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Office Depot soldiers on amid numerous uncertainties

3/17/2008

DELRAY BEACH, FLA. —While the retail industry ponders the question of how deep and how long as it relates to a national recession, a more useful long-term exercise involves knowing how to spot an impending economic slowdown before it takes place.

As it turns out, a good place to look is the office products industry and more specifically, Office Depot. The company’s exposure to high-flying real estate markets in Florida and California resulted in it seeing a softening of its results in the second quarter of last year. That’s when a modest decline in net income for the quarter, ended June 30, 2007, ended what had been a string of eight consecutive quarters of earnings per share growth in excess of 30%.

“We’re not economists, but it appears that Office Depot was a leading indicator as we were seeing effects as early as last spring from the economic slowdown that U.S. retailers and manufacturers are now widely reporting,” Office Depot chairman and ceo Steve Odland said on the company’s conference call to discuss fourth-quarter results.

The weakness the company noticed in the second quarter of 2007 extended into the third quarter and was most evident in the results for the fourth quarter, ended Dec. 29, 2007, as the company reported deteriorating results at both of its North American divisions. Fourth-quarter sales at the company’s 1,222-unit North American retail division declined 3% to $1.7 billion and same-store sales declined 7%. An even larger decline was seen in profitability, where operating income dipped to $23 million from $109 million. Office Depot’s North American Business Solutions division saw its sales decline 4% to $1.1 billion and operating profit decline to $1 million from $72 million. The company’s international division managed to increase sales by 12% to $1.1 billion, but operating profit declined to $60 million from $77 million.

The net result was a fourth quarter in which total company sales increased 1% to $3.9 billion and profits tumbled. Fourth-quarter net income slid to $19 million from $127 million the previous year and earnings per share declined to 7 cents from 45 cents.

Much of that weakness is blamed on Florida and California, states where 296 of Office Depot’s 1,222 stores are located. As the housing markets in those states fell further and faster than some other states, Office Depot’s results suffered because it generates about 26% of its retail sales in California and Florida. About 40% of the decline in the company’s fourth-quarter store sales was attributed to weakness there.

In addition, to the housing related impact on its business, Office Depot continues to work through a number of distracting personnel issues. The company had to delay the release of its third-quarter results last year as it sorted through accounting issues related to when vendor funds were recognized. Four merchandising executives were dismissed as a result of an international investigation into the accounting issue. The company named Kim Maguire as evp of merchandising on Nov. 14, 2007, to fill a position previously occupied by senior vp of merchandising Scott Koerner.

However, when the company released its fourth-quarter results on Feb. 26, it disclosed that Maguire had resigned for personal reasons, less than fourth months after assuming the head merchant job. In addition, the company said cfo Pat McKay had resigned and international division president Charles Brown would assume cfo duties on an interim basis. McKay, an Office Depot board member at the time, was hired to fill the cfo role in August 2005 after Brown was appointed to his current role after serving four years as cfo.

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