ODP report - Zacks Investment Research



|Office Depot Inc. |(ODP – NYSE) |$4.34 |

Note: More details to come; changes are highlighted. Except where noted, and highlighted, no other sections of this report have been updated.

Reason for Report: Flash Update: Office Depot to Exit Mexican JV

Note: April 30, 2013, Flash Update: 1Q13 Earnings Update.

Prev. Ed.: November 30, 2012, 3Q12 Earnings Update

Flash News Update

Office Depot to Offload Stake in Mexican JV – June 4, 2013

In a strategic decision to create value for shareholders, Office Depot, Inc decided to exit its Mexican joint venture with Grupo Gigante, S.A.B. de C.V. by selling its 50% stake to the latter for approximately $690 million. The joint venture, which was formed in 1994, currently operates over 248 stores throughout Mexico and Central America generating more than $1.1 billion in annual sales.

Office Depot indicated that net after-tax proceeds of estimated $550 million would be deployed in redeeming 50% of the convertible preferred shares held by BC Partners and its affiliates. The company also intends to redeem its 6.25% bonds of $150 million due in August 2013.

MORE DETAILS WILL COME IN THE IMMIMENT EDITIONS OF ZACKS RD REPORTS ON ODP.

Portfolio Manager Executive Summary [Note: only highlighted material has been changed]

Office Depot Inc. (ODP) supplies a range of office products and services in the United States and internationally. It offers an assortment of merchandise, such as general office supplies, computer supplies, business machines and related supplies, and office furniture through its chain of office supply stores under the Office Depot, Foray, Ativa, Break Escapes, Worklife and Christopher Lowell brand names.

Of the analysts in the Digest group providing ratings on the stock, 76.9% provided Neutral ratings, 15.4% assigned Positive ratings, while 7.7% rendered a negative rating on the stock.

Neutral or equivalent outlook (76.9%; 10/13 firms): The company is taking several initiatives by consolidating its supply chain and introducing new services, which should contribute to its improving margins. Moreover, the company’s continuous efforts to integrate its cost structure supplements the same. The firms believe that the company’s strategic initiatives, such as to close the underperforming stores, reduce costs and stress on optimum pricing, will boost its financial results going forward.

However, despite the company’s continued target expansion and profit-enhancing strategies, these firms remain concerned about a weak domestic and international backdrop and a very competitive and promotional environment. Further, the firms do not see any near-term catalyst to boost sales and thus remain on the sidelines.

Positive or equivalent outlook (15.4%; 2/13 firms): These firms believe that ODP’s top line is highly correlated to factors such as, GDP payroll and industrial production growth. The firms added that the company would witness a commensurate improvement in sales of office-related products with the improvement in economy, resulting in upward earnings revisions and multiple expansions. The firms also remain positive on the company’s incessant effort to stabilize and improve its businesses in a recovering environment.

The firms also point out that lately the company has taken various initiatives, such as focusing on cost cutting efforts and implementation of core strategies, to augment sales and bring in operating efficiencies.

Negative or equivalent outlook (7.7%; 1/13 firms): The firm maintains a near-term cautious outlook for Office Depot given the prevalent weakness in the macro environment and relatively high unemployment levels, which might weigh upon the margins of the company and restrict business growth.

Apart from the above factors, the following point should be taken into consideration before coming to an investment decision:

ODP operates internationally. Its main competitors are OfficeMax Inc. (OMX) and Staples Inc. (SPLS). The brokerage firms believe Office Depot’s persistent problems may represent a growth opportunity for other players, particularly industry-leader, SPLS. The firms expect Staples to take advantage of the difficulties of Office Depot and use them against it to win new customers, especially in the contract business. Meanwhile, ODP's competitive position may erode and even worsen if Staples and Corporate Express (CXP) eventually combine.

November 30, 2012

Overview [Note: only highlighted material has been changed]

The firms identified the following key factors for evaluating the investment merits of ODP:

|Key Positive Arguments |Key Negative Arguments |

|The firms believe ODP is effectively raising its operating margin |The office supply market is saturated, which makes it highly competitive and |

|with the help of various cost-saving initiatives and can achieve |difficult to expand in. |

|continued growth over time. |ODP faces the risk of its in-store initiatives (to drive U.S. retail sales) |

|The company is taking several initiatives by consolidating its supply|failing to gain traction. |

|chain, introducing new services, and increasing private label |Exposure to international markets subjects ODP to unanticipated risks, such as |

|offerings. |currency exchange, political turmoil, and cultural differences. |

|The company provided an update on its Business Process Improvement |Demand for office products remains tied to small business spending and |

|Initiative, relating to a $100 million cost saving plan with a |white-collar employment. Deterioration in business investment is expected to |

|targeted annual run-rate by the end of 2013. |have a material impact on the company’s results. |

|The company generates healthy margins through favorable product mix |High exposure to retail stores in Florida and California, which are currently |

|coupled with effective pricing. |being hurt by weak housing markets. |

| |Significant infrastructure investments required relative to the company’s |

| |peers. |

Founded in 1986 and based in Boca Raton, Florida, Office Depot Inc. (ODP) supplies a range of office products and services across the globe. The company has operations throughout North America, Europe, Asia, and Central America. Sales are processed through various channels, including office supply stores, a contract sales force, an outbound telephone account management sales force, Internet sites, direct marketing catalogs and call centers. The company operates through three business segments – North American Retail Division, North American Business Solutions Division and International Division.

• North American Retail Division sells a wide range of merchandise through its stores in the U.S. and Canada. The company’s merchandise offering includes general office supplies, computer supplies, business machines and related supplies, and office furniture under the banner of national brands as well as the company’s own private brands, such as Office Depot, Foray, Ativa, Break Escapes, Worklife and Christopher Lowell. It also provides graphic design, printing, mailing, shipping, and other services.

• North American Business Solutions Division trades in nationally branded and private brand office supplies, technology products, furniture and services through its dedicated sales force, catalogs and internet sites.

• International Division trades in office products and services through direct mail catalogs, contract sales force, Internet sites, and retail stores, through a mix of company-owned operations, joint ventures, licensing and franchise agreements, and alliances.

More information is available at the company’s website: .

Office Depot’s fiscal year ends on December 31.

November 30, 2012

Long-Term Growth [Note: only highlighted material has been changed]

The firms believe ODP benefits from a number of positive factors, including favorable labor environment, industry consolidation in North American retail and delivery, better inventory management, improved terms with vendors, a stronger product return policy, and cost cutting measures.

During its 3Q12 conference call, management laid down various strategies to boost growth and efficiently as well as control its cost in the coming years. The strategies formulated by the company include downsizing or relocating the stores, on which the lease has expired, thereby reducing the occupancy costs along with providing better customer buying experience. Further, the company focuses on generating revenue through its enhanced services and solutions.

With a view to expand globally, management focuses on increasing the awareness of its brand with various efforts made by its team. Moreover, the company plans to emphasize on small to mid-sized business that offers high-margin contracts.

The company outlined growth-oriented elements for turning around in each of its three divisions as follows:

• North American Retail – Focusing on micro-business customers with a new product assortment and a re-launched loyalty program to provide an even stronger value proposition; improving the company’s value programs Buy More & Save, Private Brands, and Worklife Rewards; and enhancing service offerings to complement product offerings.

• North American Business Solutions – Redesigning a direct marketing program that includes launching of a new telephone account management strategy and structure; improving online marketing efficiency and effectiveness; and pursuing a detailed contact strategy to optimize the penetration of the existing customers.

• International – Improving services in the UK and actively managing costs and maximizing distribution efficiency; improving productivity by changing back-office functions to a shared service center in Eastern Europe and consolidating European call centers and distribution facilities; leveraging global sourcing to increase direct import and private brand penetration in Europe and Asia.

November 30, 2012

Target Price/Valuation [Note: only highlighted material has been changed]

|Rating Distribution |

|Positive |15.4% |

|Neutral |76.9% |

|Negative |7.7% |

|Avg. Target Price |$3.24↑ |

|Maximum Target |$5.00↓ |

|Minimum Target |$2.00↑ |

|No. of Analysts with Target Price/Total |9/13 |

The major near-term business risks include continued pressure in the housing market, given its substantial presence in the California and Florida markets, though these pressures appear to have spread to other markets as well. ODP would also be vulnerable to a slowdown in the U.K. Other business risks include declines in consumer and business spending, which may be impacted by issues beyond the company's control including employment trends.

Recent Events [Note: only highlighted material has been changed]

On Apr 30, 2013, Office Depot posted breakeven bottom-line results for the first quarter of 2013 that fell short of the Zacks Consensus Estimate of $0.05 and went down significantly from the year-ago earnings of $0.11. Soft top-line performance muted the company’s cost containment efforts.

Including one-time items, Office Depot slumped to a loss of $0.06 a share compared with earnings of $0.14 registered in the year-ago quarter.

Office Depot’s total revenue of $2,718.3 million decreased 5.4% (in both constant currency and U.S. dollars) from the prior-year quarter and also came below the Zacks Consensus Estimate of $2,783 million.

The company stated that shift in the timing of the New Year and Easter holidays negatively impacted sales by approximately $58 million or 200 basis points year over year.

Despite a 5.5% decline in cost of goods and occupancy costs during the quarter, gross profit dropped 5% to $659.7 million. However, gross margin expanded 10 basis points to 24.3% in the quarter.

Office Depot reported adjusted operating income of $34.2 million down from $56 million in the year-ago quarter, whereas operating margin shriveled 60 basis points to 1.3%.

On Feb 20, 2013, Office Depot posted breakeven earnings for the fourth quarter of 2012 that fell short of both the Zacks Consensus Estimate as well as the prior-year quarter earnings by $0.03. Soft top-line performance muted the company’s cost containment efforts.

Including one-time items, Office Depot slumped to a loss of $0.06 a share compared with earnings of $0.04 registered in the year-ago quarter.

Office Depot’s total revenue of $2,622.8 million decreased 11.7% from the prior-year quarter and also came below the Zacks Consensus Estimate of $2,767 million. In constant currency, revenue slipped 11%.

Despite an 11.2% decline in cost of goods and occupancy costs during the quarter, adjusted gross profit dropped 12.9% to $783.8 million. Gross margin contracted 40 basis points to 29.9% in the quarter.

Office Depot reported adjusted operating income of $26 million down from $35.8 million in the year-ago quarter, whereas operating margin shriveled 20 basis points to 1%.

Concurrent with the earnings release, the company announced a long speculated merger deal with OfficeMax.

Segment Performance

During the quarter, North American Retail division revenue decreased 13% to $1,070.7 million, whereas comparable-store sales dropped 6%.

Office Depot witnessed sales decline across notebook computers and software but registered sales increase across tablets, e-readers and desktop computers. Sales of Copy and Print, and cleaning and breakroom supplies rose but fell for office furniture and supplies. Management stated that customer transaction counts dropped 5%, while the average order value remained even.

The division reported an operating income of $10.6 million, substantially down from an operating income of $32.4 million in the prior-year quarter.

Total store count at the North America Retail division stood at 1,112 at the end of the quarter. During the quarter, the company opened 2, closed 4 and relocated 15 stores.

Revenue for North American Business Solutions decreased 8% to $763.4 million. Both direct and contract channels sales declined during the quarter. However, online sales increased on the back of higher traffic and increase in average order value but the direct channel witnessed fall in purchases from consumers who use catalogs while shopping and give orders via call centers. The division posted operating income of $55.2 million up from $44.7 million in the year-ago quarter.

The International division’s revenue dipped 13% to $788.7 million, whereas it fell 11% in constant currency. The overall sales in European contract channel dropped in the mid-single digits as the growth witnessed in Germany and even sales in the UK were mitigated by soft sales in other parts of Europe. Asia contract channel sales remained flat compared with the prior-year quarter. European direct channel experienced a sales decline but the rate of fall decelerated sequentially. The retail channel sales slipped in Europe due to softness witnessed across Sweden and Hungary, partly offset by marginal sales increment in France, whereas in Asia, South Korean retail witnessed a marginal increase in sales.

The division posted an operating income of $23.4 million, down from $33 million in the year-ago quarter. At the end of the quarter, total store count at the International division stood at 123. During the quarter, the company closed 11 stores.

Other Financial Details

Office Depot generated cash flow of $95.2 million from operating activities and incurred capital expenditures of $31.5 million, resulting in free cash flow of $63.7 million.

The company ended the quarter with cash and cash equivalents of $670.8 million, long-term debt of $485.3 million and shareholders’ equity of $661.4 million, excluding non-controlling interest of $107,000.

About the Merger

Though the future remains unpredictable, efforts to combat the tough economy are obvious. Business budget remains tight, consumers are cautious than ever before and companies are trying hard to navigate through the challenging environment. Amid such a scenario, Office Depot and OfficeMax decided to unite.

The all-stock merger agreement, which involves 2.69 Office Depot shares for each share of OfficeMax, would result in cost synergies of $400 to $600 million yearly by the third year from the time of closing of the transaction. The transaction is expected to be concluded by the end of 2013. Management of both the companies are yet to decide on the name of newly formed company, the location of corporate headquarters and the CEO.

The consolidation augurs well for both the companies, who have been grappling with soft sales. The combined sales for the recently concluded year ended on Dec 29, 2012 stood at approximately $18 billion, whereas cash and cash equivalents together comes at $1.2 billion.

On Dec 20, 2012, Office Depot announced that it is selling its Hungary business to Central Fund Venture Capital Fund. However, financial terms of the deal were not disclosed.

As per the agreement, Central Fund will provide support to Office Depot's existing customers in Hungary and will be using Office Depot's trade names and receive sourcing services. Office Depot commenced its operations in Hungary in 1997 through licensed operation and later transformed the business into its wholly owned subsidiary in 2004.

On November 6, 2012, Office Depot posted 3Q12 financial results. The company reported earnings of $0.06 per share, compared with break-even in the year-ago quarter, and way ahead of the Zacks Consensus Estimate of $0.01. Including one-time items, Office Depot slumped to a loss of $0.25 per share against an earnings of $0.28 registered in the prior-year quarter. Office Depot’s total revenue of $2,692.9 million decreased 5% from the prior-year quarter and fell short of the Zacks Consensus Estimate of $2,724 million.

On October 15, 2012, Office Depot said that it has been granted the office supplies purchasing contract by the State of South Carolina. The financial terms of this deal were undisclosed. Management is quite confident on this deal and believes that Office Depot can supply its office products on heavy discounts to thousands of public agency purchasers within the State. Office Depot has been retailing in the State of South Carolina since 1989. The first store was opened in Greenville in the State.

Revenue [Note: only highlighted material has been changed]

According to the company, total revenue came in at $2,692.9 million, down 5% from $2,836.7 million in 3Q11, reflecting soft sales at North America Retail segment and International segment. In constant currency, revenue slipped 3%.

Segment Details

North American Retail (NAR): Revenue decreased 5% to $1,173.7 million. The fall in the comparable sales of computers and associated products dragged down comparable-store sales by 4%.

This segment witnessed sharp sales decline across computers and other related products, but registered sales increase across tablets and e-readers. Sales of Copy and Print improved, while it fell for office furniture. Sales in the supplies category remained even, whereas sales of ink and toner climbed marginally. Management stated that customer transaction counts dropped 4%, while the average order value was modestly negative.

During 4Q12, the company expects computer sales to rise, mainly due to the launch of a new software operating system designed for personal computers.

North American Business Solutions Division: Segment’s revenue inched up 1% to $827.4 million compared with $820.9 million in 3Q11. Direct channel sales decreased, whereas contract channel sales hiked. The division witnessed improved sales in Copy and Print, furniture and cleaning, and breaks room supplies. Sales remained soft to Federal and state government due to budget constraint, but were these were higher to customers related to education sector.

International: Sales from the International business dipped 12% in the U.S. dollars to $691.9 million, whereas it fell 4% in constant currency. The overall sales in European contract channel dropped in the low single-digits as the growth witnessed in Germany and even sales in the UK was mitigated by soft sales in other parts of Europe. Asia contract channel sales rose in the high single-digits.

European direct channel experienced a sales decline, but the rate of fall decelerated sequentially. The retail channel sales slipped in low single-digits in Europe, whereas in Asia, South Korean retail witnessed sales increase in high single-digits.

Outlook

Management, through its strategic initiatives, expects sales to accelerate, while costs are expected to come down in the coming quarters as Office Depot emphasizes on enhancing customers’ shopping experience, closing underperforming stores and merchandise.

Management expects North American Retail division sales to improve sequentially in 4Q12, whereas revenue is expected to decline in North American Business Solution division in 4Q12, including the impact of an extra week. However, excluding the impact of the 53rd week, the division’s revenue is anticipated to be flat compared with the year-ago period. In the international division, sales in constant currency are forecasted to fall in high-single digits, mainly due to lingering woes in European market.

Further, management expects overall sales for the company to decline by about 5% in 4Q12. Moreover, the company’s total sales will suffer by 300 basis points due to a negative impact of 53rd week in FY11. Excluding this impact and the effect of foreign exchange, sales for the company is expected to decline by about 4% in 4Q12 compared to the prior-year quarter.

Margins [Note: only highlighted material has been changed]

Cost of goods sold and occupancy costs declined 6.0% y-o-y to $1,858.2 million during the quarter compared with $1,981.7 million in 3Q11.

Gross profit in 3Q12 was $834.7 million, down 2.0% compared with $855.0 million in 3Q11. However, gross margin expanded 90 basis points (bps) to 31.0% in 3Q12, reflecting contraction of 90 basis points in cost of goods sold and occupancy costs, as a percentage of revenue.

Storage, warehouse & selling expenses decreased to $636.8 million in 3Q12 compared with $668.1 million in the prior-year quarter. General & administrative (G&A) expenses were $165.1 million in the quarter compared with $163.3 million in 3Q11.

Adjusted operating profit came in at $40.5 million compared with adjusted operating profit of $24.9 million, whereas operating margin increased 60 bps to 1.5%.

Segment Details as per the Company

North American Retail (NAR): The division reported an operating loss of $21.3 million against an operating profit of $41.9 million in the prior-year quarter. The loss was attributable to lower sales and an asset impairment charge of approximately $73 million.

Operating profit for the segment is expected to fall in 4Q12, mainly due to positive effect from the 53rd week in FY11.

North American Business Solutions Division (BSD): Operating profit jumped to $54.8 million from $39.1 in the year-ago quarter. The y-o-y increase in operating income is attributable to expansion in gross margins and decreased supply chain costs along with lower professional fees, partially offset by increased promotional expenses. Going forward, management expects operating profit to increase marginally on a y/y basis in 4Q12.

International: The division posted an operating profit of $1.0 million, drastically down from $19.5 million in the year-ago quarter, mainly due to decrease in sales, partially offset by a fall in operating expenses. Management expects operating profit to decline in 4Q12, due to projected fall in sales, which is expected to more than offset the company’s cost containment efforts.

Outlook

For 4Q12, the company expects adjusted EBITDA to decrease compared with the last year, mainly due to weak sales in International division and the positive impact of 53rd week in FY11. Management expects EBIT to be about $130 million for FY12, marking a $10 million improvement from the prior-year quarter.

Earnings per Share [Note: only highlighted material has been changed]

Office Depot reported earnings of $0.06 per share compared with a breakeven in the year-ago quarter, and way ahead of the Zacks Consensus Estimate of $0.01. Effective cost management facilitated this office supply retailer to deliver better-than-expected bottom-line results.

Including one-time items, Office Depot slumped to a loss of $0.25 per share against an earnings of $0.28 registered in the prior-year quarter.

Outlook

Some of the firms have increased their FY12 EPS estimation rate based on the strategies taken up by the company. However, the firms are of the view that the company will still be facing difficulties in the next few quarters owing to the current economic woes.

November 30, 2012

– The Online Stock Research Community

Discover what other investors are saying about Office Depot, Inc. (ODP) at:

ODP profile on

|Research Analyst |Shreya Hansaria |

|Copy Editor |Sumit Singh |

|Content Ed. |Sumit Singh |

|No. of brokers reported/Total brokers | |

|Reason for Update |Flash |

|Lead Analyst |Sumit Singh |

|QCA |Sumit Singh |

| | |

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June 4, 2013

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