (962) 197
- -----------------------------------------------------------------------------------------------------------------------------------
Earnings before income taxes 388,727 371,591 312,083 302,857 240,157
Income taxes 155,531 136,730 115,865 117,797 96,818
- -----------------------------------------------------------------------------------------------------------------------------------
Net earnings $ 233,196 $ 234,861 $ 196,218 $ 185,060 $ 143,339
===================================================================================================================================
Earnings per share
Basic $ .95 $ .97 $ .82 $ .79 $ .63
Diluted .91 .93 .79 .75 .60
Dividends -- -- -- -- --
===================================================================================================================================
Pro forma earnings per share(2)
Basic $ .64 $ .65 $ .55 $ .53 $ .42
Diluted .61 .62 .53 .50 .40
</TABLE>
<TABLE>
<CAPTION>
Statistical Data
====================================================================================================================
<S> <C> <C> <C> <C> <C>
Facilities open at end of period:
United States and Canada:
Office supply stores 702 602 561 501 420
Customer service centers 30 33 32 31 30
Call Centers 8 8 6 5 5
International (excluding Canada):
Office supply stores(3) 87 39 21 9 3
Customer service centers(3) 17 16 12 8 4
Call Centers 9 8 6 6 4
Balance Sheet Data
(In thousands)
====================================================================================================================
Working capital $1,249,434 $1,093,463 $ 860,280 $ 836,761 $ 594,843
Total assets 4,113,041 3,520,819 3,200,213 2,896,589 2,167,453
Long-term debt(4) 470,711 447,020 416,757 494,910 393,800
Common stockholders' equity 2,028,879 1,717,638 1,469,110 1,238,820 889,824
</TABLE>
(1) All amounts previously reported for 1994 through 1997 have been
restated to reflect the Company's merger with Viking Office Products, Inc.
in August 1998 on a pooling of interests basis. All periods consist of 52
weeks, except 1995, which consists of 53 weeks.
(2) Pro forma earnings per share reflect the Company's declaration of a
three-for-two stock split on February 24, 1999 in the form of a 50% stock
dividend, payable April 1, 1999.
(3) Includes facilities operated under licensing and joint venture agreements.
(4) Excludes current maturities.
2 - Letter to Stockholders; 6 - Industry Overview; 7 - Business Review;
8 - Stores; 14 - Business Services; 22 - International; 33 - Financial
Information; 64 - Corporate Directors & Officers; IBC - Corporate Information
<PAGE> 2
Office Depot, Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
Office Depot, Inc. ("Office Depot" or the "Company") is the largest supplier of
office products and services in the world. The Company sells to consumers and
businesses of all sizes through its three business segments - Stores, Business
Services and International. The Company operates on a 52 or 53 week fiscal year
ending on the last Saturday in December.
On February 24, 1999, the Company declared a three-for-two stock split in the
form of a 50% stock dividend payable on April 1, 1999 to stockholders of record
on March 11, 1999. With the exception of pro forma earnings per share, share and
per share amounts reported do not reflect this stock split.
Stores Division: Office Depot began operations by opening its first office
supply store in Florida in October 1986. From its inception, the Company has
used store expansion to establish itself as a leader in the retail office
supplies industry, targeting markets with high concentrations of small- and
medium-sized businesses. As of the end of 1998, the Company's Stores Division
operated 702 office supply stores in 41 states, the District of Columbia and
Canada. Store activity for the last five years has been as follows:
<TABLE>
<CAPTION>
Open at Open at
Beginning End
of Period Opened Closed Relocated of Period
===========================================================
<S> <C> <C> <C> <C> <C>
1994 351 71 2 1 420
1995 420 82 1 6 501
1996 501 60 -- 3 561
1997 561 42 1 2 602
1998 602 101 1 5 702
===========================================================
</TABLE>
The rate of new store openings during 1997 and the first nine months of 1998 was
reduced due to uncertainty associated with the proposed merger with Staples,
Inc. ("Staples"), which was terminated in July 1997. By the end of 1998, the
Company had restaffed its real estate department and increased the pace of its
store openings. The Company currently plans to open at least 105 retail stores
in the United States and Canada during 1999.
Business Services Group: In 1993 and 1994, the Company expanded into the full
service contract stationer business by acquiring eight contract stationers with
18 domestic customer service centers. Customer service centers ("CSCs") are
warehouse and delivery facilities, many of which also house sales offices, call
centers and administrative offices. These acquisitions also allowed the Company
to broaden its commercial and retail delivery business. During the past four
years, the Company has replaced several outdated, inefficient facilities with
new CSCs and converted all of these facilities' warehouse and order entry
systems to a common platform. With the integration of these facilities complete,
the Company continues to direct its attention toward increasing market share in
its Business Services Group. With the addition of 10 domestic facilities through
its August 1998 merger with Viking Office Products, Inc. ("Viking"), the
Company's Business Services Group operated 30 CSCs throughout the United States
at the end of 1998. While the Company plans to integrate its delivery network,
it will continue to operate under both the Office Depot and Viking brands.
In January 1998, the Company introduced its Office Depot public Internet site
(www.officedepot.com), expanding its e-commerce capabilities beyond its existing
contract web site. In 1998, the Company's e-commerce sales exceeded $66 million,
$29 million of which were made in the fourth quarter. Although this channel is
relatively new to the Company, based on growth rates experienced during 1998,
management believes its Internet-based business will provide further growth
opportunities for the Business Services Group through the Office Depot and
Viking (www.vikingop.com) web sites.
International Division: In December 1993, the Company established its presence
outside of the United States and Canada by opening its first store in Colombia
through a license agreement. The Company continued its international expansion
through license and joint venture agreements. Prior to 1998, all of the
International Division's office supply
33
<PAGE> 3
stores and its Office Depot CSCs were operated under license and joint venture
agreements. In 1998, the Company expanded internationally through its merger
with Viking, whose international operations are wholly-owned, and by increasing
its ownership position in its operations in France and Thailand to 100% and 80%,
respectively. International store and CSC activity, including facilities
operated through license and joint venture agreements, for the last five years
is as follows:
<TABLE>
<CAPTION>
Office Supply Stores Customer Service Center
-------------------------------------------- --------------------------------------------
Open at Open at Open at Open at
Beginning End Beginning End
of Period Opened Closed of Period of Period Opened Closed of Period
=====================================================================================================
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1994 1 2 -- 3 3 1 -- 4
1995 3 6 -- 9 4 4 -- 8
1996 9 12 -- 21 8 4 -- 12
1997 21 18 -- 39 12 4 -- 16
1998 39 48 -- 87 16 2 1 17
=====================================================================================================
</TABLE>
Results of Operations
Sales
<TABLE>
<CAPTION>
Annual
Dollars in thousands Sales increase
=============================================================
1998
<S> <C> <C>
Stores Division $ 5,128,621 9%
Business Services Group 2,825,564 13%
International Division 1,047,472 19%
Inter-segment (3,919)
-------------------------------------------------------------
Total $ 8,997,738 11%
=============================================================
1997
Stores Division $ 4,716,991 6%
Business Services Group 2,503,826 22%
International Division 882,806 20%
Inter-segment (3,304)
-------------------------------------------------------------
Total $ 8,100,319 12%
=============================================================
1996
Stores Division $ 4,470,525
Business Services Group 2,046,189
International Division 737,380
Inter-segment (3,163)
-------------------------------------------------------------
Total $ 7,250,931
=============================================================
</TABLE>
The increases in sales in the Stores Division resulted from comparable stores
sales growth of 3% in 1998 and 1% in 1997, coupled with the incremental sales
attributable to the net increases in its store base in 1998 and 1997 of 100 and
41, respectively. The Company's comparable store sales in the future may be
impacted by competition, the opening of new Office Depot stores in markets where
stores already exist, and various other economic conditions. The increases in
sales in the Business Services Group were achieved primarily by expanding its
contract sales force and by increasing circulation of direct mail catalogs from
95 million in 1996 to 113 million in 1998. The sales increases in the
International Division were primarily the result of continued penetration of the
Viking brand in existing and new European markets. In U.S. dollars, the Company
increased its sales in the U.K. by 14% in 1998 and 16% in 1997; with increases
of 31% and 46% for the same two years, respectively, in Germany. Over 60% of the
International Division's sales are made in the U.K. and Germany.
The Company's sales by product group are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
=========================================================================
<S> <C> <C> <C>
General office supplies 42.85% 42.65% 42.73%
Computers, business machines
and related supplies 46.02% 45.69% 45.65%
Office furniture 11.13% 11.66% 11.62%
- -------------------------------------------------------------------------
100.00% 100.00% 100.00%
=========================================================================
</TABLE>
The Company's merchandise mix has remained relatively stable over the periods,
with the increase in computers, business machines and related supplies in 1998
driven by growth in business machine supplies.
34
<PAGE> 4
Gross Profit
<TABLE>
<CAPTION>
Gross Gross
Dollars in thousands profit profit %
=========================================================
1998
<S> <C> <C>
Stores Division $ 1,222,529 23.8%
Business Services Group 862,069 30.5%
International Division 430,173 41.1%
Inter-segment (1,497)
- ---------------------------------------------------------
Total $ 2,513,274 27.9%
=========================================================
1997
Stores Division $ 1,012,127 21.5%
Business Services Group 768,059 30.7%
International Division 357,792 40.5%
Inter-segment (1,180)
- ---------------------------------------------------------
Total $ 2,136,798 26.4%
=========================================================
1996
Stores Division $ 916,665 20.5%
Business Services Group 644,942 31.5%
International Division 295,113 40.0%
Inter-segment (1,012)
- ---------------------------------------------------------
Total $ 1,855,708 25.6%
=========================================================
</TABLE>
As the Company has grown and strengthened its relationships with its key
vendors, gross profit percentages continue to benefit from decreasing net
product costs. Furthermore, while the computers, business machines and related
supplies product group yields lower gross profit percentages than other product
groups, the Company has seen a favorable shift in product mix within that group
toward machine supplies and accessories, which has contributed to higher overall
gross profit margins. In addition, the Company has improved its margins on
computers by reducing its brand assortment and inventory levels and by
increasing its inventory turns.
In addition to strengthening technology margins, the improvements in gross
profit percentage in the Stores Division are largely due to proactive
merchandising and pricing strategies applied to all product categories. As the
Business Services Group has aggressively pursued market share growth in a highly
competitive environment, particularly in the contract business, its gross margin
percentage has declined somewhat. The Company expects its Business Services
margins to improve as its market penetration increases and as it continues to
utilize a more disciplined pricing approach. Gross profit in the International
Division has improved as the Company's direct mail operations in various
European countries have continued to mature.
The Company's gross profit percentage fluctuates as a result of numerous
factors, including competitive pricing pressures, changes in product and
customer mix, suppliers' pricing changes, as well as the Company's ability to
achieve purchasing leverage through growth in total merchandise purchases.
Additionally, occupancy costs, which reduce gross profit, can vary as the
Company adds stores and CSCs in new markets.
Store and Warehouse Operating and Selling Expenses
<TABLE>
<CAPTION>
Store and
warehouse
operating
and selling Percentage
Dollars in thousands expenses of sales
==========================================================
<S> <C> <C>
1998
Stores Division $ 684,348 13.3%
Business Services Group 675,674 23.9%
International Division 283,102 27.0%
Other (1,082)
- ---------------------------------------------------------
Total $1,642,042 18.3%
=========================================================
1997
Stores Division $ 622,266 13.2%
Business Services Group 577,752 23.1%
International Division 243,952 27.6%
Other (778)
- ---------------------------------------------------------
Total $1,443,192 17.8%
=========================================================
1996
Stores Division $ 578,055 12.9%
Business Services Group 494,797 24.2%
International Division 207,894 28.2%
Other (639)
- ---------------------------------------------------------
Total $1,280,107 17.7%
=========================================================
</TABLE>
The largest components of operating and selling expenses are personnel expenses
and credit card processing fees for the Stores Division; personnel and delivery
expenses for the Business Services Group; and advertising, personnel and
delivery expenses for the International Division. Direct mail constitutes the
largest international sales channel, and advertising includes the cost of
catalog preparation and mailing. Operating and selling expenses as a percentage
of sales are significantly higher in the Business Services Group than in the
Stores Division, principally because of the need for a more experienced and more
highly compensated sales force. Operating expenses as a percentage of sales are
significantly higher in the International Division than in the Company's other
segments primarily because of the use of an extensive catalog marketing program
to drive sales in new and existing markets. Additionally, operating
internationally typically requires a longer start-up period for certain sales
channels, resulting in higher costs relative to sales during the start-up phase.
The Stores Division added 100 stores in 1998 (68 of which opened in the fourth
quarter) and 41 stores in 1997 (28 of
35
<PAGE> 5
which were in the fourth quarter), resulting in an overall lower average age for
the store base. Because newer stores generally have lower average sales than
mature ones, operating and selling expenses as a percentage of sales in the
Stores Division have increased. These increases were driven largely by payroll
and other expenses which have a fixed cost component. In addition, opening new
stores in existing markets can cannibalize the sales of other Office Depot
stores in those markets, causing increases in expense percentages. Certain
incremental expenses were also incurred in the Stores Division in 1998 because
of the Company's aggressive store remodeling program. The Stores Division
completed approximately 200 store remodels in 1998 and plans to continue its
remodeling program in 1999.
Operating and selling expenses as a percentage of sales increased in the
Business Services Group in 1998 as compared to 1997 primarily because of the
costs associated with consolidating and integrating five Office Depot CSCs into
two larger and more efficient facilities, and converting its Office Depot
warehouse and order entry systems to common platforms. These expenses as a
percentage of sales declined in 1997 as compared to 1996 largely as a result of
enhanced operating efficiencies in its warehouses, coupled with a 22% increase
in sales. Management believes that operating synergies arising from the Viking
merger will positively impact the Business Services Group's operating and
selling expenses as a percentage of sales in 1999 as the Company begins
integrating Office Depot's and Viking's warehouses and systems. See additional
discussion of the planned integration in "Merger and Restructuring Costs."
Operating and selling expenses as a percentage of sales decreased in the
International Division primarily as a result of the Company's operations
continuing to mature in countries such as Germany, which the Company entered in
late 1995. As the Company's operations in a particular market grow, certain
fixed operating expenses decline relative to sales. Additionally, as market
share increases, costs for advertising in the form of prospecting decline as a
percentage of sales. The Company expects its International Division's operating
expenses as a percentage of sales to continue to improve in its established
markets. These improvements, however, will be offset by incremental costs
incurred to develop newer markets.
Pre-opening Expenses
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Dollars in thousands 1998 1997 1996
=================================================================
Pre-opening expenses $17,150 $6,609 $9,827
- -----------------------------------------------------------------
Office supply stores opened* 106 44 63
=================================================================
*Includes relocations.
</TABLE>
Pre-opening expenses consist principally of personnel, property and advertising
expenses incurred in the Stores Division. Since these items are expensed as
incurred, the amount of pre-opening expenses each year is generally proportional
to the number of new stores opened, in the process of being opened, or relocated
during the year. The decrease in these expenses from 1996 to 1997 was due to the
slowed store openings that resulted from uncertainty surrounding the proposed
merger with Staples. Pre-opening expenses, which currently approximate $125,000
per standard office supply store, are predominantly incurred during a six-week
period prior to the store opening. Pre-opening expenses also include, to a
lesser extent, expenses incurred to open and relocate CSCs in the Business
Services Group. Expenses incurred in the pre-opening phase of a new
standard-sized CSC are approximately $500,000, and pre-opening expenses for a
new, larger-sized CSC approximate $1,750,000. However, these expenses may vary
with the size and type of future CSCs.
General and Administrative Expenses
<TABLE>
<CAPTION>
Dollars in thousands 1998 1997 1996
========================================================================
<S> <C> <C> <C>
General and administrative
expenses $330,194 $272,022 $222,714
- ------------------------------------------------------------------------
Percentage of sales 3.7% 3.4% 3.1%
========================================================================
</TABLE>
General and administrative expenses consist primarily of personnel-related costs
incurred in the administration of support functions. As these functions, for the
most part, support all segments of the Company's business, they are not
considered in determining segment profitability. The increase in general and
administrative expenses as a percentage of sales in 1998 is principally
attributable to the strengthening of the Company's overall corporate management
infrastructure, including the addition of several key executives. In the area of
merchandising and supply chain operations, this increased staffing drove
reductions in inventory levels. Additionally, certain incremental corporate
expenses were incurred to support the Company's store remodeling and CSC
consolidation initiatives. Costs associated with the Company's Year 2000
compliance efforts and e-commerce initiatives also contributed to higher general
and administrative expenses in 1998. In 1997, staffing issues associated with
the proposed Staples merger resulted in fewer corporate personnel, thus reducing
certain general and administrative costs. However, these reductions were offset
by the Company's continued investment in improving its management information
systems and, to some extent, by bonus accruals under the Company's incentive pay
programs. In contrast, in 1996, the Company did
36
<PAGE> 6
not meet most of its performance goals under these programs; thus, no bonuses
were awarded to senior management. While the Company has been able to decrease
certain other general and administrative expenses as a percentage of sales,
there can be no assurance that the Company will be able to continue to increase
sales without a proportionate increase in corporate expenditures. Synergies
arising from the Viking merger are expected to positively impact the Company's
general and administrative expenses in the future.
Other Income and Expenses
<TABLE>
<CAPTION>
In thousands 1998 1997 1996
=======================================================================
<S> <C> <C> <C>
Interest income $ 25,309 $ 7,570 $ 3,726
Interest expense (22,356) (21,680) (26,378)
Equity in earnings (losses)
of investees, net (12,811) (7,034) (2,178)
=======================================================================
</TABLE>
As interest income and expense arise from corporate financing strategies, they
are not considered by management in the determination of segment profitability.
Increases in interest income reflect improved operating cash flows, which have
yielded higher cash balances, allowing the Company to repay all of its
short-term borrowings during 1997. The majority of the Company's interest
expense is fixed in nature and relates to its convertible, subordinated debt.
Equity in earnings (losses) of investees, net, represents the Company's share of
the earnings (losses) of the joint ventures in which the Company has an
ownership interest of 50% or less, as well as royalty and license income
generated under license agreements. Because all of the Company's equity
investees operate outside of the United States and Canada, equity in earnings
(losses) of investees is included in the determination of profitability of the
International Division. During 1998, the Company increased its share of
ownership in its operations in France and Thailand to 100% and 80%,
respectively. Accordingly, the results of these operations have been
consolidated from the date of the respective share purchase transactions. The
increased losses in 1998 and 1997 were substantially attributable to start-up
losses in the Company's joint venture in Japan. The Company, through its equity
method joint ventures, opened 34 locations in 1998 (excluding six locations in
Mexico that were purchased and did not require start-up costs and one location
in France that was opened subsequent to November 1998, when the Company began
consolidating its results), 18 locations in 1997 and 10 locations in 1996.
Aggregate losses incurred by the Company's joint venture operations are expected
to continue in 1999 as a result of the protracted start-up period generally
associated with international operations. However, the addition of Viking's
management expertise and marketing experience is expected to shorten the
start-up period and improve the Company's profitability in its international
operations.
Merger and Restructuring Costs: In August 1998, the Company completed its merger
with Viking. In conjunction with the merger, each outstanding share of Viking
common stock was converted into one share of Office Depot common stock. The
merger was accounted for as a pooling of interests. Accordingly, the prior
periods' consolidated financial statements and other non-financial information
of the Company have been restated and combined with the consolidated financial
statements and other non-financial information of Viking as if the merger had
taken place at the beginning of the periods reported. In September 1998, in
formulating its strategy for integrating the two companies, management announced
its plan to close several facilities by the end of 2000. These facilities have
been identified as redundant, or management believes that the business handled
by these facilities can be more efficiently handled by other existing
facilities. Accordingly, certain assets have been written off and certain costs
accrued. Additionally, in November 1998, management decided to focus its
attention on continued growth in its core businesses and on expansion of its
international operations. In conjunction with this decision, the Company plans
to close its five Furniture at Work(TM) and five Images(TM) stores, one of which
was closed during the fourth quarter of 1998. Management expects all remaining
stores to be closed by the end of the third quarter of 1999.
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.
37
<PAGE> 7
Merger and restructuring costs in 1998 and 1997 consist of the following
charges:
<TABLE>
<CAPTION>
In thousands 1998 1997
================================================================================
<S> <C> <C>
Viking and Staples mergers:
Costs directly attributable to merger
transactions $ 31,555 $16,094
Asset impairment associated with the closure
of identified facilities and the write-off of
software applications to be abandoned 41,962 --
Other facility exit costs, principally estimated
lease costs subsequent to closing
of facilities 18,143 --
Personnel retention and termination costs
incurred through December 26, 1998 14,553 --
Other integration costs 1,936 --
- --------------------------------------------------------------------------------
108,149 16,094
- --------------------------------------------------------------------------------
Furniture at Work(TM) and Images(TM) closings:
Asset impairment associated with the closure
of stores 3,882 --
Other exit costs, principally estimated lease
costs subsequent to closing of stores 7,098 --
- --------------------------------------------------------------------------------
10,980 --
- --------------------------------------------------------------------------------
Total $119,129 $16,094
================================================================================
</TABLE>
The fair value of asset impairments was determined based on estimating the net
realizable value at the time of the anticipated closure or discontinuation.
Estimated proceeds from and costs in connection with disposal of these assets
were determined through analysis of historical data and expected outcomes.
As of December 26, 1998, approximately $84.8 million related to merger and
restructuring costs is included in accrued expenses on the consolidated balance
sheet. Excluding the after-tax impact of merger and restructuring costs and the
effect of the stock split described in Note A, the Company's diluted earnings
per share would have been $1.24 in 1998 and $.97 in 1997.
Income Taxes
<TABLE>
<CAPTION>
Dollars in thousands 1998 1997 1996
================================================================================
<S> <C> <C> <C>
Income taxes $ 155,531 $ 136,730 $ 115,865
Effective income tax rate* 40.0% 36.8% 37.1%
Effective income tax rate,*
excluding merger and
restructuring costs 37.0% 36.8% 37.1%
================================================================================
</TABLE>
*Income taxes as a percentage of earnings before income taxes.
The increase in the overall effective income tax rate between 1997 and 1998 is
the result of certain non-deductible merger-related charges incurred in the last
half of 1998. The Company's effective income tax rate, excluding merger and
restructuring costs, generally fluctuates as a result of various tax planning
strategies employed domestically and internationally.
Liquidity and Capital Resources
Cash provided by (used in) the Company's operating, investing and financing
activities has been as follows:
<TABLE>
<CAPTION>
In thousands 1998 1997 1996
===================================================================
<S> <C> <C> <C>
Operating activities $ 660,032 $ 446,975 $ 181,645
- -------------------------------------------------------------------
Investing activities $(252,734) $(141,056) $(242,439)
- -------------------------------------------------------------------
Financing activities $ 61,747 $(131,929) $ 61,690
===================================================================
</TABLE>
Operating: The Company has historically relied principally on cash flow
generated from its operations as the primary source of its funds because the
majority of the Company's store sales are on a cash and carry basis.
Furthermore, the Company utilizes private label credit card programs
administered and financed by financial services companies, which allow the
Company to expand its sales without the burden of carrying additional
receivables. Cash requirements are also 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 and direct mail channels are generally
made pursuant to regular commercial credit terms under which the Company carries
its own receivables, as opposed to sales made to smaller retail and commercial
customers, who generally pay in cash or by credit card. Therefore, as the
Company expands its contract and direct mail business, management anticipates
that its accounts receivable portfolio 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
somewhat seasonally, growing during the second half of the year and declining
during the first half, as certain collections occur after an entire program year
has been completed.
38
<PAGE> 8
Slower store openings contributed to the $265 million increase in net cash
provided by operating activities in 1997. By the fourth quarter of 1998, the
Company had restaffed its real estate department and increased the pace of its
store openings. While these increases in store openings utilized additional
cash, the increase in comparable store sales, coupled with a reduction in
overall inventory levels, provided funds to more than offset this impact in
1998. As a result, net cash provided by operating activities grew to $660.0
million in 1998. The Company's continued focus on supply chain management drove
the $138.9 million reduction in inventory balances in 1998 without negatively
impacting its in-stock position. Increases in contract and commercial sales from
existing CSCs, both in 1998 and 1997, also leveraged assets employed and
generated incremental operating cash flow.
Investing: The acquisition of capital assets, which is generally driven by the
number of stores and CSCs opened or remodeled each year, as well as the increase
in computer and other equipment at the corporate office required to support such
expansion, represents the Company's primary investing activity. The increase and
decrease in capital expenditures in 1998 and 1997, respectively, resulted
primarily from the fluctuation in store openings and remodels.
The Company currently plans to open at least 105 stores during 1999. Management
estimates that the Company's cash requirements, exclusive of pre-opening
expenses, will be approximately $1.5 million for each new office supply store,
with approximately $784,000 allocated to leasehold improvements, fixtures,
point-of-sale terminals and other equipment in the stores, and approximately
$750,000 allocated to that portion of the inventories that is not financed by
vendors. In addition, management estimates that each new office supply store
requires pre-opening expenses of approximately $125,000. The cash requirements
for a new CSC, exclusive of pre-opening expenses, are significantly more than
for a store. Each new CSC requires pre-opening expenses ranging from $500,000 to
$1,750,000, depending upon the size of the facility.
Financing: The Company paid down all of its short-term borrowings, totaling $140
million, in February 1997. Since that time, the Company has not borrowed any
amounts against its credit facility. In February 1998, the Company entered into
a new credit agreement 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 for
various borrowing rate options, including a rate based on credit rating and
fixed charge coverage ratio factors that currently would result in an interest
rate of .18% over LIBOR. The credit facility expires in February 2003 and
contains certain restrictive covenants relating to various financial statement
ratios. As of December 26, 1998, the Company had no outstanding borrowings under
the credit facility and had outstanding letters of credit totaling $9.2 million.
In addition to bank borrowings, the Company has historically used equity
capital, convertible debt and capital equipment leases as supplemental sources
of funds.
In 1992 and 1993, the Company issued Liquid Yield Option Notes ("LYONs") which
are zero coupon, convertible subordinated notes maturing in 2007 and 2008,
respectively. Each LYON is convertible at the option of the holder at any time
on or prior to maturity into common stock of the Company at conversion rates of
29.263 and 21.234 shares per 1992 and 1993 LYON, respectively. The Company, at
its option, may elect to pay the purchase price on any particular conversion
date in cash or common stock, or any combination thereof.
The Company's management continually reviews its financing options. Although it
currently anticipates that all 1999 expansion and other activities will be
financed through cash on hand, funds generated from operations, equipment leased
under the Company's lease facilities and funds available under the Company's
revolving credit facility, alternative financing will be considered if market
conditions make it financially attractive. The Company's financing requirements
beyond 1999 will be affected by changes in operating and investing decisions,
including the number of new stores or CSCs opened or acquired.
39
<PAGE> 9
Impact of the Year 2000 Issue
The Year 2000 ("Y2K") issues arise because of the inability of certain
electronic data operating systems to differentiate between the years 1900 and
2000 when processing data. Many systems and programs were written to recognize
and process two digits for the year, instead of four.
In recent years, the producers of electronic data operating systems, as well as
most other businesses, have generally become aware of Y2K issues and the
potential for disruption in the operation of business as a result of systems
that are not Y2K compliant. Y2K issues can arise at any point in the Company's
operational or financial processes. Most systems and programs developed in the
past several years have been designed to be Y2K compliant, whereas many of the
older systems and programs are not Y2K compliant and require various changes in
order to bring them into compliance.
Most of the Company's current application systems were developed over the past
four years and were designed to use four-digit year values. Management believes
that these systems are already Y2K compliant. To ensure a smooth transition into
the millennium, the Company has established the Year 2000 Project Office led by
a Year 2000 Project Team ("Project 2000"). The objective of Project 2000 is to
establish standards and guidelines, assist in development and remediation plans,
track and report on progress, and answer customer and vendor inquiries regarding
its Y2K compliance efforts. Project 2000 consists of four major components:
Technology Systems, including (1) Operations and (2) Development; and
Non-technology Systems, including (3) Facilities and (4) Merchandising.
Technology Systems: Operations includes the review of data center process
automation equipment, software not internally developed or supported by the MIS
department, and data/voice networks. The phases of this component are: (1)
review all equipment and complete an inventory of all hardware and software, (2)
evaluate the readiness of all hardware and software and plan for required
upgrades to Y2K compliant versions and (3) correct all non-compliant hardware
and software through upgrades certified as Y2K compliant by their vendors. The
Company expects to have all phases of this component complete by August 1999.
MIS Development focuses on the proper operation of application software
developed or supported in-house. The phases of this component are: (1) assess
systems for potential Y2K issues, (2) remediate any non-compliant systems by
changing the program code to properly process all dates, (3) test to make sure
remediation has not changed the functionality of the application, and place new
program code into production, (4) test the accuracy of the output under multiple
scenarios and (5) certify that the systems are Y2K compliant. This component is
being completed by multiple MIS teams. Although each team is at a different
phase in the project, this component, as a whole, is currently on schedule to be
substantially completed by the end of the second quarter of 1999. Overall, the
two Technology components together are currently approximately 80% complete.
Non-technology Systems: The Facilities component of Project 2000 involves the
Company's buildings and transportation. Typical concerns related to buildings
include security, environment and telephone systems. Concerns related to
transportation include scheduling, communication, security, tracking and
maintenance. The phases of this component are: (1) develop an inventory of
equipment and services and associated vendors, (2) contact all vendors to verify
Y2K compliance of their equipment and services, (3) upgrade systems and
equipment to compliant versions, if necessary, (4) test equipment and systems
and (5) certify that all such equipment and services are Y2K compliant. The
Company has completed phases 1 and 2 of this component and has begun work on
phase 3. This component is currently on schedule to be completed by April 1999.
For the Merchandising component of Project 2000, the Company will attempt to
ensure that merchandise suppliers are able to meet their delivery commitments.
The phases of this component are: (1) develop a supplier survey, (2) request
that suppliers confirm Y2K compliance, (3) establish confidence/risk levels by
product, (4) develop contingency plans for non-compliant vendors (e.g.,
alternate product sources, increased inventory levels, etc.) and (5) certify
products as Y2K compliant or implement contingency plans. Phase 1 has been
completed and phases 2 and 3 are in the process of being completed. The Company
will continue to follow up with vendors until they have all responded. Nearly
90% of respondents have plans in place for internal systems compliance and
almost 70% have already certified that their products are Y2K compliant. This
component is currently on schedule to be completed by April 1999.
40
<PAGE> 10
The Company's Y2K effort is being undertaken on a worldwide basis to identify
the level of Y2K preparedness of the Company's operations in each country.
Because of the interdependent nature of the Company's operations with those of
its suppliers and customers, the Company could be materially adversely affected
if utilities, private businesses or governmental entities with which it does
business are not adequately prepared for the year 2000. A reasonably possible
worst case scenario resulting from the Company not being fully Y2K compliant by
January 1, 2000 might include, among other things, temporary store or CSC
closings, delays in the delivery of products, delays in the receipt of supplies,
payment and collection errors, and inventory and supply obsolescence.
Consequently, the business and the results of operations of the Company could be
materially adversely affected by a temporary inability of the Company to conduct
its business in the ordinary course for a period of time after January 1, 2000.
However, management believes that its Y2K readiness program should significantly
reduce any adverse effect from any such disruptions, and the effect on the
Company's financial position or the results of its operations is not expected to
be material. The Company has not experienced any significant delays in other MIS
initiatives as a result of Project 2000.
Costs for hardware and software are capitalized and depreciated over the assets'
estimated useful lives. All other costs specifically associated with Project
2000 (e.g., labor, consulting fees, maintenance contracts, etc.) are expensed as
Total costs incurred in 1998 related to Project 2000 were approximately $5
million, most of which were expensed. The Company expects to spend another $7 to
$9 million to complete Project 2000, most of which will be expensed as incurred.
The Company's Y2K readiness program is an ongoing process, and the estimates of
costs and completion dates for various components of the Y2K readiness program
described above are subject to change. The estimates and conclusions herein
contain forward-looking statements and are based on management's best estimates
of future events. Although the Company expects its systems and facilities to be
Y2K compliant by the end of the third quarter of 1999, there is no assurance
that this goal will be achieved. Risks to completing the plan include the
availability of resources, the Company's ability to identify and correct any
potential Y2K issues, and the willingness and ability of suppliers, customers
and governmental agencies to bring their systems into Y2K compliance.
Euro
On January 1, 1999, certain member countries of the European Union established
fixed conversion rates between their existing currencies and the European
Union's common currency (the euro). The euro is currently trading on currency
exchanges and may be used in business transactions. The ultimate conversion to
the euro will eliminate currency exchange rate risk among the member countries.
The former currencies of the participating countries are scheduled to remain
legal tender as denominations of the euro until January 1, 2002. During this
transition period, parties may settle transactions using either the euro or a
participating country's former currency. Beginning in January 2002, new
euro-denominated bills and coins will become the legal currency, and, during the
ensuing months, all former currencies will be withdrawn from circulation.
The use of a single currency in the participating countries may affect the
Company's ability to price its products differently in the various European
markets because of price transparency. One possible result is price
harmonization at lower average prices for items sold in some markets.
Nevertheless, other market factors such as local taxes, customer preferences and
product assortment may reduce the need for price equalization.
The Company has significant sales in Europe and is currently evaluating the
business implications of the conversion to the euro, including the need to adapt
internal systems to accommodate euro-denominated transactions, the competitive
implications of cross border price transparency, the impact on existing
marketing programs, and other strategic implications. Based on these
evaluations, the Company does not expect the conversion to the euro to have a
material effect on its financial position or the results of its operations.
41
<PAGE> 11
INTEREST RATE AND FOREIGN EXCHANGE MARKET RISKS
INTEREST RATE RISKS: The Company's short-term investment portfolio generates
interest income which is affected by changes in interest rates. As of December
26, 1998, assuming the investment portfolio was held constant, management
estimates that a ten percent change in short-term interest rates would result in
an after-tax increase or decrease of approximately $2 million in investment
income on an annual basis. The Company's zero coupon, convertible, subordinated
notes offer stated yields to maturity which are not subject to interest rate
risks. Borrowings under the Company's bank credit agreement would be subject to
variable interest rates; however, there were no such borrowings at December 26,
1998.
FOREIGN EXCHANGE RATE RISKS: The Company conducts business in various
countries outside of the United States, and does, from time to time, enter into
forward or option contracts to minimize its exposure to foreign exchange rate
risk related to specific transactions. During 1998, a maximum of $13.1 million
in foreign exchange forward contracts was outstanding at any one time. As of
December 26, 1998, there were no forward or option contracts outstanding.
Foreign currency transaction exposure arises when an operating unit transacts
business denominated in a currency that is not its own functional currency. The
Company's transaction risks are attributable primarily to inventory purchases
from third party vendors. The introduction of the euro has significantly reduced
such risks, and transaction exposures on an overall basis are not significant.
The Company also has foreign exchange translation exposures resulting from the
translation of foreign currency-denominated earnings into U.S. dollars in the
Company's consolidated financial statements. Management estimates that, as of
December 26, 1998, a ten percent change in applicable foreign exchange rates
would have raised or lowered the Company's after-tax earnings by approximately
$3.5 million on an annual basis.
INFLATION AND SEASONALITY
Although the Company cannot precisely determine the effects of inflation on its
business, it does not believe inflation has a material impact on its sales or
the results of its operations. The Company considers its business to be somewhat
seasonal, with sales in its Stores and Business Services Groups trending
slightly higher during the first and fourth quarters of each year and sales in
its International Division trending slightly higher in the third quarter.
NEW ACCOUNTING PRONOUNCEMENT
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which requires reporting every derivative
instrument at its fair value on the balance sheet. This statement also requires
recognizing any change in the derivatives' fair value in earnings for the
current period unless specific hedge accounting criteria are met.
SFAS No. 133 is effective for fiscal quarters of fiscal years that begin after
June 15, 1999. The Company has not determined the impact that this statement
will have on its financial position or the results of its operations upon
adoption.
42
<PAGE> 12
CAUTIONARY STATEMENTS FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
In December 1995, the Private Securities Litigation Reform Act of 1995 (the
"Act") was enacted by the United States Congress. The Act contains certain
amendments to the Securities Act of 1933 and the Securities Exchange Act of
1934. These amendments provide protection from liability in private lawsuits for
"forward-looking" statements made by public companies and other persons
specified in the Act. The Company desires to take advantage of the "safe harbor"
provisions of the Act. In order to do so, these cautionary statements are
provided.
This Annual Report contains both information which is historical in nature and
other information which looks toward the future performance of the Company.
Examples of historical information include the 1998 financial statements and the
commentary on past performance contained in this Management's Discussion and
Analysis. The Company cautions readers that, with the exception of information
which clearly deals with historical matters, the information contained in this
Annual Report should be considered to be "forward-looking statements" as
referred to in the Act.
Forward-looking information involves risks and uncertainties, including certain
matters which are discussed in more detail below and in the Company's report on
Form 10-K, filed with the Securities & Exchange Commission. This information is
based on various factors and important assumptions about future events that may
or may not actually come true. As a result, the Company's operations in the
future and its financial results could differ materially and substantially from
those discussed in the forward-looking statements in this Annual Report. In
particular, the factors discussed below and in the Company's Form 10-K could
affect the Company's actual results and could cause the Company's actual results
during 1999 and in future years to differ materially from those expressed in any
forward-looking statement made by or on behalf of the Company in this Annual
Report.
COMPETITION: The Company competes with a variety of retailers, dealers and
distributors in a highly competitive marketplace, including high-volume office
supply chains, warehouse clubs, computer stores, contract stationers and
well-established mass merchant retailers. Internet-based merchandisers have
begun competing with the Company. This competition is expected to increase in
the future as both the Company and these and other companies continue to expand
their operations. Many startup operations focused heavily on Internet sales may
be able to effectively compete with the Company in the areas of price
competition and selection.
Some of these competitors may be willing to substantially sacrifice their
profitability in order to gain a foothold in the marketplace. In addition,
certain manufacturers of computer hardware, software and peripherals, including
suppliers of the Company, have expanded their own direct marketing of products,
particularly over the Internet. If the Company is unable to effectively counter
this competitive expansion, it could have a material adverse effect on the
Company's sales growth and operating results.
EXECUTION OF EXPANSION PLANS: The Company plans to open at least 105 stores in
1999, and the Company considers its expansion program to be an integral part of
its plan to achieve anticipated operating results in future years. Conditions
outside the Company's control, such as adverse weather conditions affecting
construction schedules, unavailability of acceptable sites or materials, labor
disputes and similar issues could impact anticipated store openings.
Additionally, as the Company expands the number of its stores in existing
markets, sales of existing stores may suffer from cannibalization. New stores
typically require an extended period of time, generally exceeding a year, to
reach the sales and profitability levels of the Company's existing stores. 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 failure to expand by opening new stores as planned and the
failure to generate the anticipated sales growth in markets where new stores are
opened could have a material adverse effect on the Company's future sales
growth, profitability and operating results.
VIKING MERGER AND INTEGRATION: On August 26, 1998, the Company merged with
Viking. Costs related to the integration of Viking's warehouse facilities with
the Company's delivery network will increase warehouse expenses in 1999 and
possibly beyond 1999. Moreover, integrating the operations and management of
Office Depot and Viking is a complex process. The integration of the two
companies will require significant management attention, which may temporarily
distract management from other matters. The inability of management to integrate
successfully the operations of Office Depot and Viking could have a material
adverse effect on the future revenues, sales growth, profitability, and
operating results of the Company.
43
<PAGE> 13
INTERNATIONAL MARKET: The Company has operations in a number of international
markets. The Company intends to enter additional international markets as
attractive opportunities arise. In addition to the risks described above,
internationally the Company faces such risks as foreign currency fluctuations,
unstable political and economic conditions, obtaining adequate and appropriate
inventory and, because some of its foreign operations are not wholly-owned,
compromised operating control in certain countries.
BUSINESS SERVICES SALES: The Company competes with a number of contract
stationers, mail order operators and retailers who supply office products and
services to large and small businesses both nationally and internationally. In
order to achieve and maintain expected profitability levels, the Company must
continue to grow this segment of the business. Some of the Company's competitors
do not compete in the retail superstore category in which the Company operates
and therefore may be able to focus more attention on the business services
segment, thereby providing formidable competition for the Company. Failure of
the Company to adequately address this segment of its business could put it at a
competitive disadvantage relative to these competitors.
SOURCES AND USES OF CASH; FINANCING: The Company believes that its current level
of cash and cash equivalents, future operating cash flows, lease financing
arrangements and funds available under its revolving credit facility should be
sufficient to fund its planned expansion, integration and other operating cash
needs for at least the next year. 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, opportunities for expansion or
acquisition, changes in growth strategy or adverse operating results. The
inability of the Company to access needed financial resources could have a
material adverse effect on the Company's financial position or its results from
operations.
Y2K ISSUES: While the Company has worked diligently to bring its own systems
into Year 2000 compliance and has endeavored to ensure that its suppliers,
vendors and major customers are also Y2K compliant, there can be no assurance
that the Company and all of its suppliers, vendors or major customers will, in
fact, become Y2K compliant on a timely basis. Any significant failure by the
Company's suppliers, vendors or major customers, or indeed, any unanticipated
failure by the Company to become fully Y2K compliant could have a material
adverse effect on the Company's financial position and results of operations.
DISCLAIMER OF OBLIGATION TO UPDATE: The Company assumes no obligation (and
specifically disclaims any obligation) to update these Cautionary Statements or
any other forward-looking statements contained in this Annual Report to reflect
actual results, changes in assumptions or other factors affecting such
forward-looking statements.
44
<PAGE> 14
Office Depot, Inc. and Subsidiaries
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of Office Depot, Inc.
We have audited the consolidated balance sheets of Office Depot, Inc. and
Subsidiaries as of December 26, 1998 and December 27, 1997, and the related
consolidated statements of earnings, stockholders' equity and cash flows for
each of the three years in the period ended December 26, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Office
Depot, Inc. and Subsidiaries as of December 26, 1998 and December 27, 1997 and
the results of their operations and their cash flows for each of the three years
in the period ended December 26, 1998 in conformity with generally accepted
accounting principles.
DELOITTE & TOUCHE LLP
Certified Public Accountants
Miami, Florida
February 17, 1999 (February 24, 1999 as to the
stock split described in Note A)
45
<PAGE> 15
Office Depot, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 26, December 27,
(In thousands, except share and per share amounts) 1998 1997
====================================================================================================
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 704,541 $ 239,877
Short-term investments 10,424 17,868
Receivables, net of allowances of $25,927 in 1998 and
$25,587 in 1997 721,446 652,786
Merchandise inventories 1,258,355 1,397,266
Deferred income taxes 52,422 35,846
Prepaid expenses 33,247 37,436
- ----------------------------------------------------------------------------------------------------
Total current assets 2,780,435 2,381,079
Property and equipment, net 979,229 846,676
Goodwill, net of amortization 227,964 212,344
Other assets 125,413 80,720
- ----------------------------------------------------------------------------------------------------
$ 4,113,041 $ 3,520,819
====================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,027,591 $ 988,738
Accrued expenses 430,666 265,267
Income taxes 69,910 31,138
Current maturities of long-term debt 2,834 2,473
- ----------------------------------------------------------------------------------------------------
Total current liabilities 1,531,001 1,287,616
Long-term debt, net of current maturities 35,490 29,406
Deferred income taxes and other credits 82,450 68,545
Zero coupon, convertible subordinated notes 435,221 417,614
Commitments and contingencies
Stockholders equity:
Common stock--authorized 800,000,000 shares of
$.01 par value; issued 249,211,803 in 1998 and
245,109,330 in 1997 2,492 2,451
Additional paid-in capital 839,368 762,911
Unamortized value of long-term incentive stock grants (2,874) (3,210)
Accumulated other comprehensive income (18,078) (19,289)
Retained earnings 1,209,721 976,525
Less: 2,163,447 shares of treasury stock, at cost (1,750) (1,750)
- ----------------------------------------------------------------------------------------------------
2,028,879 1,717,638
- ----------------------------------------------------------------------------------------------------
$ 4,113,041 $ 3,520,819
====================================================================================================
</TABLE>
The accompanying notes are an integral part of these statements.
46
<PAGE> 16
Office Depot, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF EARNINGS
<TABLE>
<CAPTION>
52 WEEKS 52 Weeks 52 Weeks
ENDED Ended Ended
DECEMBER 26, December 27, December 28,
(In thousands, except per share amounts) 1998 1997 1996
=======================================================================================================
<S> <C> <C> <C>
Sales $ 8,997,738 $ 8,100,319 $ 7,250,931
Cost of goods sold and occupancy costs 6,484,464 5,963,521 5,395,223
- -------------------------------------------------------------------------------------------------------
Gross profit 2,513,274 2,136,798 1,855,708
Store and warehouse operating and selling expenses 1,642,042 1,443,192 1,280,107
Pre-opening expenses 17,150 6,609 9,827
General and administrative expenses 330,194 272,022 222,714
Amortization of goodwill 6,174 6,146 6,147
Merger and restructuring costs 119,129 16,094 --
- -------------------------------------------------------------------------------------------------------
Operating profit 398,585 392,735 336,913
Other income (expense):
Interest income 25,309 7,570 3,726
Interest expense (22,356) (21,680) (26,378)
Equity in earnings (losses) of investees, net (12,811) (7,034) (2,178)
- -------------------------------------------------------------------------------------------------------
Earnings before income taxes 388,727 371,591 312,083
Income taxes 155,531 136,730 115,865
- -------------------------------------------------------------------------------------------------------
Net earnings $ 233,196 $ 234,861 $ 196,218
=======================================================================================================
Earnings per share:
Basic $ .95 $ .97 $ .82
Diluted .91 .93 .79
=======================================================================================================
Pro forma earnings per share:
Basic $ .64 $ .65 $ .55
Diluted .61 .62 .53
=======================================================================================================
</TABLE>
The accompanying notes are an integral part of these statements.
47
<PAGE> 17
Office Depot, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
Period from December 31, 1995 to December 26, 1998
<TABLE>
<CAPTION>
Unamortized Accumulated
Value of Other
Common Common Additional Long-term Compre- Compre-
(In thousands, Stock Stock Paid-in Incentive Retained Treasury hensive hensive
except for number of shares) Shares Amount Capital Stock Grant Earnings Stock Income Income
====================================================================================================================================
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995 240,306,271 $2,403 $ 699,545 $(7,445) $ 545,446 $(1,750) $ 621
Comprehensive income:
Net earnings 196,218 $196,218
Foreign currency translation
adjustment (1,567) (1,567)
--------
Comprehensive income $194,651
========
Exercise of stock options (including
tax benefits) 2,593,503 26 24,907
Issuance of stock under employee
stock purchase plan 393,790 4 7,982
Restricted stock awards 54,127 1 771
401(k) plan matching contributions 108,681 1 2,070
Conversion of LYONs to
common stock 292 -- 6
incentive stock grant 30,000 -- 745 (745)
Cancellation of long-term
incentive stock grant (400,000) (4) (3,071) 2,358
Amortization of long-term -- --
incentive stock grant 588
===================================================================================================================================
Balance at December 28, 1996 243,086,664 $ 2,431 $732,955 $(5,244) $ 741,664 $(1,750) $ (946)
Comprehensive income:
Net earnings 234,861 $234,861
Foreign currency translation
adjustment (18,343) (18,343)
--------
Comprehensive income $216,518
========
Exercise of stock options (including
tax benefits) 1,818,162 18 23,104
Issuance of stock under employee
stock purchase plan 352,379 4 6,336
401(k) plan matching contributions 151,190 1 2,800
Conversion of LYONs to
common stock 935 -- 20
Cancellation of long-term
incentive stock grant (300,000) (3) (2,304) 1,640
Amortization of long-term
incentive stock grant -- -- 394
===================================================================================================================================
Balance at December 27, 1997 245,109,330 $ 2,451 $762,911 $(3,210) $ 976,525 $(1,750) $(19,289)
Comprehensive Income:
Net earnings 233,196 $233,196
Foreign currency translation
adjustments 1,211 1,211
--------
Comprehensive income $234,407
========
Exercise of stock options (including
tax benefits) 3,599,964 36 63,474
Issuance of stock under employee
stock purchase plan 311,596 3 7,897
401(k) and deferred compensation
plans matching contributions 135,370 1 3,883
Conversion of LYONs to
common stock 55,543 1 1,203
Amortization of long-term
incentive stock grant 336
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at December 26, 1998 249,211,803 $ 2,492 $839,368 $(2,874) $1,209,721 $(1,750) $(18,078)
===================================================================================================================================
</TABLE>
The accompanying notes are an integral part of these statements.
48
<PAGE> 18
Office Depot, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
52 Weeks 52 Weeks 52 Weeks
Ended Ended Ended
December 26, December 27, December 28,
(In thousands) 1998 1997 1996
======================================================================================================================
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Cash received from customers $ 8,928,519 $ 8,017,406 $ 7,193,535
Cash paid to suppliers (8,137,802) (7,420,731) (6,924,217)
Interest received 23,972 (4,703) 3,914
Interest paid (3,625) (4,166) (9,187)
Income taxes paid (151,032) (140,831) (82,400)
- ----------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 660,032 446,975 181,645
- ----------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of short-term investment securities and bonds (36,697) -- (30,230)
Proceeds from maturities or sale of short-term investment
securities and bonds 44,260 20,030 20,539
Purchase of remaining ownership interest in joint venture (27,680)
Capital expenditures (254,981) (165,213) (234,489)
Proceeds from sale of property and equipment 22,364 4,127 1,741
- ----------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (252,734) (141,056) (242,439)
- ----------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options and sale of stock under
employee stock purchase plan 64,237 19,959 22,677
Proceeds from long- and short-term borrowings -- -- 146,652
Payments on long- and short-term borrowings (2,490) (151,888) (107,639)
- ----------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities 61,747 (131,929) 61,690
- ----------------------------------------------------------------------------------------------------------------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS (4,381) (1,939) (1,020)
- ----------------------------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 464,664 172,051 (124)
Cash and cash equivalents at beginning of period 239,877 67,826 67,950
- ----------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 704,541 $ 239,877 $ 67,826
======================================================================================================================
RECONCILIATION OF NET EARNINGS TO NET CASH
PROVIDED BY OPERATING ACTIVITIES:
Net earnings $ 233,196 $ 234,861 $ 196,218
Adjustments to reconcile net earnings to net cash provided by
operating activities:
Depreciation and amortization 140,940 119,476 99,118
Provision for losses on inventory and accounts receivable 81,270 76,919 49,606
Accreted interest on zero coupon, convertible
subordinated notes 18,812 18,005 17,064
Contributions of common stock to employee benefit and
stock purchase plans 4,501 3,373 2,780
Deferred income taxes (38,244) 9,534 6,605
Loss (gain) on disposal of property & equipment 2,023 4,657 (430)
Changes in assets and liabilities:
Increase in receivables (88,595) (147,991) (61,791)
Decrease (increase) in merchandise inventories 106,189 (28,251) (103,463)
Increase in prepaid expenses and other assets (42,013) (22,492) (26,607)
Increase in accounts payable, accrued expenses and
deferred credits 241,953 178,884 2,545
- ----------------------------------------------------------------------------------------------------------------------
Total adjustments 426,836 212,114 (14,573)
- ----------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities $ 660,032 $ 446,975 $ 181,645
======================================================================================================================
</TABLE>
The accompanying notes are an integral part of these statements.
49
<PAGE> 19
Note A: Summary of Significant Accounting Policies
Office Depot, Inc. and Subsidiaries (the "Company" or "Office Depot") is the
world's largest supplier of office products and services, utilizing an
international chain of high-volume office supply stores; a contract sales
network throughout the United States; and catalog, mail order and delivery
operations to serve its customers in 19 countries. The Company currently
operates under two brands--Office Depot and Viking Office Products.
Basis of Presentation: The consolidated financial statements include the
accounts of the Company and its wholly- and majority-owned subsidiaries. All
significant intercompany transactions have been eliminated in consolidation.
Certain reclassifications were made to prior year statements to conform them to
the current year presentation.
The Company maintains license agreements for the operation of Office Depot
stores in Colombia, Hungary and Poland and joint venture agreements to operate
stores in Israel, Japan, Mexico and Thailand. In April 1998, the Company
increased its ownership share in its Thai joint venture from 20% to 80%, and in
November 1998, the Company increased its ownership share in its French
operations from 50% to 100%. Accordingly, the Company's share of the Thai joint
venture's financial position, results of operations and cash flows since April
1998, as well as the entire financial position, results of operations and cash
flows of its French operations since November 1998, have been included in the
consolidated financial statements. All other joint ventures are accounted for
using the equity method.
In August 1998, the Company merged with Viking Office Products, Inc. ("Viking").
The merger was accounted for as a pooling of interests. Accordingly, the
consolidated financial statements of the Company have been restated and combined
with the consolidated financial statements of Viking as if the merger had taken
place at the beginning of the periods reported. With the addition of Viking, the
Company now has operations on a wholly-owned, joint venture or licensed basis in
Australia, Austria, Belgium, Canada, Colombia, France, Germany, Hungary,
Ireland, Israel, Italy, Japan, Luxembourg, Mexico, the Netherlands, Poland,
Thailand, the United Kingdom and the United States.
The Company operates on a 52- or 53-week fiscal year ending on the last Saturday
in December. Prior to the merger, Viking operated on a 52- or 53-week fiscal
year ending on the last Friday in June. In order to conform Viking's financial
statements to Office Depot's fiscal years, Viking's historical quarterly amounts
were realigned according to Office Depot's fiscal year.
On February 24, 1999, the Company declared a three-for-two stock split in the
form of a 50% stock dividend payable on April 1, 1999 to stockholders of record
on March 11, 1999. Pro forma earnings per share reflect the impact of the
three-for-two stock split on reported amounts. In conjunction with the stock
split, approximately 125 million additional shares will be issued on April 1,
1999.
Use of Estimates: The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect amounts reported in the financial
statements, and to disclose contingent assets and liabilities at the date of the
financial statements. Actual results could differ from those estimates.
Foreign Currency Translation: The financial statements of the Company's
subsidiaries outside of the United States are measured using the local currency
as the functional currency. Assets and liabilities are translated at the rates
of exchange at the balance sheet date. Income and expenses are translated at the
average monthly rates of exchange. The resulting translation adjustments are
included in accumulated other comprehensive income, which is a separate
component of common stockholders' equity. Accumulated other comprehensive income
also includes gains and losses on intercompany loans that are not expected to be
repaid in the foreseeable future.
Cash and Cash Equivalents: The Company considers all highly liquid investments
with original maturities of three months or less to be cash equivalents.
Short-term Investments: Short-term investments are classified as "available for
sale" under the provisions of Statement of Financial Accounting Standards
("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," and are, accordingly, reported at fair value. Under SFAS No. 115,
fluctuations in fair value are included as a separate component of stockholders'
equity. At December 26, 1998, short-term investments consisted of $9.0 million
of tax exempt municipal bonds and $1.4 million of investments in government
agency bonds. All of the tax exempt municipal bonds at December 26, 1998 are due
within one year. As of December 26, 1998 and December 27, 1997, the fair value
of short-term investments approximated cost.
50
<PAGE> 20
Receivables: Receivables as of December 26, 1998 and December 27, 1997 include
trade receivables not sold through outside programs, totaling $464.0 million and
$428.4 million, respectively. An allowance for doubtful accounts is provided for
estimated amounts considered uncollectible. The credit risk related to these
trade receivables is limited because of the large number of customers comprising
the Company's customer base and their dispersion across many different
industries and geographic regions.
Other receivables, totaling $257.4 million and $224.4 million as of December 26,
1998 and December 27, 1997, respectively, consist primarily of estimated
receivables from vendors under purchase rebate, cooperative advertising and
various other marketing programs. Funds received from vendors under rebate and
other programs related to purchases of merchandise inventories are capitalized
and recognized as a reduction of cost of goods sold as the merchandise is sold.
Amounts relating to cooperative advertising and marketing programs are
recognized as a reduction of advertising expense in the period that the related
expenses are incurred.
Merchandise Inventories: Inventories are stated at the lower of cost or market
value. The Company uses the weighted average method of determining cost for
approximately 90% of its inventories and the first-in-first-out (FIFO) method
for the balance.
Income Taxes: The Company provides for Federal and state income taxes currently
payable, as well as deferred income taxes resulting from temporary differences
between the bases of assets and liabilities for tax purposes and for financial
statement purposes, using the provisions of SFAS No. 109, "Accounting for Income
Taxes." Under this standard, deferred tax assets and liabilities represent the
tax effects, based on current tax law, of future deductible or taxable amounts
attributable to events that have been recognized currently in the financial
statements.
The Company has not recognized income taxes on the undistributed earnings of
certain of its foreign subsidiaries. It is the Company's intention to reinvest
such earnings permanently to fund further overseas expansion. Cumulative
undistributed earnings of foreign subsidiaries for which no Federal income taxes
have been provided approximated $248.3 million and $172.2 million as of December
26, 1998 and December 27, 1997, respectively.
Property and Equipment: Property and equipment is recorded at cost. Depreciation
and amortization are provided in amounts sufficient to relate the cost of
depreciable assets to operations over their estimated useful lives using the
straight line and accelerated methods. Estimated useful lives are 10 to 30 years
for buildings and 3 to 10 years for furniture, fixtures and equipment. Leasehold
improvements are amortized over the lesser of the terms of the underlying
leases, including probable renewal periods, or the estimated useful lives of the
improvements.
Goodwill: Goodwill represents the excess of purchase price and related costs
over the value assigned to the net tangible and identifiable intangible assets
of businesses acquired under the purchase method of accounting. Goodwill is
amortized on a straight-line basis over 40 years. Accumulated amortization of
goodwill was $37.5 million and $31.3 million as of December 26, 1998 and
December 27, 1997, respectively.
Impairment of Long-Lived Assets: In accordance with SFAS No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of," long-lived assets, certain identifiable intangibles, and goodwill related
to those assets to be held and used are reviewed for impairment whenever events
or changes in circumstances indicate that the carrying amount of such assets may
not be recoverable. Measurement of an impairment loss for such long-lived assets
and identifiable intangibles is based on the fair value of the asset. Long-lived
assets and certain identifiable intangibles to be disposed of are reported at
the lower of the carrying amount or fair value less cost to sell. With the
exception of costs included in merger and restructuring costs (see Note B), the
Company has not recognized significant impairment losses during the periods
presented.
Fair Value of Financial Instruments: SFAS No. 107, "Disclosure about Fair Value
of Financial Instruments," requires disclosure of the fair value of financial
instruments, both assets and liabilities, recognized and not recognized in the
consolidated balance sheets of the Company, for which it is practicable to
estimate fair value. The estimated fair values of financial instruments which
are presented herein have been determined by the Company using available market
information and appropriate valuation methodologies. However, considerable
judgment is required in interpreting market data to develop estimates of fair
value. Accordingly, the estimates presented herein are not necessarily
indicative of amounts the Company could realize in a current market exchange.
51
<PAGE> 21
The following methods and assumptions were used to estimate fair
value:
- the carrying amounts of cash and cash equivalents, receivables
and accounts payable approximate fair value because of their
short-term nature;
- discounted cash flows using current interest rates for
financial instruments with similar characteristics and
maturity were used to determine the fair value of short-term
and long-term debt; and
- quoted market prices were used to determine the fair value of
short-term investments and the zero coupon, convertible
subordinated notes.
There were no significant differences as of December 26, 1998 and December 27,
1997 in the carrying value and fair value of financial instruments except for
the zero coupon, convertible subordinated notes which had a carrying value of
$435.2 million and $417.6 million and a fair value of $633.6 million and $429.4
million at the end of 1998 and 1997, respectively.
Advertising: Advertising costs are either charged to expense when incurred or,
in the case of direct marketing advertising, capitalized and amortized in
proportion to related revenues. The Company and its vendors participate in
cooperative advertising programs in which the vendors reimburse the Company for
a portion of certain advertising costs. Advertising expense, net of vendor
cooperative advertising allowances, amounted to $230.8 million in 1998, $201.8
million in 1997 and $171.5 million in 1996.
Pre-opening Expenses: Pre-opening expenses related to the opening of new and
relocated stores and warehouses are expensed as incurred.
Post-retirement Benefits: The Company does not currently provide post-retirement
benefits for its employees.
Insurance Risk Retention: The Company retains certain risks for workers'
compensation, auto and general liability, and employee medical insurance
programs and accrues estimated liabilities on an undiscounted basis for known
claims and claims incurred but not reported.
Comprehensive Income: Comprehensive income represents the change in
stockholders' equity from transactions and other events and circumstances
arising from non-stockholder sources. The Company's comprehensive income for
1998, 1997 and 1996 consists of net income and foreign currency translation
adjustments.
Derivative Financial Instruments: The Company's use of derivatives is currently
limited to forward exchange contracts that are used to minimize foreign exchange
risk related to specific transactions. During 1998 and 1997, the Company
purchased foreign currency contracts to hedge certain inventory purchases. In
1996, in addition to hedging certain inventory purchases, the Company purchased
foreign currency contracts to hedge certain advances to one of its subsidiaries.
The Company's foreign exchange contracts minimize the exposure to exchange rate
movement risk. At December 26, 1998, the Company had no forward exchange
contracts outstanding. At December 27, 1997, the Company had approximately $13.1
million of forward exchange contracts outstanding which matured at varying dates
through June 1998. Gains and losses on qualifying hedges of these exposures are
deferred and recognized in earnings when the underlying hedged transaction is
consummated.
New Accounting Pronouncement: In June 1998, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards ("SFAS") No. 133,
"Accounting for Derivative Instruments and Hedging Activities," which requires
reporting every derivative instrument at its fair value on the balance sheet.
This statement also requires recognizing any change in the derivatives' fair
value in earnings for the current period unless specific hedge accounting
criteria are met.
SFAS No. 133 is effective for fiscal quarters of fiscal years that begin after
June 15, 1999. The Company has not determined the impact that this statement
will have on its financial position or the results of its operations upon
adoption.
Note B: Merger and Restructuring Transactions
In August 1998, the Company completed its merger with Viking. In conjunction
with the merger, each outstanding share of Viking common stock was converted
into one share of Office Depot common stock. A total of 85,404,459 shares of
Office Depot common stock were issued pursuant to the merger. The merger was
accounted for as a pooling of interests. Accordingly, the prior periods'
consolidated financial statements and other non-financial information of
52
<PAGE> 22
the Company have been restated and combined with the consolidated financial
statements and other non-financial information of Viking as if the merger had
taken place at the beginning of the periods reported. In September 1998, in
formulating its strategy for integrating the two companies, management announced
its plan to close several facilities by the end of 2000. These facilities have
been identified as redundant, or management believes that the business handled
by these facilities can be more efficiently handled by other existing
facilities. Accordingly, certain assets have been written off and certain costs
accrued. Additionally, in November 1998, management decided to focus its
attention on continued growth in its core businesses and on expansion of its
international operations. In conjunction with this decision, the Company plans
to close its five Furniture at Work and five Images stores, one of which was
closed during the fourth quarter of 1998. Management expects all remaining
stores to be closed by the end of the third quarter of 1999.
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.
Merger and restructuring costs in 1998 and 1997 consist of the following
charges:
<TABLE>
<CAPTION>
(in thousands) 1998 1997
=========================================================================
<S> <C> <C>
Viking and Staples mergers:
Costs directly attributable to merger
transactions $ 31,555 $16,094
Asset impairment associated with the
closure of identified facilities and the
write-off of software applications to
be abandoned 41,962 --
Other facility exit costs, principally
estimated lease costs subsequent
to closing of facilities 18,143 --
Personnel retention and termination costs
incurred through December 26, 1998 14,553 --
Other integration costs 1,936 --
- -------------------------------------------------------------------------
108,149 16,094
- -------------------------------------------------------------------------
Furniture at Work(TM) and Images(TM) closings:
Asset impairment associated with the closure
of stores 3,882 --
Other exit costs, principally estimated
lease costs subsequent to
closing of stores 7,098 --
- -------------------------------------------------------------------------
10,980 --
- -------------------------------------------------------------------------
Total $119,129 $16,094
=========================================================================
</TABLE>
The fair value of asset impairments was determined based on estimating the net
realizable value at the time of the anticipated closure or discontinuation.
Estimated proceeds from and costs in connection with disposal of these assets
were determined through analysis of historical data and expected outcomes.
As of December 26, 1998, approximately $84.8 million related to merger and
restructuring costs is included in accrued expenses on the accompanying
consolidated balance sheet. Excluding the after-tax impact of merger and
restructuring costs and the effect of the stock split described in Note A, the
Company's diluted earnings per share would have been $1.24 in 1998 and $.97 in
1997.
The following is a reconciliation for 1997 and 1996 of amounts previously
reported by Office Depot to amounts restated to reflect the merger with Viking
on a pooling of interests basis:
<TABLE>
<CAPTION>
(in thousands) 1997 1996
======================================================================
<S> <C> <C>
Sales
Office Depot, as previously reported $6,717,514 $6,068,598
Viking 1,382,805 1,182,333
- ----------------------------------------------------------------------
As restated $8,100,319 $7,250,931
======================================================================
Net earnings
Office Depot, as previously reported $ 159,676 $ 129,042
Viking 75,185 67,176
- ----------------------------------------------------------------------
As restated $ 234,861 $ 196,218
======================================================================
</TABLE>
No adjustments to the sales, net earnings or net assets of Office Depot or
Viking were required to conform the two companies' accounting practices.
In
November 1998, the Company increased its ownership position in its operations in
France from 50% to 100% by purchasing its joint venture partner's ownership
share for $27.7 million. As a result of the purchase, the Company recorded
goodwill of $20.2 million.
53
<PAGE> 23
Note C: Property and Equipment
Property and equipment consists of:
<TABLE>
<CAPTION>
December 26, December 27,
(in thousands) 1998 1997
=====================================================================
<S> <C> <C>
Land $ 81,617 $ 83,848
Buildings 165,650 150,601
Leasehold improvements 491,343 403,258
Furniture, fixtures and equipment 740,076 603,036
- --------------------------------------------------------------------
1,478,686 1,240,743
Less accumulated depreciation
and amortization (499,457) (394,067)
- --------------------------------------------------------------------
$ 979,229 $ 846,676
=====================================================================
</TABLE>
Assets held under capital leases included in property and equipment consists of:
<TABLE>
<CAPTION>
December 26, December 27,
(in thousands) 1998 1997
==============================================================
<S> <C> <C>
Assets, at cost $ 47,374 $ 40,489
Less accumulated depreciation (9,786) (8,696)
- ----------------------------------------------------------
$ 37,588 $ 31,793
==============================================================
</TABLE>
Note D: Long-Term Debt Long-term debt consists of the following:
<TABLE>
<CAPTION>
December 26, December 27,
(in thousands) 1998 1997
=========================================================================
<S> <C> <C>
Capital lease obligations collateralized
by certain buildings and equipment $ 38,324 $ 31,879
Less current portion (2,834) (2,473)
=========================================================================
$ 35,490 $ 29,406
</TABLE>
In February 1998, the Company entered into a new credit agreement 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 for various borrowing rate options,
including a rate based on credit rating and fixed charge coverage ratio factors
that currently would result in an interest rate of .18% over LIBOR. The credit
facility expires in February 2003 and contains certain restrictive covenants
relating to various financial statement ratios.
As of December 26, 1998, the Company had no outstanding borrowings under the
credit facility and had outstanding letters of credit totaling $9.2 million.
Future minimum annual lease payments under capital leases together with the
present value of these minimum lease payments as of December 26, 1998 are as
follows:
<TABLE>
<CAPTION>
(in thousands)
================================================================
<S> <C>
1999 $ 5,880
2000 5,465
2001 3,657
2002 2,723
2003 3,903
Thereafter 51,126
- ----------------------------------------------------------------
Total minimum lease payments 72,754
Less amount representing interest at 5.0% to 8.95% (34,430)
- ----------------------------------------------------------------
Present value of net minimum lease payments 38,324
Less current portion (2,834)
- ----------------------------------------------------------------
Non-current portion $ 35,490
================================================================
</TABLE>
Note E: Zero Coupon, Convertible Subordinated Notes
On December 11, 1992, the Company issued Liquid Yield Option Notes ("LYONs")
with principal amounts totaling $316.3 million to the public at a price totaling
$150.8 million. The issue price of each such LYON was $476.74, and the notes
require no periodic payments of interest. These LYONs will mature on December
11, 2007 at $1,000 per LYON, representing a yield to maturity, computed on a
semi-annual bond equivalent basis, of 5%.
On November 1, 1993, the Company issued LYONs with principal amounts totaling
$345.0 million to the public at a price totaling $190.5 million. The issue price
of each such LYON was $552.07, and the notes require no periodic payments of
interest. These LYONs will mature on November 1, 2008 at $1,000 per LYON,
representing a yield to maturity, computed on a semi-annual bond equivalent
basis, of 4%.
54
<PAGE> 24
All LYONs are subordinated to all existing and future senior indebtedness of the
Company.
Each LYON is convertible at the option of the holder at any time on or prior to
maturity into common stock of the Company at a conversion rate of 29.263 shares
per 1992 LYON and 21.234 shares per 1993 LYON. The Company, at the option of the
holder, may be required to purchase the LYONs as of December 11, 2002 for the
1992 LYONs and as of November 1, 2000 for the 1993 LYONs, at the issue price
plus accrued original issue discount. The Company, at its option, may elect to
pay the purchase price on any particular purchase date in cash or common stock,
or any combination thereof. The total outstanding amounts of the 1992 and 1993
LYONs as of December 26, 1998, including accrued interest, approximated $201.6
million and $233.6 million, respectively.
In addition, in the event of a change in control of the Company prior to
November 1, 2000, the holders of the 1993 LYONs can require the Company to
purchase the 1993 LYONs for cash. This option is no longer available to holders
of the 1992 LYONs. Beginning on December 11, 1996 for the 1992 LYONs and on
November 1, 2000 for the 1993 LYONs, the LYONs are redeemable for cash at any
time at the option of the Company in whole or in part at the issue price plus
accrued original issue discount through the date of redemption.
As of December 26, 1998, the Company has reserved 16,508,704 shares of unissued
common stock for conversion of the zero coupon, convertible subordinated notes.
Note F: Income Taxes
The income tax provision consists of the following:
<TABLE>
<CAPTION>
(in thousands) 1998 1997 1996
=========================================================================
Current provision:
<S> <C> <C> <C>
Federal $ 147,031 $ 90,889 $ 80,141
State 23,975 16,161 10,076
Foreign 22,769 20,146 19,043
Deferred (benefit) provision (38,244) 9,534 6,605
- ------------------------------------------------------------------------
Total provision for
income taxes $ 155,531 $136,730 $115,865
========================================================================
</TABLE>
The tax-effected components of deferred income tax assets and liabilities
consist of the following:
<TABLE>
<CAPTION>
(in thousands) 1998 1997
======================================================================
<S> <C> <C>
Self-insurance accruals $17,503 $ 13,956
Inventory 9,910 5,297
Vacation pay and other accrued compensation 10,765 7,673
Reserve for bad debts 6,352 4,172
Reserve for facility closings 5,829 5,467
Merger costs 29,179 --
Other items 20,123 17,021
- ----------------------------------------------------------------------
Deferred tax assets 99,661 53,586
- ----------------------------------------------------------------------
Basis difference in fixed assets 45,462 38,957
Capitalized leases 3,335 3,762
Excess of tax over book amortization 2,385 2,288
Other items 10,516 8,860
- ----------------------------------------------------------------------
Deferred tax liabilities 61,698 53,867
- ----------------------------------------------------------------------
Net deferred tax assets (liabilities) $37,963 $ (281)
======================================================================
</TABLE>
The following is a reconciliation of income taxes at the Federal statutory rate
to the provision for income taxes:
<TABLE>
<CAPTION>
(in thousands) 1998 1997 1996
============================================================================
<S> <C> <C> <C>
Federal tax computed at
the statutory rate $ 136,054 $ 130,057 $ 109,229
State taxes, net of Federal
benefit 14,978 11,477 8,034
Nondeductible goodwill
amortization 1,990 1,992 1,993
Nondeductible merger costs 11,044 -- --
Foreign income taxed at rates
other than Federal (10,061) (6,463) (1,785)
Other items, net 1,526 (333) (1,606)
- ----------------------------------------------------------------------------
Provision for income taxes $ 155,531 $ 136,730 $ 115,865
============================================================================
</TABLE>
55
<PAGE> 25
Note G: Commitments and Contingencies
Leases: The Company conducts its operations in various facilities under leases
that are classified as operating leases for financial statement purposes. The
leases require the Company to pay real estate taxes, common area maintenance and
certain other expenses, including, in some instances, contingent rentals based
on sales. Lease terms expire between 1999 and 2020. In addition to the base
lease term, the Company has various renewal option periods. Also, certain
equipment used in the Company's operations is leased under operating leases.
Fixed operating lease commitments as of December 26, 1998 are as follows:
<TABLE>
<CAPTION>
(in thousands)
=======================================
<S> <C>
1999 $ 242,730
2000 218,077
2001 185,507
2002 161,397
2003 147,530
Thereafter 825,027
- ---------------------------------------
1,780,268
Less sublease income (21,236)
- ---------------------------------------
$ 1,759,032
=======================================
</TABLE>
The above amounts include commitments under leases for 19 stores that had not
yet opened as of December 26, 1998. The Company is in the process of opening new
stores and CSCs in the ordinary course of business, and leases signed subsequent
to December 26, 1998 are not included in the above described commitment amount.
Rent expense, including equipment rental, was approximately $252.7 million,
$218.4 million and $197.3 million in 1998, 1997 and 1996, respectively. Rent
expense was offset in 1998, 1997 and 1996 by sublease income of approximately
$4.1 million, $3.0 million and $2.2 million, respectively.
Receivables Sold with Recourse: The Company has two private label credit card
programs which are managed by financial services companies. All credit card
receivables related to these programs were sold on a recourse basis during 1998,
1997 and 1996. Proceeds to the Company for such receivables sold with recourse
were approximately $1.1 billion in 1998 and 1997, and $1.0 billion in 1996. The
Company's maximum exposure to off-balance sheet credit risk is represented by
the outstanding balance of private label credit card receivables with recourse,
which totaled approximately $209.7 million at December 26, 1998.
Impact of the Year 2000 Issue (Unaudited): The Year 2000 ("Y2K") issues arise
because of the inability of certain electronic data operating systems to
differentiate between the years 1900 and 2000 when processing data. Many systems
and programs were written to recognize and process two digits for the year,
instead of four.
In recent years, the producers of electronic data operating
systems, as well as most other businesses, have generally become aware of Y2K
issues and the potential for disruption in the operation of business as a result
of systems that are not Y2K compliant. Y2K issues can arise at any point in the
Company's operational or financial processes. Most systems and programs
developed in the past several years have been designed to be Y2K compliant,
whereas many of the older systems and programs are not Y2K compliant and require
various changes in order to bring them into compliance.
Most of the Company's current application systems were developed over the past
four years and were designed to use four-digit year values. Management believes
that these systems are already Y2K compliant. To ensure a smooth transition into
the millennium, the Company has established the Year 2000 Project Office led by
a Year 2000 Project Team ("Project 2000"). The objective of Project 2000 is to
establish standards and guidelines, assist in development and remediation plans,
track and report on progress, and answer customer and vendor inquiries regarding
its Y2K compliance efforts. Project 2000 consists of four major components:
Technology Systems, including (1) Operations and (2) Development; and
Non-technology Systems, including (3) Facilities and (4) Merchandising.
Technology Systems: Operations includes the review of data center process
automation equipment, software not internally developed or supported by the MIS
department, and data/voice networks. The phases of this component are: (1)
review all equipment and complete an inventory of all hardware and software, (2)
evaluate the readiness of all hardware and software and plan for required
upgrades to Y2K compliant versions and (3) correct all non-compliant hardware
and software through upgrades certified as Y2K compliant by their vendors. The
Company expects to have all phases of this component complete by August 1999.
56
<PAGE> 26
MIS Development focuses on the proper operation of application software
developed or supported in-house. The phases of this component are: (1) assess
systems for potential Y2K issues, (2) remediate any non-compliant systems by
changing the program code to properly process all dates, (3) test to make sure
remediation has not changed the functionality of the application, and place new
program code into production, (4) test the accuracy of the output under multiple
scenarios and (5) certify that the systems are Y2K compliant. This component is
being completed by multiple MIS teams. Although each team is at a different
phase in the project, this component, as a whole, is currently on schedule to be
substantially completed by the end of the second quarter of 1999. Overall, the
two Technology components together are currently approximately 80% complete.
Non-technology Systems: The Facilities component of Project 2000 involves the
Company's buildings and transportation. Typical concerns related to buildings
include security, environment and telephone systems. Concerns related to
transportation include scheduling, communication, security, tracking and
maintenance. The phases of this component are: (1) develop an inventory of
equipment and services and associated vendors, (2) contact all vendors to verify
Y2K compliance of their equipment and services, (3) upgrade systems and
equipment to compliant versions, if necessary, (4) test equipment and systems
and (5) certify that all such equipment and services are Y2K compliant. The
Company has completed phases 1 and 2 of this component and has begun work on
phase 3. This component is currently on schedule to be completed by April 1999.
For the Merchandising component of Project 2000, the Company will attempt to
ensure that merchandise suppliers are able to meet their delivery commitments.
The phases of this component are: (1) develop a supplier survey, (2) request
that suppliers confirm Y2K compliance, (3) establish confidence/risk levels by
product, (4) develop contingency plans for non-compliant vendors (e.g.,
alternate product sources, increased inventory levels, etc.) and (5) certify
products as Y2K compliant or implement contingency plans. Phase 1 has been
completed and phases 2 and 3 are in the process of being completed. The Company
will continue to follow up with vendors until they have all responded. Nearly
90% of respondents have plans in place for internal systems compliance and
almost 70% have already certified that their products are Y2K compliant. This
component is currently on schedule to be completed by April 1999.
The Company's Y2K effort is being undertaken on a worldwide basis to identify
the level of Y2K preparedness of the Company's operations in each country.
Because of the interdependent nature of the Company's operations with those of
its suppliers and customers, the Company could be materially adversely affected
if utilities, private businesses or governmental entities with which it does
business are not adequately prepared for the year 2000. A reasonably possible
worst case scenario resulting from the Company not being fully Y2K compliant by
January 1, 2000 might include, among other things, temporary store or CSC
closings, delays in the delivery of products, delays in the receipt of supplies,
payment and collection errors, and inventory and supply obsolescence.
Consequently, the business and the results of operations of the Company could be
materially adversely affected by a temporary inability of the Company to conduct
its business in the ordinary course for a period of time after January 1, 2000.
However, management believes that its Y2K readiness program should significantly
reduce any adverse effect from any such disruptions, and the effect on the
Company's financial position or the results of its operations is not expected to
be material. The Company has not experienced any significant delays in other MIS
initiatives as a result of Project 2000.
Costs for hardware and software are capitalized and depreciated over the assets'
estimated useful lives. All other costs specifically associated with Project
2000 (e.g., labor, consulting fees, maintenance contracts, etc.) are expensed as
incurred. Total costs incurred in 1998 related to Project 2000 were
approximately $5 million, most of which were expensed. The Company expects to
spend another $7 to $9 million to complete Project 2000, most of which will be
expensed as incurred.
The Company's Y2K readiness program is an ongoing process, and the estimates of
costs and completion dates for various components of the Y2K readiness program
described above are subject to change. The estimates and conclusions herein
contain forward-looking statements and are based on management's best estimates
of future events. Although the Company expects its systems and facilities to be
Y2K compliant by the end of the third quarter of 1999, there is no assurance
that this goal will be achieved. Risks to completing the
57
<PAGE> 27
plan include the availability of resources, the Company's ability to identify
and correct any potential Y2K issues, and the willingness and ability of
suppliers, customers and governmental agencies to bring their systems into Y2K
compliance.
Other: The Company is involved in litigation arising in the normal course of its
business. In the opinion of management, these matters will not materially affect
the financial position or results of operations of the Company.
Note H: Employee Benefit Plans
Long-Term Equity Incentive Plan: The Long-Term Equity Incentive Plan, which was
approved effective October 1, 1997, provides for grants of stock options and
other incentive awards to certain of the Company's directors, officers and key
employees. Pursuant to the merger with Viking, Viking's employee and director
stock option plans were terminated. Accordingly, all exercises of outstanding
options issued under Viking's prior plans result in issuance of Office Depot
common stock.
As of December 26, 1998, the Company had reserved 22,691,710 shares of common
stock for issuance to officers and key employees under its Long-Term Equity
Incentive Plan. Under this plan, the option price of stock options granted must
be equal to or in excess of the market price of the stock on the date of the
grant or; in the case of employees who own 10% or more of the Company's
outstanding common stock, the minimum price must be 110% of the market price.
Options granted under this plan and all prior stock option plans of Viking to
date become exercisable from one to five years after the date of grant, provided
that the individual is continuously employed by the Company. All options expire
no more than ten years after the date of grant.
Employee Stock Purchase Plans: Office Depot has an Employee Stock Purchase Plan,
which permits eligible employees to purchase common stock from the Company at
90% of its fair market value. The maximum aggregate number of shares eligible
for purchase under this plan is 1,625,000. Additionally, Viking has three
different employee stock purchase plans. These plans allow eligible employees to
purchase up to 1,940,000 shares of common stock, at 80-85% of its fair market
value.
Long-Term Incentive Stock Plan: Viking has a Long-Term Incentive Stock Plan
enabling the Company's Board of Directors to award up to 1,600,000 shares of
common stock to key employees. Under this plan, 1,230,000 shares have been
issued to date at no cost to key employees, 600,000 of which have been canceled.
The fair market value of these awards approximated $10.0 million as of the date
of the grants. Common stock issued under this plan is restricted and vests at
the end of fifteen years from the grant dates. Compensation expense is
recognized over the vesting period.
Retirement Savings Plans: Office Depot has a retirement savings plan, which
permits eligible employees to make contributions to the plan on a pretax salary
reduction basis in accordance with the provisions of Section 401(k) of the
Internal Revenue Code. The Company makes a matching contribution of common stock
of 50% of the employee's pretax contribution, up to 3% of the employee's
compensation, in any calendar year. The Company may, at its option, make
discretionary matching common stock contributions in addition to the normal
match. Office Depot also has a deferred compensation plan, which permits
eligible employees to make tax-deferred contributions to the plan. The Company
makes matching contributions similar to those made under its Office Depot
retirement savings plan.
58
<PAGE> 28
Additionally, Viking has a profit sharing plan which includes a 401(k) plan
allowing eligible employees to make pretax contributions. Under the profit
sharing plan, the Company makes a matching cash contribution of 25% of the
employee's pretax 401(k) contributions, up to 6% of the employee's compensation.
Accounting for Stock-Based Compensation: The Company applies Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and
related Interpretations in accounting for its stock-based compensation plans.
The compensation cost that has been charged against income for its employee
stock purchase plans, Long-Term Incentive Stock Plan and Long-Term Equity
Incentive Plan approximated $2.5 million, $1.0 million and $2.2 million in 1998,
1997 and 1996, respectively. No other compensation costs have been recognized
under the Company's stock-based compensation plans. Had compensation cost for
the Company's stock-based compensation plans been determined using the fair
value method described in SFAS No. 123, "Accounting for Stock-Based
Compensation," at the grant dates for awards under these plans, the Company's
net earnings and earnings per share would have been reduced to the pro forma
amounts presented below:
<TABLE>
<CAPTION>
(in thousands, except
per share data) 1998 1997 1996
========================================================================================
<S> <C> <C> <C>
Net earnings
As reported $ 233,196 $ 234,861 $ 196,218
Pro forma 204,859 214,835 183,752
Basic earnings per share
As reported $ .95 $ .97 $ .82
Pro forma .84 .89 .77
Diluted earnings per share
As reported $ .91 $ .93 $ .79
Pro forma .81 .86 .74
========================================================================================
</TABLE>
The fair value of each stock option grant is established on the date of grant
using the Black-Scholes option-pricing model using the following weighted
average assumptions for grants in 1998, 1997 and 1996:
- expected volatility of 25% for all three years
- risk-free interest rates of 4.88% for 1998, 5.75% for 1997,
and 6.35% for 1996
- expected lives of approximately five years for all three years
- a dividend yield of zero for all three years.
A summary of the status of and the changes in the option plan for each of the
three years in the period ended December 26, 1998 is presented below:
<TABLE>
<CAPTION>
1998 1997 1996
-------------------------- -------------------------- -------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
============================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year 19,138,998 $ 16.19 15,631,066 $ 15.53 15,521,557 $ 13.14
Granted 6,150,000 30.73 6,965,069 16.70 3,926,683 20.43
Canceled (776,812) 20.34 (1,654,071) 20.67 (1,348,542) 19.42
Exercised (3,599,438) 14.39 (1,803,066) 8.26 (2,468,632) 6.22
- ----------------------------------------------------------------------------------------------------------------------------
Outstanding at end of year 20,912,748 $ 20.63 19,138,998 $ 16.19 15,631,066 $ 15.53
============================================================================================================================
</TABLE>
As of December 26, 1998, the weighted average fair values of options granted
during 1998, 1997 and 1996 were $10.16, $6.51 and $5.40, respectively.
59
<PAGE> 29
The following table summarizes information about options outstanding at December
26, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
- --------------------------------------------------------------- ----------------------------
Weighted
Average Remaining Weighted Weighted
Range of Number Contractual Life Average Number Average
Exercise Prices Outstanding (in years) Exercise Price Exercisable Exercise Price
===============================================================================================
<S> <C> <C> <C> <C> <C>
$0.25--$ 2.93 389,148 3.3 $ 2.06 389,148 $ 2.06
2.94-- 4.41 394,376 1.3 3.70 394,376 3.70
4.42-- 6.63 896,649 1.7 5.69 896,649 5.69
6.64-- 9.96 454,566 2.9 8.05 454,566 8.05
9.97-- 14.95 3,786,433 4.2 13.46 2,569,090 13.25
14.96-- 22.44 6,569,997 6.9 18.23 3,275,548 19.32
22.45-- 33.67 6,976,579 7.1 28.29 2,599,603 26.23
33.68-- 36.25 1,445,000 9.5 36.16 -- --
- ----------------------------------------------------------------------------------------------
$ 0.25--$36.25 20,912,748 5.0 $20.63 10,578,980 $16.69
==============================================================================================
</TABLE>
Note I: Capital Stock
Preferred Stock: As of December 26, 1998, there were 1,000,000 shares of $.01
par value preferred stock authorized of which none are issued or outstanding.
Stockholder Rights Plan: Effective September 4, 1996, the Company's Board of
Directors adopted a Stockholder Rights Plan (the "Rights Plan"). The Rights Plan
provides for the issuance to stockholders of one right for each outstanding
share of the Company's common stock. The rights will become exercisable only if
a person or Division acquires 20% or more of the Company's outstanding common
stock or announces a tender or exchange offer that would result in ownership of
20% or more of the Company's common stock. Each right, should it become
exercisable, will entitle the holder to purchase one one-thousandth of a share
of Junior Participating Preferred Stock, Series A of the Company at an exercise
price of $95.00, subject to adjustment.
In the event of an acquisition, each right will entitle the holder, other than
an acquirer, to receive a number of shares of common stock with a market value
equal to twice the exercise price of the right. In addition, in the event that
the Company is involved in a merger or other business combination wherein the
Company is not the surviving corporation, or wherein common stock is changed or
exchanged, or in a transaction with any entity in which 50% or more of the
Company's assets or earning power is sold, each holder of a right, other than an
acquirer, will have the right to receive, at the exercise price of the right, a
number of shares of common stock of the acquiring company with a market value
equal to twice the exercise price of the right.
The Company's Board of Directors may redeem the rights for $0.01 per right at
any time prior to an acquisition.
Stock Split: On February 24, 1999, the Company declared a three-for-two stock
split in the form of a 50% stock dividend, payable April 1, 1999. Pro forma
earnings per share reflect the impact of the three-for-two stock split on
reported amounts. (See Note A).
60
<PAGE> 30
Note J: Net Earnings Per Share
Basic earnings per share is based upon the weighted average number of shares
outstanding during each period. Diluted earnings per share further assumes that
the zero coupon, convertible subordinated notes, if dilutive, are converted as
of the beginning of the period and that, under the treasury stock method,
dilutive stock options are exercised. Net earnings under this assumption have
been adjusted for interest on the notes, net of the related income tax effect.
Pro forma earnings per share reflect the three-for-two stock split declared on
February 24, 1999 and payable April 1, 1999 (See Note A).
The information required to compute basic and diluted net earnings per share is
as follows:
<TABLE>
<CAPTION>
(in thousands) 1998 1997 1996
==========================================================================================================
<S> <C> <C> <C>
Basic:
Weighted average number of common shares outstanding 244,710 241,755 239,828
==========================================================================================================
Diluted:
Net earnings $233,196 $234,861 $196,218
Interest expense related to convertible notes, net of tax 11,532 11,037 10,580
- ----------------------------------------------------------------------------------------------------------
Adjusted net earnings $244,728 $245,898 $206,798
==========================================================================================================
Weighted average number of common shares outstanding 244,710 241,755 239,828
Shares issued upon assumed conversion of convertible notes 16,541 16,565 16,565
Shares issued upon assumed exercise of stock options 6,962 4,966 6,177
- ----------------------------------------------------------------------------------------------------------
Shares used in computing diluted net earnings per common share 268,213 263,286 262,570
==========================================================================================================
</TABLE>
Options to purchase 6,163,813 shares of common stock at an average exercise
price of approximately $31.26 per share were not included in the computation of
diluted earnings per share for 1998 because their effect would be anti-dilutive.
Note K: Supplemental Information on Noncash Investing and Financing Activities
The Consolidated Statements of Cash Flows for 1998, 1997 and 1996 do not include
the following noncash investing and financing transactions:
<TABLE>
<CAPTION>
(in thousands) 1998 1997 1996
===================================================================================================================
<S> <C> <C> <C>
Building and equipment purchased under capital leases $ 8,935 $24,300 $ 4,805
Conversion of convertible, subordinated debt to common stock 1,204 20 6
Additional paid-in capital related to tax benefit on stock options exercised 11,235 8,165 10,302
===================================================================================================================
</TABLE>
61
<PAGE> 31
Note L: Segment Information
The Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise
and Related Information," effective for the fiscal year ended December 26, 1998.
The Company has three reportable operating segments: Stores, Business Services
and International. These segments were determined based on how management
evaluates its business. The following is a summary of significant accounts and
balances by segment, reconciling to the Company's totals.
<TABLE>
<CAPTION>
Sales Earnings Before Income Taxes
----------------------------------------------- -----------------------------------------
(in thousands) 1998 1997 1996 1998 1997 1996
================================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
Stores $ 5,128,621 $ 4,716,991 $ 4,470,525 $ 524,575 $ 383,619 $ 328,829
Business Services 2,825,564 2,503,826 2,046,189 182,851 189,940 150,099
International 1,047,472 882,806 737,380 134,260 106,806 85,041
- --------------------------------------------------------------------------------------------------------------------------------
Total reportable segments 9,001,657 8,103,623 7,254,094 841,686 680,365 563,969
Eliminations and other (3,919) (3,304) (3,163) (452,959) (308,774) (251,886)
- --------------------------------------------------------------------------------------------------------------------------------
Total $ 8,997,738 $ 8,100,319 $ 7,250,931 $ 388,727 $ 371,591 $ 312,083
================================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
Capital Expenditures Depreciation and Amortization
------------------------------------ -----------------------------------
(in thousands) 1998 1997 1996 1998 1997 1996
==============================================================================================================
<S> <C> <C> <C> <C> <C> <C>
Stores $159,007 $ 67,541 $133,490 $ 60,858 $ 51,761 $43,980
Business Services 32,581 46,373 37,974 32,171 29,254 23,664
International 10,628 25,963 42,932 16,251 13,760 10,173
- --------------------------------------------------------------------------------------------------------------
Total reportable segments 202,216 139,877 214,396 109,280 94,775 77,817
Other 52,765 25,336 20,093 31,660 24,701 21,301
- --------------------------------------------------------------------------------------------------------------
Total $254,981 $165,213 $234,489 $140,940 $119,476 $99,118
==============================================================================================================
</TABLE>
<TABLE>
<CAPTION>
Provision for Losses on Equity in (Losses)
Accounts Receivable and Inventory Earnings of Investees, net
--------------------------------- ------------------------------------
(in thousands) 1998 1997 1996 1998 1997 1996
============================================================================================================
<S> <C> <C> <C> <C> <C> <C>
Stores $26,037 $27,716 $24,281 $ -- $ -- $ --
Business Services 31,532 39,524 17,836 -- -- --
International 23,701 9,679 7,489 (12,811) (7,034) (2,178)
- ------------------------------------------------------------------------------------------------------------
Total reportable segments 81,270 76,919 49,606 (12,811) (7,034) (2,178)
Other -- -- -- -- -- --
- ------------------------------------------------------------------------------------------------------------
Total $81,270 $76,919 $49,606 $(12,811) $(7,034) $(2,178)
============================================================================================================
</TABLE>
<TABLE>
<CAPTION>
Assets
--------------------------
(in thousands) 1998 1997
===========================================================
<S> <C> <C>
Stores $1,848,476 $1,797,516
Business Services 859,802 896,991
International 528,212 357,727
- -----------------------------------------------------------
Total reportable segments 3,236,490 3,052,234
Other 876,551 468,585
- -----------------------------------------------------------
Total $4,113,041 $3,520,819
===========================================================
</TABLE>
62
<PAGE> 32
A reconciliation of earnings before income taxes reported by reportable segments
to earnings before income taxes in the consolidated financial statements is as
follows:
<TABLE>
<CAPTION>
(in thousands) 1998 1997 1996
=====================================================================================
<S> <C> <C> <C>
Reportable segments $ 841,686 $ 680,365 $ 563,969
General and administrative expenses (330,194) (272,022) (222,714)
Amortization of goodwill (6,174) (6,146) (6,147)
Interest, net 2,953 (14,110) (22,652)
Merger and restructuring costs (119,129) (16,094) --
Inter-segment transactions (415) (402) (373)
- -------------------------------------------------------------------------------------
Total reported $ 388,727 $ 371,591 $ 312,083
=====================================================================================
</TABLE>
Total sales by operating segment include inter-segment sales, which are
generally recorded at cost to the selling entity. The Company's management
evaluates the performance of each segment based on results of operations before
income taxes, merger and restructuring costs, goodwill amortization and general
and administrative expenses. The accounting policies of the segments are the
same as those described in the summary of significant accounting policies (See
Note A). Assets not allocated to segments consist primarily of corporate cash
balances, tax related accounts, employee benefit plan balances and assets
associated with corporate investing and financing transactions.
Office Depot has operations in Australia, Austria, Belgium, Canada, Colombia,
France, Germany, Hungary, Ireland, Israel, Italy, Japan, Luxembourg, Mexico, The
Netherlands, Poland, Thailand, the United Kingdom and the United States. There
is no single geographic area outside of the United States that generates 10% or
more of total Company revenues. Summarized geographic information relating to
those operations is as follows:
<TABLE>
<CAPTION>
Sales Assets
------------------------------------------ --------------------------
(in thousands) 1998 1997 1996 1998 1997
==============================================================================================
<S> <C> <C> <C> <C> <C>
United States $7,761,516 $7,031,498 $6,345,235 $3,634,927 $3,177,698
International 1,236,222 1,068,821 905,696 478,114 343,121
- ----------------------------------------------------------------------------------------------
Total $8,997,738 $8,100,319 $7,250,931 $4,113,041 $3,520,819
==============================================================================================
</TABLE>
Note M: Quarterly Financial Data (Unaudited)
<TABLE>
<CAPTION>
First Second Third Fourth
(in thousands, except per share data) Quarter Quarter Quarter Quarter
===================================================================================================================
<S> <C> <C> <C> <C>
Fiscal Year Ended December 26, 1998
Net sales $2,398,677 $2,068,558 $2,234,900 $2,295,603
Gross profit (a) 630,494 573,649 622,036 687,095
Net earnings 81,094 67,676 15,748 68,678
Net earnings per common share:
Basic $ .33 $ .28 $ .06 $ .28
Diluted (c) .32 .26 .06 .27
Pro forma net earnings per common share:
Basic (b) $ .22 $ .18 $ .04 $ .19
Diluted (b) (c) .21 .17 .04 .18
Fiscal Year Ended December 27, 1997
Net sales $2,125,527 $1,858,005 $2,030,549 $2,086,238
Gross profit (a) 544,493 491,854 537,202 563,249
Net earnings 59,535 47,029 61,738 66,559
Net earnings per common share:
Basic $ .25 $ .19 $ .26 $ .27
Diluted .24 .19 .24 .26
Pro forma net earnings per common share:
Basic (b) $ .16 $ .13 $ .17 $ .18
Diluted (b) .16 .13 .16 .17
===================================================================================================================
</TABLE>
(a) Gross profit is net of occupancy costs.
(b) Pro forma amounts reflect the stock split described in Note A.
(c) For the third quarter of 1998, the zero coupon, convertible
subordinated notes were anti-dilutive and, accordingly, were not
included in the diluted earnings per share computation.
63
<PAGE> 1
EXHIBIT 21.1
LIST OF THE COMPANY'S SUBSIDIARIES
NAME JURISDICTION OF INCORPORATION
- ---- -----------------------------
Eastman, Inc. Delaware
Office Depot, Inc. Delaware
OD International, Inc. Delaware
The Office Club, Inc. California
Office Club Thai Co., Ltd. Thailand
Office Depot France, S.N.C. France
Office Depot de Mexico, S.A. de C.V. Mexico
Office Depot Japan Co. Ltd. KK Japan
Viking Office Products Pty., Limited Australia
Viking Office Products (Italia) S.R.L. Italy
Viking Direkt GesmbH Austria
Viking Direkt GmbH Germany
Viking Direct B.V. Holland
Viking Direct S.A.R.L. France
Viking Direct Limited United Kingdom
VOP Ireland Limited Ireland
Viking Office Products, Inc. California
Viking Office Products Japan KK Japan
<PAGE> 1
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statements No.
33-31743, No. 33-62781, No. 33-62801, No. 333-24521, No. 333-45591, No.
333-59603, No. 333-63507, No. 333-68081 and No. 333-69831, of Office Depot, Inc.
on Form S-8 of our reports dated February 17, 1999 included and incorporated by
reference in the Annual Report on Form 10-K of Office Depot, Inc. for the year
ended December 26, 1998.
DELOITTE & TOUCHE LLP
Certified Public Accountants
Miami, Florida
March 19, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF OFFICE DEPOT, INC. FOR THE YEAR ENDED DECEMBER 26, 1998,
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-26-1998
<PERIOD-START> DEC-28-1997
<PERIOD-END> DEC-26-1998
<CASH> 704,541
<SECURITIES> 0
<RECEIVABLES> 464,051
<ALLOWANCES> 25,927
<INVENTORY> 1,258,355
<CURRENT-ASSETS> 2,780,435
<PP&E> 1,478,686
<DEPRECIATION> 499,457
<TOTAL-ASSETS> 4,113,041
<CURRENT-LIABILITIES> 1,531,001
<BONDS> 473,545
0
0
<COMMON> 2,492
<OTHER-SE> 2,026,387
<TOTAL-LIABILITY-AND-EQUITY> 4,113,041
<SALES> 8,997,738
<TOTAL-REVENUES> 8,997,738
<CGS> 6,484,464
<TOTAL-COSTS> 8,262,785
<OTHER-EXPENSES> 336,368
<LOSS-PROVISION> 23,702
<INTEREST-EXPENSE> 22,356
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