<PAGE> 1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 26, 1999
-------------------
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________________ to ________________
Commission file number 1-10948
--------------------------------------------------------
OFFICE DEPOT, INC.
- -------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 59-2663954
- -------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2200 Old Germantown Road; Delray Beach, Florida 33445
- -------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(561) 438-4800
- -------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
- -------------------------------------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
----- -----
The registrant had 374,812,190 shares of common stock outstanding as of August
6, 1999.
<PAGE> 2
OFFICE DEPOT, INC.
FORM 10-Q - QUARTER ENDED JUNE 26, 1999
INDEX
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Earnings for the
13 and 26 Weeks Ended June 26, 1999 and
June 27, 1998 3
Consolidated Balance Sheets as of
June 26, 1999 and December 26, 1998 4
Consolidated Statements of Stockholders'
Equity for the 26 Weeks Ended June 26, 1999
and the Year Ended December 26, 1998 5
Consolidated Statements of Cash Flows for the
26 Weeks Ended June 26, 1999 and
June 27, 1998 6
Notes to the Consolidated Financial Statements 7 - 12
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 13- 26
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 26
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 26
Item 2. Changes in Securities and Use of Proceeds 26
Item 3. Defaults Upon Senior Securities 26
Item 4. Submission of Matters to a Vote of Security
Holders 26
Item 5. Other Information 26
Item 6. Exhibits and Reports on Form 8-K 26
SIGNATURES 27
INDEX TO EXHIBITS 28
</TABLE>
2
<PAGE> 3
OFFICE DEPOT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
13 Weeks Ended 26 Weeks Ended
June 26, June 27, June 26, June 27,
1999 1998 1999 1998
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Sales $2,343,036 $2,068,558 $4,965,887 $4,467,235
Cost of goods sold and occupancy costs 1,664,801 1,494,909 3,558,804 3,263,092
---------- ---------- ----------- -----------
Gross profit 678,235 573,649 1,407,083 1,204,143
Store and warehouse operating
and selling expenses 453,210 384,006 924,879 803,967
Pre-opening expenses 5,239 2,839 11,702 4,013
General and administrative expenses 89,707 74,362 179,430 149,293
Merger and restructuring costs 12,718 --- 15,479 ---
----------------------------- ------------------------------
Operating profit 117,361 112,442 275,593 246,870
Other income (expense):
Interest income, net 2,010 (1,097) 5,371 (1,033)
Miscellaneous expense, net (1,807) (5,070) (3,645) (11,113)
-------------- ------------- -------------- ------------
Earnings before income taxes 117,564 106,275 277,319 234,724
Income taxes 43,448 38,599 102,627 85,954
------------ ------------ ----------- ------------
Net earnings $ 74,116 $ 67,676 $ 174,692 $ 148,770
=========== =========== ========== ==========
Earnings per share:
Basic $0.20 $0.18 $0.47 $0.41
Diluted 0.19 0.17 0.44 0.38
</TABLE>
The accompanying notes are an integral part of these statements.
3
<PAGE> 4
OFFICE DEPOT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
June 26, December 26,
1999 1998
----------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 622,152 $ 704,541
Short-term investments 107,831 10,424
Receivables, net of allowances 742,693 721,446
Merchandise inventories 1,280,596 1,258,355
Deferred income taxes 55,380 52,422
Prepaid expenses 44,714 33,247
---------- ----------
Total current assets 2,853,366 2,780,435
Property and equipment, net 1,078,930 935,407
Goodwill, net of amortization 244,437 227,964
Other assets 116,767 125,413
---------- ----------
$4,293,500 $4,069,219
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $1,001,680 $1,027,591
Accrued expenses 428,513 430,666
Income taxes payable 54,117 69,910
Current maturities of long-term debt 7,335 2,834
---------- ----------
Total current liabilities 1,491,645 1,531,001
Long-term debt, net of current maturities 64,614 35,490
Deferred income taxes and other credits 48,810 38,628
Zero coupon, convertible subordinated notes payable 444,580 435,221
---------- ----------
2,049,649 2,040,340
---------- ----------
Commitments and Contingencies
Stockholders' equity:
Common stock - authorized 800,000,000 shares of
$.01 par value; issued 377,813,469 in 1999 and
373,817,704 in 1998 3,778 3,738
Additional paid-in capital 895,349 838,122
Accumulated other comprehensive income (35,664) (18,078)
Unamortized value of long-term incentive stock grant (2,275) (2,874)
Retained earnings 1,384,413 1,209,721
Less: 3,245,170 shares of treasury stock, at cost (1,750) (1,750)
---------- ----------
2,243,851 2,028,879
---------- ----------
$4,293,500 $4,069,219
========== ==========
</TABLE>
The accompanying notes are an integral part of these statements.
4
<PAGE> 5
OFFICE DEPOT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
Unamortized Accumulated
Common Common Additional Value of Long- Other
Stock Stock Paid-in Term Incentive Retained Treasury Comprehensive
Shares Amount Capital Stock Grant Earnings Stock Income
------ ------ ----------- -------------- -------- --------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 27, 1997 367,663,995 $3,677 $761,685 $(3,210) $ 976,525 $(1,750) $(19,289)
Comprehensive income:
Net earnings for the year 233,196
Foreign currency translation
adjustment 1,211
Exercise of stock options, including
income tax benefits 5,399,946 54 63,456
Issuance of stock under employee
stock purchase plans 467,394 4 7,896
Matching contributions under 401(k) and
deferred compensation plans 203,055 2 3,882
Conversion of LYONs to common stock 83,314 1 1,203
Amortization of long-term incentive
stock grant -- -- 336
----------- ------ -------- ------- ---------- ------- --------
BALANCE AT DECEMBER 26, 1998 373,817,704 3,738 838,122 (2,874) 1,209,721 (1,750) (18,078)
(UNAUDITED):
Comprehensive income:
Net earnings for the period 174,692
Foreign currency translation
adjustment (17,586)
Exercise of stock options, including
income tax benefits 3,645,971 37 50,229
Issuance of stock under employee
stock purchase plans 198,727 2 3,729
Matching contributions under 401(k) and
deferred compensation plans 134,376 1 3,076
Conversion of LYONs to common stock 20,857 -- 286
Amortization of long-term incentive
stock grant 599
Payment for fractional shares in
connection with stock split (4,166) -- (93)
----------- ------ -------- ------- ---------- ------- --------
BALANCE AT JUNE 26, 1999 377,813,469 $3,778 $895,349 $(2,275) $1,384,413 $(1,750) $(35,664)
=========== ====== ======== ======= ========== ======= ========
Total Comprehensive Income for the periods:
52 Weeks Ended December 26, 1998 $234,407
26 Weeks Ended June 26, 1999 157,106
</TABLE>
The accompanying notes are an integral part of these statements.
5
<PAGE> 6
OFFICE DEPOT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
26 Weeks Ended 26 Weeks Ended
June 26, June 27,
1999 1998
-------------- --------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Cash received from customers $4,926,894 $4,422,354
Cash paid to suppliers (4,651,368) (4,115,438)
Interest received 18,413 12,643
Interest paid (3,307) (1,867)
Income taxes paid (108,223) (56,643)
------------ ------------
Net cash provided by operating activities 182,409 261,049
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities or sale of short-term
investment securities and bonds 5,045 10,501
Purchase of short-term investment securities and bonds (102,452) (73,539)
Purchase of remaining 50% interest in Japanese joint venture (21,629) --
Proceeds from sale of property and equipment 2,734 17,679
Capital expenditures (189,462) (99,248)
------------ ------------
Net cash used in investing activities (305,764) (144,607)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options and sales
of stock under employee stock purchase plans 45,752 23,210
Payments on long- and short-term borrowings (2,652) (1,326)
------------ ------------
Net cash provided by financing activities 43,100 21,884
------------ ------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS (2,134) (9,920)
------------ ------------
Net (decrease) increase in cash and cash equivalents (82,389) 128,406
Cash and cash equivalents at beginning of period 704,541 239,877
------------ ------------
Cash and cash equivalents at end of period $ 622,152 $ 368,283
============ ============
RECONCILIATION OF NET EARNINGS TO NET CASH
PROVIDED BY OPERATING ACTIVITIES:
Net earnings $ 174,692 $ 148,770
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Depreciation and amortization 79,059 67,012
Provision for losses on inventories and receivables 33,441 30,984
Accreted interest on zero coupon, convertible
subordinated notes 9,646 9,281
Contributions of common stock to employee
benefit and stock purchase plans 3,077 2,783
Loss on disposal of property and equipment 4,519 360
Changes in assets and liabilities:
Decrease (increase) in receivables (49,977) 27,044
Decrease (increase) in merchandise inventories (33,635) 114,120
Net increase in prepaid expenses and other assets (9,724) (42,643)
Net increase in accounts payable, accrued
expenses and deferred credits (28,689) (96,662)
------------ ------------
Total adjustments 7,717 112,279
------------ ------------
Net cash provided by operating activities $ 182,409 $ 261,049
============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
6
<PAGE> 7
OFFICE DEPOT, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Tabular amounts in thousands, except share data)
NOTE A - BASIS OF PRESENTATION
Office Depot, Inc., together with our Subsidiaries, including Viking,
(collectively referred to as the "Company" or "Office Depot") is the world's
largest supplier of office products and services. References to the Company
throughout these Notes to the Consolidated Financial Statements are made using
the first person notations of "we" or "our."
In August 1998, Office Depot merged with Viking Office Products, Inc.
("Viking"). The merger was accounted for as a pooling of interests. The
consolidated financial statements and other non-financial information of Office
Depot have been restated and combined with the consolidated financial statements
and other non-financial information of Viking to show you the results as if the
merger had taken place at the beginning of the periods reported.
With the addition of Viking, we now have 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. In certain of these countries, we operate under license
or joint venture arrangements. We serve our customers through a combination of
high-volume office supply retail stores, catalog and Internet operations. In the
United States, we also operate a contract sales network. We do business
primarily under two brands -- Office Depot(R) and Viking Office Products(R).
Joint ventures in which we own 50% or less of the business are accounted for
using the equity method. The joint venture in which we own more than 50% is
accounted for on a consolidated basis. In November 1998, we purchased the
remaining 50% ownership interest in our joint venture operations in France.
Accordingly, we have consolidated the financial position, results of operations
and cash flows of our French operations since November 1998. On March 29, 1999,
we purchased the remaining 50% interest in our joint venture operations in
Japan; and, we have consolidated the financial position, results of operations
and cash flows of our Japanese operations since that date.
We operate on a 52 or 53 week fiscal year ending on the last Saturday of
December. Our interim financial statements as of June 26, 1999 and for the 13
and 26-week periods ended June 26, 1999 (also referred to as "the second
quarter of 1999" and "the first half of 1999," respectively), and June 27, 1998
(also referred to as "the second quarter of 1998" and "the first half of 1998,"
respectively) are unaudited. However, in our opinion, the interim financial
statements reflect all adjustments (consisting only of normal recurring items)
necessary to provide to you a fair presentation of our financial position,
results of operations and cash flows for the periods presented. We have made
certain reclassifications to our prior year statements to conform them to the
presentation we used in the current year. These interim results do not
necessarily indicate the results you should expect for the full year. For a
better understanding of our Company and its financial statements, we recommend
that you read our interim financial statements in conjunction with our audited
financial statements for the year ended December 26, 1998.
7
<PAGE> 8
On February 24, 1999, our Board of Directors declared a three-for-two stock
split in the form of a 50% stock dividend distributed on April 1, 1999 to
stockholders of record on March 11, 1999. We have restated all share and per
share amounts in our financial statements retroactively to reflect this stock
split. In conjunction with the stock split, we issued 124,560,075 additional
shares on April 1, 1999.
NOTE B - MERGER TRANSACTIONS
As part of Office Depot's merger with Viking, each outstanding share of Viking
common stock was converted into one share of Office Depot common stock. We
issued a total of 128,106,688 shares of Office Depot common stock pursuant to
the merger.
The following is a reconciliation of amounts that Office Depot reported for the
second quarter of 1998 (prior to merging with Viking) to amounts that we have
restated to reflect the merger on a pooling of interests basis.
Second Quarter First Half
1998 1998
-------------- ----------
SALES
Office Depot, as previously reported $1,697,539 $3,678,635
Viking 371,019 788,600
---------- ----------
Combined $2,068,558 $4,467,235
========== ==========
NET EARNINGS
Office Depot, as previously reported $ 45,714 $ 101,537
Viking 21,962 47,233
---------- ----------
Combined $ 67,676 $ 148,770
========== ==========
No adjustments to the sales, net earnings or net assets of Office Depot or
Viking were required to conform the two companies' accounting practices.
As we continue to integrate the two companies, both domestically and
internationally, we intend to close certain facilities. Furthermore, as a result
of our management's decision to focus on the continued growth of our core
businesses and on expanding our international operations, we are in the process
of closing our Furniture at Work(TM) and Images(TM) stores. During the third and
fourth quarters of 1998, we incurred merger and restructuring costs of $119.1
million. These costs consisted principally of facility exit costs and personnel
related costs.
On March 29, 1999, we increased our ownership share in the Office Depot Japan
operations from 50% to 100%. Following this purchase of the interests of our
former joint venture partner, we plan to restructure and integrate the separate
Office Depot and Viking operations. During the first half of 1999, we recorded
$15.4 million for merger and restructuring costs, principally associated with
our plans for restructuring and integrating our Japanese operations. As of June
26, 1999 and December 26, 1998, we have included approximately $72.5 million and
$84.8 million, respectively, related to the merger and restructuring costs
described above in accrued expenses on our Consolidated Balance Sheets.
8
<PAGE> 9
NOTE C - NET EARNINGS PER SHARE ("EPS")
"Basic EPS" is based on the weighted average number of shares outstanding
during each period. "Diluted EPS" is calculated as if our zero coupon,
convertible subordinated notes, if dilutive (i.e. if they reduce EPS), were
converted as of the beginning of the period and that, under the treasury stock
method, dilutive stock options were exercised. We have adjusted net earnings
under this assumption for interest accreted on the notes, if dilutive, net of
the related income tax effect.
The following information may be used by you to compute basic and diluted EPS
for the periods indicated.
<TABLE>
<CAPTION>
Second Quarter First Half
1998 1999 1998 1999
-------------- -------------- ---------- ----------
<S> <C> <C> <C> <C>
Basic:
Weighted average number of
common shares outstanding 374,285 366,467 373,545 365,748
======= ======= ======= =======
Diluted:
Net earnings $74,116 $67,676 $174,692 $148,770
Interest expense related to
convertible notes, net of income taxes 2,978 2,852 5,912 5,689
--------- --------- ----------- -----------
Adjusted net earnings $77,094 $70,528 $180,604 $154,459
======= ======= ======== ========
Weighted average number of
common shares outstanding 374,285 366,467 373,545 365,748
Shares issued upon assumed
conversion of convertible notes 24,740 24,830 24,747 24,838
Shares issued upon assumed
exercise of stock options 9,865 11,795 10,790 10,739
--------- -------- --------- --------
Shares used in computing diluted
EPS 408,890 403,092 409,082 401,325
======= ======= ======= =======
</TABLE>
Excluding the after-tax impact of these merger and restructuring costs discussed
in Note C, our diluted earnings per share would have been $0.21 for the second
quarter of 1999 and $0.47 for the first half of 1999.
NOTE D - NON-CASH INVESTING AND FINANCING TRANSACTIONS
Our Consolidated Statements of Cash Flows do not include the following non-cash
investing and financing transactions.
9
<PAGE> 10
<TABLE>
<CAPTION>
First Half
1999 1998
---------- ----------
<S> <C> <C>
Additional paid-in capital related
to income tax benefits on stock options exercised $ 8,161 $2,302
Assets acquired under capital leases 36,293 8,292
Common stock issued upon conversion of debt 287 343
</TABLE>
NOTE E - 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." SFAS No. 133 requires that we report every
derivative instrument at its fair value on the balance sheet. This Accounting
Statement also requires that we recognize any change in the derivatives' fair
value in our earnings for the current period unless the derivatives meet
specific hedge accounting criteria.
SFAS No. 133 is effective for fiscal quarters of fiscal years that begin after
June 15, 2000. We have not yet determined the impact that this statement will
have on our financial position or the results of our operations when we adopt
it.
NOTE F - SEGMENT INFORMATION
We operate through three reportable operating segments: Stores, Business
Services and International. There is a more complete description of each of
these operating groups in paragraphs 5 through 7 of ITEM 2 (MD&A). We have
identified and defined these segments based on how our management evaluates our
business for internal management purposes. In the second quarter of 1999, we
revised our segment definitions to better reflect management accountability.
All segment amounts presented here have been restated to reflect this change.
The accounting policies we apply to each of our segments are the same as those
applied to the consolidated Company. You will find a summary of our significant
accounting policies in Note A to our audited 1998 consolidated financial
statements. The following is a summary of significant accounts and balances by
segment for the 13 and 26 weeks ended June 26, 1999 and June 27, 1998,
respectively, that reconciles to our consolidated financial statements for the
comparable periods.
<TABLE>
<CAPTION>
SALES
----------------------------------------------------------------
Second Quarter First Half
1999 1998 1999 1998
-------------- -------------- ---------- ----------
<S> <C> <C> <C> <C>
Stores $1,280,299 $1,115,017 $2,802,340 $2,499,503
Business Services 759,852 713,027 1,534,287 1,452,606
International 303,879 241,456 631,437 516,897
---------- ---------- ---------- ----------
Total reportable segments 2,344,030 2,069,500 4,968,064 4,469,006
Eliminations and other (994) (942) (2,177) (1,771)
---------- ---------- ---------- ----------
Total $2,343,036 $2,068,558 $4,965,887 $4,467,235
========== ========== ========== ==========
</TABLE>
10
<PAGE> 11
<TABLE>
<CAPTION>
PROVISION FOR LOSSES ON INVENTORIES AND RECEIVABLES
-----------------------------------------------------------------
Second Quarter First Half
1999 1998 1999 1998
-------------- -------------- ---------- ----------
<S> <C> <C> <C> <C>
Stores $ 1,098 $ 5,366 $10,626 $12,503
Business Services 9,055 7,467 17,348 14,492
International 2,715 957 5,467 3,989
------- ------- ------- -------
Total reportable segments 12,868 13,790 33,441 30,984
Other -- -- -- --
------- ------- ------- -------
Total $12,868 $13,790 $33,441 $30,984
======= ======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
DEPRECIATION AND AMORTIZATION
-----------------------------------------------------------------
Second Quarter First Half
1999 1998 1999 1998
-------------- -------------- ---------- ----------
<S> <C> <C> <C> <C>
Stores $18,464 $14,755 $35,578 $28,939
Business Services 6,385 6,471 12,740 12,227
International 3,371 2,067 6,093 4,138
------- ------- ------- -------
Total reportable segments 28,220 23,293 54,411 45,304
Other 12,385 11,113 24,648 21,708
------- ------- ------- -------
Total $40,605 $34,406 $79,059 $67,012
======= ======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
EARNINGS BEFORE INCOME TAXES
-----------------------------------------------------------------
Second Quarter First Half
1999 1998 1999 1998
-------------- -------------- ---------- ----------
<S> <C> <C> <C> <C>
Stores $ 117,880 $105,933 $ 257,702 $ 232,561
Business Services 67,672 45,558 130,338 90,533
International 34,334 31,927 82,284 65,269
--------- -------- --------- ---------
Total reportable segments 219,886 183,418 470,324 388,363
Eliminations and other (102,322) (77,143) (193,005) (153,639)
--------- -------- --------- ---------
Total $ 117,564 $106,275 $ 277,319 $ 234,724
========= ======== ========= =========
</TABLE>
The following is a reconciliation of earnings before income taxes by reportable
segment to earnings before income taxes in our consolidated financial
statements.
<TABLE>
<CAPTION>
Second Quarter First Half
1999 1998 1999 1998
-------------- -------------- ---------- ----------
<S> <C> <C> <C> <C>
Reportable segments $219,886 $183,418 $470,324 $388,363
General and administrative expenses (89,707) (74,362) (179,430) (149,293)
Unallocated portion of miscellaneous
expense, net (1,836) (1,536) (3,373) (3,072)
Interest income (expense), net 2,010 (1,097) 5,371 (1,033)
Merger and restructuring costs (12,718) --- (15,479) --
Intersegment transactions (71) (148) (94) (241)
-------- -------- -------- --------
Total $117,564 $106,275 $277,319 $234,724
======== ======== ======== ========
</TABLE>
11
<PAGE> 12
Total sales by operating segment include intersegment sales, which we
generally record at the cost to the selling entity. As illustrated above, we
evaluate the performance of each of our business segments based on their
results of operations before income taxes, merger and restructuring costs,
goodwill amortization, interest income (expense) and general and administrative
expenses. Assets that we have 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 activities.
<TABLE>
<CAPTION>
CAPITAL EXPENDITURES
------------------------------------------------------------------
Second Quarter First Half
1999 1998 1999 1998
-------------- -------------- ---------- ----------
<S> <C> <C> <C> <C>
Stores $57,152 $32,685 $123,050 $40,524
Business Services 23,018 15,086 24,219 26,311
International 957 5,579 5,991 9,238
------- ------- -------- -------
Total reportable segments 81,127 53,350 153,260 76,073
Other 2,951 11,640 36,202 23,175
------- ------- -------- -------
Total $84,078 $64,990 $189,462 $99,248
======= ======= ======== =======
</TABLE>
ASSETS
------------------------------------
As of
June 26, December 26,
1999 1998
-------- ------------
Stores $1,930,751 $1,783,183
Business Services 832,583 882,248
International 532,478 501,581
---------- ----------
Total reportable segments 3,295,812 3,167,012
Eliminations and other 997,688 902,207
---------- ----------
Total $4,293,500 $4,069,219
========== ==========
We currently have operations, including joint ventures and licensees, 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. We do not generate 10% or
more of our total sales in any single country outside of the United States.
Summarized geographic information relating to our operations inside and outside
the United States is as follows:
<TABLE>
<CAPTION>
SALES ASSETS
---------------------------------------------------- ---------------------------
As of
Second Quarter First Half June 26, December 26,
1999 1998 1999 1998 1999 1998
---------- ---------- ----------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
United States $1,992,760 $1,783,247 $4,236,637 $3,853,511 $3,652,148 $3,470,241
International* 350,276 285,311 729,250 613,724 641,352 598,978
---------- ---------- ----------- ---------- ---------- ----------
Total $2,343,036 $2,068,558 $4,965,887 $4,467,235 $4,293,500 $4,069,219
========== ========== ========== ========== ========== ==========
</TABLE>
* As used above, International includes Canada. For purposes of identifying our
reportable operating segments, we include our Canadian operations in our Stores
segment.
12
<PAGE> 13
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
(Tabular amounts in thousands)
GENERAL
Office Depot, Inc., (together with our Subsidiaries and collectively referred
to as "Office Depot" or "we") is the largest supplier of office products and
services in the world. We sell to consumers and businesses of all sizes through
three business segments: Stores, Business Services and International. Each of
these segments is described in more detail below. We operate on a 52 or 53-week
fiscal year ending on the last Saturday in December.
This Management's Discussion and Analysis ("MD&A") is intended to provide
information to assist you in better understanding and evaluating our financial
results and financial condition. Included in this analysis are our cautionary
statements regarding "forward-looking information." We recommend that you read
this MD&A in conjunction with our Consolidated Financial Statements and the
Notes to those statements, as well as our 1998 Annual Report on Form 10-K.
In August 1998, Office Depot, Inc. merged with Viking Office Products, Inc.
("Viking"). As part of 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, we have restated and
combined all prior period consolidated financial statements and other
non-financial information of Office Depot with the consolidated financial
statements and other non-financial information of Viking for those same periods
to show you the results as if the merger had taken place at the beginning of
the periods reported.
On February 24, 1999, our Board of Directors declared a three-for-two stock
split in the form of a 50% stock dividend distributed on April 1, 1999 to
stockholders of record on March 11, 1999. We have restated all of our share and
per share amounts retroactively to reflect this stock split.
STORES DIVISION -- Our Stores Division sells office products and copy and high
volume print services primarily under the Office Depot(R) brand to retail
customers through our chain of office supply retail stores in the United States
and Canada. In the first half of 1999, our Stores Division opened 57, relocated
6 and closed 2 office supply stores, bringing our total number of stores open at
the end of the second quarter to 757. This compares with 619 stores that were
open at the end of the second quarter of 1998.
BUSINESS SERVICES GROUP ("BSG") -- Through our Business Services Group, we sell
office products and services to contract and commercial customers using our
Office Depot(R) and Viking Office Products(R) direct mail catalogs, a contract
sales force dedicated solely to serving the needs of contract customers and our
Internet sites. To facilitate delivery to our domestic commercial, contract and
retail customers, BSG operated 30 customer service centers ("CSCs") at the end
of the second quarter 1999. This compares to 31 CSCs in operation for the
comparable period in 1998.
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<PAGE> 14
INTERNATIONAL -- Our International Division sells office products and services
to retail and commercial customers in 17 countries outside the United States and
Canada. At the end of the second quarter of 1999, we had 96 office supply
stores, 22 of which were wholly owned. This compares to 49 stores, none of which
were wholly owned by us, at the end of the comparable period in 1998. In
addition to these stores, located in eight foreign countries, our International
Division has catalog and delivery operations in eleven countries.
As we integrate our Office Depot and Viking operations, we intend to close
certain facilities, both domestically and internationally, over the next 18
months. We plan to expense the estimated costs of this integration, primarily
asset impairment and facility exit costs, as these costs are incurred. These
costs are included in merger and restructuring costs. See MERGER AND
RESTRUCTURING COSTS.
RESULTS OF OPERATIONS
SALES
<TABLE>
<CAPTION>
SALES INCREASE SALES INCREASE
----------- -------- ---------- --------
FIRST
SECOND QUARTER 1999 FIRST HALF 1999
------------------- ---------------
<S> <C> <C> <C> <C> <C>
Stores $1,280,299 15% Stores $2,802,340 12%
Business Services 759,852 7% Business Services 1,534,287 6%
International 303,879 26% International 631,437 22%
Inter-segment (994) Inter-segment (2,177)
---------- ----------
Total $2,343,036 13% Total $4,965,887 11%
SECOND QUARTER 1998 FIRST HALF 1998
- ------------------- ---------------
Stores $1,115,017 * Stores $2,499,503 *
Business Services 713,027 * Business Services 1,452,606 *
International 241,456 * International 516,897 *
Inter-segment (942) Inter-segment (1,771)
---------- ----------
Total $2,068,558 * Total $4,467,235 *
</TABLE>
* Increase over 1997 second quarter is outside the scope of this MD&A.
Our Stores Division increased its sales, both for the quarter and for the first
half of 1999, primarily through sales generated by the 138 stores we have added
since the end of the second quarter of 1998. Comparable store sales increased 3%
for the quarter and 1% for the first six months of 1999. Sales of technology
products (computers, peripheral products, software and related supplies) in our
stores led the increases, with the increase in units sold exceeding the decline
in average selling prices.
Our Business Services Group achieved increased sales for the second quarter and
first half of 1999 through the addition of new customer accounts, primarily as a
result of the expansion of our contract sales force in the fourth quarter of
1998 and the first quarter of 1999. Additionally, the introduction of the Office
Depot public Internet site (www.officedepot.com) in January 1998 contributed to
increased sales in our Business Services Group by offering our customers greater
flexibility in their ordering choices. Sales from our public and
business-to-business web sites increased to $70.2 million in the second quarter
of 1999 and $120.5 million in the first half of 1999, compared with sales of
$12.2 million and $18.1 million in the second quarter and first half of 1998,
respectively.
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<PAGE> 15
A significant portion of the sales increases in our International segment
resulted from the inclusion of 100% of the sales from our French and Japanese
stores in our 1999 results, but not in our 1998 results. These results were not
consolidated until the fourth quarter of 1998 and the second quarter of 1999,
respectively, when we purchased the remaining 50% interest in these operations
from our joint venture partners. International sales were also enhanced as our
Viking brand continued to achieve increased market penetration, with higher
catalog sales in each country in which we operate.
Our sales in the future may be impacted by competition, the opening of new
Office Depot stores in markets where stores already exist, and political and
economic conditions in the international markets in which we do business.
GROSS PROFIT
<TABLE>
<CAPTION>
GROSS GROSS
GROSS PROFIT PROFIT % GROSS PROFIT PROFIT %
------------ -------- ------------ --------
SECOND QUARTER 1999 FIRST HALF 1999
------------------- ---------------
<S> <C> <C> <C> <C> <C>
Stores $313,247 24.5% Stores $661,926 23.6%
Business Services 243,914 32.1% Business Services 487,374 31.8%
International 121,465 40.0% International 258,647 41.0%
Inter-segment (391) Inter-segment (864)
-------- ----------
Total $678,235 29.0% Total $1,407,083 28.3%
SECOND QUARTER 1998 FIRST HALF 1998
- ------------------- ---------------
Stores $263,310 23.6% Stores $564,841 22.6%
Business Services 211,950 29.7% Business Services 429,040 29.5%
International 98,797 40.9% International 210,883 40.8%
Inter-segment (408) Inter-segment (621)
-------- ----------
Total $573,649 27.7% Total $1,204,143 27.0%
</TABLE>
As we have grown and our relationships with our key vendors have strengthened,
we have lowered our net product costs, thereby improving our gross profit
percentages. During the fourth quarter of 1998, our Finance and Merchandising
groups made substantial improvements to the systems and processes we use to
manage our volume rebate, cooperative advertising and marketing programs. As a
result, we have been able to reflect the impact of these programs on a more
consistent and timely basis during the year than in the past. This improvement
was a significant contributor to the increases in gross profit percentages in
our Stores and Business Services segments for the second quarter and first half
of 1999. Furthermore, while we earn lower gross profit percentages on our
technology products (i.e., computers, business machines and related supplies)
than on our other product groups, we continue to see a favorable shift in
product mix within the technology group toward machine supplies and accessories
which yield higher margins. However, these improvements were offset to some
extent in the second quarter by price reductions on certain brands of computer
hardware. In our general office supplies group, we have benefited from lower
purchase costs for paper products.
15
<PAGE> 16
In our Stores Division, real estate occupancy costs, which reduce gross profit,
increased as a percentage of sales for the second quarter of 1999 because of the
comparatively high volume of new store openings. Until a store reaches maturity,
its fixed expenses as a percentage of sales are typically higher than more
mature stores. Proactive merchandising and pricing strategies put in place in
our stores during the first quarter of 1999 continued to benefit our gross
profit in the second quarter. In our Business Services Group, a more disciplined
pricing approach and lower net costs for our paper products also contributed to
improved gross profit. Paper and other general office supplies account for a
much larger percentage of total sales in our Business Services Group than in our
Stores Division.
Gross profit in our International Division for the second quarter decreased
with the consolidation of our French and Japanese retail operations, which were
previously accounted for under the equity method. Gross profit percentages
earned in our international retail stores are significantly lower than in our
international catalog business. Additionally, increased competition in several
of our international markets resulted in lower margins during the second
quarter of 1999, offsetting to some extent the stronger margins achieved in the
first quarter.
Our overall 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 our ability to lower our net product
costs through growth in total merchandise purchases. Additionally, our
occupancy costs can vary as we add stores and CSCs in new markets, including in
some cases geographic areas with higher rental and other occupancy costs.
STORE AND WAREHOUSE OPERATING AND SELLING EXPENSES
<TABLE>
<CAPTION>
STORE AND STORE AND
WAREHOUSE WAREHOUSE
OPERATING AND % OF OPERATING AND % OF
SELLING EXPENSES SALES SELLING EXPENSES SALES
---------------- ----- ---------------- -----
SECOND QUARTER 1999 FIRST HALF 1999
------------------- ---------------
<S> <C> <C> <C> <C> <C>
Stores $190,342 14.9% Stores $393,499 14.0%
Business Services 176,198 23.2% Business Services 356,992 23.3%
International 86,990 28.6% International 175,158 27.7%
Inter-segment (320) Inter-segment (770)
-------- --------
Total $453,210 19.3% Total $924,879 18.6%
SECOND QUARTER 1998 FIRST HALF 1998
- ------------------- ---------------
Stores $155,465 13.9% Stores $330,189 13.2%
Business Services 165,465 23.2% Business Services 336,585 23.2%
International 63,336 26.2% International 137,573 26.6%
Inter-segment (260) Inter-segment (380)
-------- --------
Total $384,006 18.6% Total $803,967 18.0%
</TABLE>
The largest components of operating and selling expenses in our Stores Division
are personnel costs and advertising expenses. Our Stores Division has expanded
its store base by 138 stores since the second quarter of 1998. This has lowered
the average age of our store base. Because newer stores usually generate lower
average sales than mature stores, operating and selling expenses as a
percentage of sales in our Stores Division have increased. This increase was
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<PAGE> 17
driven largely by payroll and other expenses which have a relatively large fixed
cost component. In addition, we believe that opening new stores in existing
markets has cannibalized the sales of other Office Depot stores in those markets
(i.e., had the effect of reducing sales at existing stores), causing our
expenses to increase relative to sales. The overall increase in operating
expenses compared to the prior year was offset somewhat by a reduction in our
remodeling costs. We completed the remodeling of 53 stores during the first half
of 1999, compared to 129 stores during the comparable period in 1998.
Operating and selling expenses as a percentage of sales are significantly
higher in our Business Services Group than in our Stores Division, principally
because of the need for a more experienced and more highly compensated sales
force. These expenses, the largest components of which are personnel and
delivery costs, have not materially changed as a percentage of sales from the
first half of 1998 to the comparable period in 1999.
While operating synergies arising from the Viking merger began to have a
positive impact on our Business Services Group's operating and selling expenses
during the second quarter of 1999, we believe we will achieve even greater
improvements during the remainder of 1999 and 2000. During the second quarter
of 1999, we made significant progress in planning the integration of our Office
Depot and Viking warehouses. We expect to begin combining facilities during the
third quarter of this year and to have fully integrated all facilities by the
end of 2000. This will significantly reduce the total number of warehouse
facilities operated by our Company. See additional discussion of the planned
integration in MERGER AND RESTRUCTURING COSTS.
Similar to the situation in our Business Services Group, personnel and delivery
expenses are significant elements of our International Division's operating and
selling expenses. Furthermore, because direct mail presently constitutes our
largest international sales channel, advertising expense, including the cost of
catalog production and mailing, represents a significant expense item for us.
Certain of our operations are in their start-up phase, which also increases our
international operating expenses as a percentage of sales when compared to other
reporting segments.
Operating expenses for the second quarter of 1999 increased over the prior year
primarily as a result of our entry into the Japanese catalog business and the
acquisition of the remaining interest in our Japanese retail operations, both
of which are still in the start-up phase. As we continue to grow our
international business and establish brand recognition, we expect to leverage
certain fixed operating expenses, and our cost to attract new customers should
decline as a percentage of sales. We believe, however, that these improvements
will be offset by the incremental costs incurred to continue developing other
new markets, including Japan.
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<PAGE> 18
<TABLE>
<CAPTION>
PRE-OPENING EXPENSES
PRE-OPENING LOCATIONS PRE-OPENING LOCATIONS
EXPENSES OPENED* EXPENSES OPENED*
---------- --------- ----------- ---------
SECOND QUARTER 1999 FIRST HALF 1999
------------------- ---------------
<S> <C> <C> <C> <C> <C>
Stores $5,025 36 Stores $10,725 63
Business Services 44 -- Business Services 44 --
International 170 3 International 933 5
------ -------
Total $5,239 Total $11,702
SECOND QUARTER 1998 FIRST HALF 1998
- ------------------- ---------------
Stores $1,912 17 Stores $2,091 18
Business Services 927 -- Business Services 1,922 1
International -- -- International -- --
------ ------
Total $2,839 Total $4,013
</TABLE>
* Includes relocations and wholly owned international locations.
Our pre-opening expenses consist principally of personnel, property (real
estate) and advertising expenses that we incur in opening new stores. Because we
expense these items as incurred, the amount of pre-opening expenses we incur in
each period is generally proportional to the number of new stores we open during
the period. In the first half of 1998, in addition to costs to open 18 stores,
our pre-opening expenses included costs associated with expanding one CSC and
opening one new CSC to replace three existing facilities. In the second quarter
of 1999 the pre-opening expenses in the Business Services segment are
attributable to a CSC that will be opening in the third quarter.
Pre-opening expenses generally approximate $160,000 for an office supply store.
We typically incur these expenses during a six-week period prior to the store
opening. During the first half of 1999, these costs increased significantly on a
per-store basis because of our acquisition of a group of stores from another
retailer, which generated higher occupancy costs attributable to a longer
pre-opening period.
Our pre-opening expenses also include, to a lesser extent, expenses incurred to
open and relocate facilities in our Business Services Group and our
International Division. Historically, in these segments, we have incurred
pre-opening expenses of approximately $500,000 to $1,750,000, depending upon the
size, type and location of the facility.
GENERAL AND ADMINISTRATIVE EXPENSES
<TABLE>
<CAPTION>
Second Quarter First Half
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
General and
administrative expenses $89,707 $74,362 $179,430 $149,293
Percentage of sales 3.8% 3.6% 3.6% 3.3%
</TABLE>
Our general and administrative expenses consist primarily of personnel-related
costs associated with support functions. Because these functions, for the most
part, support all segments of our business, we do not consider these costs in
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<PAGE> 19
determining our segment profitability. Throughout 1998, we strengthened our
corporate management infrastructure, including adding several key senior
executives. This initiative was the most significant contributor to the
increase in our general and administrative expenses from the first half of 1998
to the first half of 1999.
While certain other general and administrative expenses have not increased as a
percentage of sales, we cannot assure you that we will be able to continue
increasing our sales without a proportionate increase in corporate expenditures.
However, we expect synergies arising from the Viking merger and continued growth
to have a positive impact on our general and administrative expenses as a
percentage of sales in the future.
MERGER AND RESTRUCTURING COSTS
In August 1998, we completed our merger with Viking. In September 1998, as part
of formulating our strategy for integrating the two companies, we announced
plans to close several facilities by the end of 2000. The facilities that we
plan to close either are redundant or are less efficient than other existing
facilities. Additionally, in November 1998, we decided to focus our attention
on continuing to grow our core business and on expanding our international
operations. In conjunction with this decision, we plan to close our non-core
Furniture at Work(TM) and Images(TM) stores by the end of 1999 and to focus the
activities formerly carried on in these locations in our retail stores.
Beginning in the third quarter of 1998, we accrued the estimated costs
associated with these plans. Merger and restructuring costs of $2.8 million
recorded in the first quarter of 1999 consist mostly of revised estimates for
facility closure costs and additional personnel-related costs incurred.
On March 29, 1999, we increased our ownership share in our Office Depot Japan
operations from 50% to 100%. In connection with this purchase, we plan to
restructure our existing operations in Japan and to merge the separate Office
Depot and Viking operations. Approximately $9.1 million of the $12.7 million in
merger and restructuring costs recorded in the second quarter of 1999 is related
to this restructuring effort.
OTHER INCOME AND EXPENSES
We do not consider interest income and expense arising from our financing
activities at the corporate level in determining segment profitability. The net
increase in interest income results from larger average cash balances in the
first half of 1999 compared with the first half of 1998. The majority of our
interest expense is fixed in nature and relates to our convertible,
subordinated debt.
Miscellaneous expense consists of equity in the earnings (losses) of our
investments, royalty and franchise income that we generate under license
agreements, and amortization of goodwill. Because all of our equity investees
operate outside of the United States and Canada, equity in earnings (losses) of
our investees is included in determining the profitability of our International
Division. The decrease in miscellaneous expense is primarily attributable to our
Japanese operations, which are in the start-up phase. In the first quarter of
1999, we made non-recurring adjustments to earlier estimates of the start-up
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<PAGE> 20
losses in Japan. In the second quarter of 1999, we consolidated the results of
these operations. Similarly, we have consolidated our French operations since
November 1998.
CASH FLOWS AND CAPITAL RESOURCES
Cash provided by (used in) our operating, investing and financing activities
is summarized as follows:
<TABLE>
<CAPTION>
First Half Increase
1999 1998 (Decrease)
---- ---- -----------
<S> <C> <C> <C>
Operating activities $ 182,409 $ 261,049 $ (78,640)
Investing activities (305,764) (144,607) 161,157
Financing activities 43,100 21,884 21,216
</TABLE>
OPERATING
We have historically relied on cash flow generated from our operations as our
primary source of funds because the majority of our store sales are operated
on a cash and carry basis. Furthermore, we use private label credit card
programs, administered and financed by financial services companies, to expand
our sales without the burden of carrying additional receivables. Our cash
requirements are also reduced by vendor credit terms that allow us to finance a
portion of our inventory. We generally offer credit terms, under which we carry
our own receivables, to our contract and certain of our direct mail customers.
In contrast, our retail and a large number of our commercial customers
generally pay in cash or by credit card. As we expand our contract and direct
mail businesses, we anticipate that our accounts receivable portfolio will
grow. Receivables from our vendors under rebate, cooperative advertising and
marketing programs comprise a significant percentage of our total receivables.
These receivables tend to fluctuate somewhat seasonally, growing during the
second half of the year and declining during the first half, because certain
collections occur after an entire program year has been completed.
The decline in cash flows from our operating activities is attributable to
increases in operating and selling expenses as a percentage of sales in the
Stores Division. As discussed in STORE AND WAREHOUSE OPERATING AND SELLING
EXPENSES, this results from the lower average age of our store base. The Company
also experienced an increase in income tax payments, largely attributable to the
timing of payments.
20
<PAGE> 21
INVESTING
Capital assets represent our primary investing activity. The number of stores
and CSCs we open or remodel generally drives the volume of our capital
investments. The increasing requirements for computer and other equipment at our
corporate offices to support our expansion and complete our Y2K remediation (see
Year 2000) also contribute to our investing activities.
We opened 63 stores, including six relocations, in the United States and Canada
and five stores in France during the first half of 1999, compared to 18 stores
added in the comparable 1998 period. This increase was the most significant
contributor to the overall increase in our capital expenditures for the first
half of 1999.
We currently plan to open at least 52 additional stores in the United States and
Canada during the remainder of 1999. We estimate that our cash requirements,
excluding pre-opening expenses, will be approximately $1.3 million for each new
office supply store. This consists of $700 thousand for leasehold improvements,
fixtures, point-of-sale terminals and other equipment in the stores, and $600
thousand for the portion of inventories that is not financed by our vendors. In
addition, we estimate that each new office supply store will require pre-opening
expenses of approximately $160 thousand. Our cash requirements for new CSCs,
which are significantly greater than for stores, vary depending on the size,
type and location of the facility.
FINANCING
In February 1998, we entered into a new credit agreement with a syndicate of
banks. This credit agreement provides us with a working capital line and
letters of credit totaling $300 million. This credit agreement replaced our
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. Since February 1997, we have
not borrowed any amounts against this or our prior credit facility. As of June
26, 1999, we had outstanding letters of credit totaling $18 million under the
facility.
In July 1999, we entered into a term loan and revolving credit agreements with
several Japanese banks (the "yen facilities") to provide financing for our
operations in Japan. The yen facilities provide for maximum aggregate borrowings
of Yen 9.76 billion (equivalent to $80 million at the time that the agreements
were executed), and contain covenants similar to those in our domestic credit
facility. We borrowed the Yen equivalent of $15 million under the yen facilities
in July 1999. In addition to bank borrowings, we have historically used equity
capital, convertible debt and capital equipment leases as supplemental sources
of funds.
The improvement in cash provided from our financing activities in the first
half of 1999, as compared to the first half of 1998, was driven by an increase
in the volume of stock options exercised by our employees. In connection with
our merger with Viking, all options held by Viking employees prior to the
merger, with the exception of those granted under Viking's annual option award
in July 1998, became fully vested on the merger date.
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<PAGE> 22
In 1992 and 1993, we issued Liquid Yield Option Notes ("LYONS(R)"), which are
zero coupon, convertible subordinated notes maturing in 2007 and 2008,
respectively. Each LYON(R) is convertible at the option of the holder at any
time on or prior to its maturity into Office Depot common stock at conversion
rates of 43.895 and 31.851 shares per 1992 and 1993 LYON(R), respectively.
We continually review our financing options. Although we currently anticipate
that we will finance all of our 1999 expansion and other activities through
cash on hand, funds generated from operations, equipment leases and funds
available under our credit facilities, we will consider alternative financing
if market conditions make it financially attractive. Our financing requirements
beyond 1999 will be affected by our operating and investing decisions,
including the number of new stores or CSCs we open or acquire.
YEAR 2000
As the Year 2000 ("Y2K") approaches, we are faced with issues related to 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 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 our current application systems were developed over the past four years
and were designed to use four-digit year values. We believe that these systems
are already Y2K compliant. To ensure a smooth transition into the millennium,
we have established our Year 2000 Project Office led by a Year 2000 Project
Team (collectively referred to as "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 our 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. Our Y2K effort is worldwide, and our goal is to minimize
disruption of our business in each of our operations when January 1, 2000
arrives.
Technology Systems:
In the Operations component of Project 2000, we are reviewing our data center
process automation equipment, software not internally developed or supported by
our MIS department, and our data/voice networks. We are in the process of: 1)
inspecting all equipment and completing an inventory of all of our hardware and
22
<PAGE> 23
software, 2) evaluating the readiness of all hardware and software and
determining what upgrades are required and 3) correcting all non-compliant
hardware and software using upgrades certified as Y2K compliant by their
vendors. We expect to complete this component by September 1999.
In the Development component, we are focusing on the proper operation of
application software developed or supported in-house. We are in the process of:
1) assessing our systems for potential Y2K issues, 2) remediating any
non-compliant systems by changing the program code to properly process all
dates, 3) testing to make sure remediation has not changed the functionality of
the application, and implementing new program code, 4) testing the accuracy of
the output under multiple scenarios and 5) certifying that the systems are Y2K
compliant. We have multiple teams within our MIS organization working on this
component of Project 2000. Although each team is at a different stage of
completion, we are substantially finished with this component as a whole.
Overall, the two Technology components together are currently approximately 95%
complete.
Non-technology Systems:
The Facilities component of Project 2000 involves our buildings, including
security, heating/ventilation/air conditioning and telephone systems; and our
transportation systems and equipment, including scheduling, communication,
security, tracking and maintenance. We have fully completed this component. The
phases consisted of: 1) developing an inventory of equipment and services and
associated vendors, 2) contacting all of our vendors to verify Y2K compliance
of their equipment and services, 3) upgrading systems and equipment to
compliant versions, if necessary, 4) testing equipment and systems and 5)
certifying that all such equipment and services are Y2K compliant.
In the Merchandising component of Project 2000, we are attempting to ensure
that our merchandise suppliers are able to meet their delivery commitments. The
phases of this component are: 1) developing a supplier survey, 2) requesting
that our suppliers confirm their Y2K compliance, 3) establishing
confidence/risk levels by product, 4) developing contingency plans, such as
alternate product sources and increased inventory levels, for non-compliant
vendors and 5) certifying products as Y2K compliant or implement contingency
plans. We are finished with phases 1 through 4 for all critical vendors, and
are working on phase 5. We will continue to follow up with vendors until they
have all responded. Over 90% of respondents have indicated that they have plans
in place for internal systems compliance, and the majority of the respondents
have already certified that their products are Y2K compliant. We expect to
complete this component, to the extent possible, by October 1999.
Because our operations are highly dependent on those of our suppliers and
customers, we could be materially adversely affected if utilities, private
businesses or governmental entities with which we do business are not
adequately prepared for the year 2000. A reasonably possible worst case
scenario resulting from our 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. Our business and the
23
<PAGE> 24
results of our operations could be materially adversely affected by a temporary
inability to conduct business in the ordinary course for a period of time after
January 1, 2000. However, we believe that our Y2K readiness efforts will
significantly reduce any adverse effect from any such disruptions. Furthermore,
we do not believe that the effects on our financial position and the results of
our operations will be material. We have not experienced any significant delays
in other MIS initiatives as a result of Project 2000.
We capitalize costs for hardware and software and depreciate them over the
assets' estimated useful lives. We expense all other costs specifically
associated with Project 2000 (e.g., labor, consulting fees, maintenance
contracts, etc.) as incurred. We incurred approximately $5 million in 1998
related to Project 2000, substantially all of which was expensed. Additionally,
we have incurred costs of approximately $9.0 million during the first half of
1999. We expect to spend another $3.5 million to complete Project 2000, most of
which we will expense as incurred.
Our 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 further change. Our estimates and conclusions contain
forward-looking statements and are based on our best estimates of future
events. Although we expect our systems and facilities to be Y2K compliant by
the end of the third quarter of 1999, we cannot assure you that we will achieve
this goal. Risks to our completing the plan include the availability of
resources, our 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, eleven of the fifteen member countries of the European
Economic and Monetary Union ("EMU") established fixed conversion rates between
their existing currencies and the EMU's common currency (the euro). The euro is
presently 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. On January 1, 2002, new euro-denominated bills and coins will become
the sole legal currency, and all former currencies will be withdrawn from
circulation.
The use of a single currency in the participating countries may affect our
ability to price products differently in various European markets because of
price transparency. We realize that we may be faced with price harmonization at
lower average prices for items we sell in some markets. Nevertheless, other
market factors such as local taxes, customer preferences and product assortment
may reduce the likelihood of price equalization.
We generate significant sales in Europe and are currently evaluating the
business implications of the conversion to the euro. We have completed our plan
to adapt our internal systems to accommodate euro-denominated transactions.
Other implications include, among other things, competitive issues related to
cross border price transparency and the impact on our existing marketing
materials. Based on these evaluations, we do not expect the conversion to the
euro to have a material effect on our financial position or the results of our
operations.
24
<PAGE> 25
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." SFAS No. 133 requires that we report every
derivative instrument at its fair value on the balance sheet as either an asset
or a liability. This statement also requires that we recognize changes in the
derivative's fair value currently in earnings unless the derivatives meet
specific hedge accounting criteria.
SFAS No. 133 is effective for fiscal quarters of fiscal years that begin after
June 15, 2000. We have not yet determined the impact that this statement will
have on our financial position or the results of our operations when we adopt
it.
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, as amended, 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. We want to take advantage of the "safe harbor"
provisions of the Act by disclosing which statements we provide to you are
forward-looking statements by providing specific cautionary statements to
inform you as to circumstances which may cause the information in
forward-looking statements not to be realized.
This Quarterly Report on Form 10-Q contains both historical information and
other information that looks towards our future performance. Examples of
historical information include our quarterly financial statements and the
commentary on past performance contained in this MD&A. We caution readers that,
with the exception of information which clearly deals with historical matters,
all the information contained in this Quarterly Report on Form 10-Q should be
considered to be "forward-looking statements" as referred to in the Act.
Without limiting the generality of the preceding sentence, any time we use the
words "estimate," "project," "intend," "expect" and similar expressions, we
intend 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 we discussed in more detail in the Cautionary Statements
contained in our 1998 Annual Report on Form 10-K. This information is based on
various factors and important assumptions about future events that may or may
not actually come true. As a result, our operations and financial results in
the future could differ materially and substantially from those we have
discussed in the forward-looking statements in this Quarterly Report. In
particular, the factors we discussed in the Cautionary Statements in our 1998
25
<PAGE> 26
Annual Report on Form 10-K could affect our actual results and could cause our
actual results during the remainder of 1999 and in future years to differ
materially from those expressed in any forward-looking statement made by or on
behalf of us in this Quarterly Report. Those Cautionary Statements are
incorporated herein by this reference to them.
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISKS
Refer to the disclosure in our 1998 Annual Report on Form 10-K, filed March 22,
1999. We do not believe that the risk we face related to interest rate changes
is materially different than it was at the date of that Report.
FOREIGN EXCHANGE RATE RISKS
Refer to the disclosure in our 1998 Annual Report on Form 10-K, filed March 22,
1999. We do not believe that the risk we face related to foreign currencies is
materially different than it was at the date of that Report.
PART II. OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS
We are involved in litigation arising in the normal course of our business. We
do not believe that these matters will materially affect our financial position
or the results of our operations.
ITEM 2 CHANGES IN SECURITIES AND USE OF PROCEEDS
Not applicable.
ITEM 3 DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5 OTHER INFORMATION
Not applicable.
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
a. 27.1 Financial Data Schedule (for SEC use only)
26
<PAGE> 27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
OFFICE DEPOT, INC.
-------------------
(Registrant)
Date: August 10, 1999 By: /s/ Barry J. Goldstein
--------------------------------
Barry J. Goldstein
Executive Vice President-Finance
and Chief Financial Officer
Date: August 10, 1999 By: /s/Charles E. Brown
--------------------------------
Charles E. Brown
Senior Vice President-Finance
and Controller
(Principal Accounting Officer)
27
<PAGE> 28
INDEX TO EXHIBITS
Exhibit No. Description
- ----------- -----------
27.1 Financial Data Schedule (for SEC use only)
28
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STTEMENTS OF OFFICE DEPOT, INC. FOR THE QUARTER ENDED JUNE 26, 1999
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-25-1999
<PERIOD-START> DEC-27-1998
<PERIOD-END> JUN-26-1999
<CASH> 622,152
<SECURITIES> 107,831
<RECEIVABLES> 742,693
<ALLOWANCES> 22,766
<INVENTORY> 1,280,596
<CURRENT-ASSETS> 2,853,366
<PP&E> 1,609,677
<DEPRECIATION> 530,747
<TOTAL-ASSETS> 4,293,500
<CURRENT-LIABILITIES> 1,491,645
<BONDS> 516,529
0
0
<COMMON> 3,778
<OTHER-SE> 2,240,073
<TOTAL-LIABILITY-AND-EQUITY> 4,293,500
<SALES> 4,965,887
<TOTAL-REVENUES> 4,965,887
<CGS> 3,558,804
<TOTAL-COSTS> 4,495,385
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 11,082
<INTEREST-EXPENSE> 13,051
<INCOME-PRETAX> 277,319
<INCOME-TAX> 102,627
<INCOME-CONTINUING> 174,692
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 174,692
<EPS-BASIC> 0.47
<EPS-DILUTED> 0.44
</TABLE>
