.
.
.
EXHIBIT 13.1
FINANCIAL HIGHLIGHTS
(In thousands, except per share amounts
and statistical data) 2002 2001(1) 2000(1)(5) 1999(1) 1998(1)
- -----------------------------------------------------------------------------------------------------------------------------------
STATEMENTS OF EARNINGS DATA(2):
Sales $ 11,356,633 $ 11,082,112 $ 11,495,493 $ 10,197,373 $ 8,934,227
Cost of goods sold and occupancy costs 8,022,663 7,940,067 8,435,928 7,405,870 6,448,046
- -----------------------------------------------------------------------------------------------------------------------------------
Gross profit 3,333,970 3,142,045 3,059,565 2,791,503 2,486,181
Store and warehouse operating and
selling expenses 2,331,384 2,322,577 2,388,108 1,999,791 1,664,100
General and administrative expenses 486,279 445,538 447,693 322,172 284,239
Facility closure costs 6,744 8,436 110,038 40,425 --
Other operating expenses 9,855 12,125 6,733 16,524 136,279
- -----------------------------------------------------------------------------------------------------------------------------------
Operating profit 499,708 353,369 106,993 412,591 401,563
Interest income 18,509 12,980 11,345 30,043 25,309
Interest expense (46,195) (43,339) (32,683) (24,852) (21,202)
Miscellaneous income (expense), net 7,183 (9,057) 4,632 (3,514) (18,985)
- -----------------------------------------------------------------------------------------------------------------------------------
Earnings from continuing operations
before income taxes 479,205 313,953 90,287 414,268 386,685
Income taxes 167,722 112,296 41,972 155,875 155,531
- -----------------------------------------------------------------------------------------------------------------------------------
Earnings from continuing operations 311,483 201,657 48,315 258,393 231,154
Discontinued operations (775) (614) 1,017 (755) 2,042
- -----------------------------------------------------------------------------------------------------------------------------------
Net earnings $ 310,708 $ 201,043 $ 49,332 $ 257,638 $ 233,196
===================================================================================================================================
Earnings per share from continuing
operations(3):
Basic $ 1.02 $ 0.68 $ 0.16 $ 0.72 $ 0.63
Diluted 0.98 0.66 0.16 0.69 0.60
Net earnings per share(3):
Basic $ 1.01 $ 0.67 $ 0.16 $ 0.71 $ 0.64
Diluted 0.98 0.66 0.16 0.69 0.61
STATISTICAL DATA:
Facilities open at end of period:
United States and Canada:
Office supply stores 867 859 888 825 702
Customer service centers 24 24 25 30 30
Call centers 13 13 7 7 8
International(4):
Office supply stores 171 143 132 118 87
Customer service centers 20 20 17 17 16
Call centers 20 15 14 14 13
BALANCE SHEET DATA:
Working capital $ 1,217,706 $ 721,867 $ 790,752 $ 687,007 $ 1,293,370
Total assets 4,765,812 4,331,643 4,196,334 4,276,183 4,025,283
Long-term debt, excluding current
maturities 411,970 317,552 598,499 321,099 470,711
Common stockholders' equity 2,297,112 1,848,438 1,601,251 1,907,720 2,028,879
===================================================================================================================================
(1) As applicable, amounts have been adjusted to reflect the Australian
business as discontinued operations.
(2) Certain amounts in prior year financial statements have been
reclassified to conform to current year presentation.
(3) Earnings per share amounts previously reported for 1998 have been
restated to reflect the three-for-two stock split declared on February
24, 1999.
(4) Includes facilities in our International Division that are wholly owned
or leased, as well as those that we operate through licensing and joint
venture agreements.
(5) Includes 53 weeks in accordance with our 52-53 week reporting
convention.
12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
GENERAL
Office Depot, Inc., together with our subsidiaries, ("Office Depot" or the
"Company") is a global supplier of office products and services. We sell to
consumers and businesses of all sizes through our three business segments: North
American Retail Division, Business Services Group, and International Division.
These segments include multiple sales channels consisting of office supply
stores, a contract sales force, Internet sites, and catalog and call centers,
all supported by our warehousing and delivery operations. 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. Our results for the fiscal year 2000
contained 53 weeks; all other years in the discussion below contained 52 weeks.
During 2002, we announced the planned sale of our business in Australia and
completed that sale in early 2003 with no significant impact on earnings. We
have accounted for the disposition of this business as a discontinued operation
and all prior periods have been restated.
This Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") is intended to provide information to assist you in better
understanding our business. We recommend that you read this MD&A in conjunction
with our Consolidated Financial Statements and the Notes to those statements.
This MD&A contains significant amounts of forward-looking information, and is
qualified by our Cautionary Statements regarding forward-looking information.
You will find Cautionary Statements throughout this MD&A; however, most of them
can be found in a separate section immediately following this MD&A. Without
limitation, wherever in this Annual Report we use the words "believe,"
"estimate," "plan," "expect," "intend," "anticipate," "continue," "project,"
"should," and similar expressions, we are identifying forward-looking
statements, and our Cautionary Statements apply to these terms and expressions
and the text in which such terms and expressions are used.
NORTH AMERICAN RETAIL DIVISION
Our North American Retail Division sells office supplies, technology and related
products, office furniture, copy and print services and other business-related
services through our chain of high-volume office supply stores in the United
States and Canada. We opened our first office supply store in Florida in October
1986. Since then, we have concentrated on expanding our store base and
increasing our sales in markets with high concentrations of small- and
medium-sized businesses. At the end of 2002, our North American Retail Division
operated 867 office supply stores in 44 states, the District of Columbia and
Canada. Our largest concentration of stores is in California, Texas and Florida,
but we have broad representation across North America. Store activity for the
last three years has been as follows:
Open at Open at
Beginning End of
of Period Opened Closed of Period Relocated
- ------------------------------------------------------------------
2000 825 70 7 888 4
2001 888 44 73 859 5
2002 859 21 13 867 8
As a result of a comprehensive review of our business late in 2000, we closed 70
under-performing store locations in the first quarter of 2001. Thirteen stores
were closed during 2002, some at the end of their lease term and others because
they were not meeting our investment requirements. However, we continued growing
our business by opening a total of 65 new stores during 2001 and 2002.
We have also modified our expansion approach to meet the needs of new markets.
We have tailored store size to match anticipated traffic and customer needs, we
have opened satellite operations in high-density locations and tested Office
Depot products within other retail outlets. We expect to continue this approach
to retail store expansion, with an emphasis on market density in order to
leverage advertising dollars and cross-channel opportunities to create a
seamless customer experience across all channels. In 2003, we plan to add
approximately 40 new retail stores, with almost half of these additions expected
to be 13,000 square feet or less.
The North American retail stores operate under the direction of Jerry Colley,
President, North American Stores. Mr. Colley has been with our Company
approximately two years. During this time, retail customer service metrics have
increased, customer complaints decreased and operating costs have been well
controlled. Mr. Colley reports directly to our Chairman and CEO, Bruce Nelson.
BUSINESS SERVICES GROUP ("BSG")
We have provided office supply products and services to large- and medium-size
businesses through our catalog and contract sales operations for almost ten
years. In 1998, we expanded our catalog business through our merger with Viking
Office Products ("Viking"). Today, BSG sells branded and private label products
and services by means of our dedicated sales force, through catalogs and call
centers, and electronically through our Internet sites.
Customer Service Centers ("CSCs") are warehouse and delivery facilities, some of
which also house sales offices, call centers and administrative offices. Our
CSCs perform warehousing and delivery services on behalf of all segments of our
business. At the end of 2002, we operated 24 CSCs in the United States,
consisting of 14 Office Depot facilities, four Viking facilities and six
combined facilities. During 2003, we anticipate combining additional Viking and
Office Depot facilities and moving all warehouses to a common systems platform.
Over the past three years, we have implemented advanced technologies to assist
with reordering, stocking, the pick-and-pack process, and delivery operations.
As a result, warehouse costs have been declining in recent years.
In 1995 we introduced on-line ordering for our large business customers,
followed in 1998, by our Office Depot public web site (www.officedepot.com) and
Viking public web site (www.vikingop.com), which offered our small- and
mid-sized customers the convenience of shopping with us on-line. We expanded our
offerings when we acquired 4Sure.com, adding web sites (www.computers4sure.com
and www.solutions4sure.com) aimed at technology purchasers. We have integrated
4Sure.com into other Office Depot offerings and have added
13
a new web site (www.techdepot.com) for technology purchases. We believe our
Internet business will provide significant future growth opportunities for our
BSG segment and our business as a whole based on the growth rates we have
experienced over the last three years.
Robert Keller, President, Business Services Group, leads our BSG organization.
Mr. Keller has been with our Company for five years in various executive
capacities. Under Mr. Keller's direction, selling and warehouse expenses have
declined, and order fill rates, delivery operations and customer service indices
have improved. Mr. Keller reports directly to our Chairman and CEO, Bruce
Nelson.
INTERNATIONAL DIVISION
Our International Division sells office products and services in 20 countries
outside the United States and Canada through Office Depot retail stores, Office
Depot(R) brand and Viking Direct(R) brand direct mail catalogs and Internet
sites, and an Office Depot contract sales force. We have grown this business
through licensing and joint venture agreements, and most particularly the 1998
merger with Viking. The growth in more recent years has come from startup
operations, primarily in Europe.
The international catalog business was launched in 1990 under the Viking
Direct(R) brand with the establishment of operations in the United Kingdom. With
the expansion into three additional countries during 2002, we now have catalog
offerings in 14 countries outside of North America.
In March 1999, we introduced our first international public web site
(www.viking-direct.co.uk) for individuals and businesses in the United Kingdom.
Today we operate 23 separate international web sites. Our international
e-commerce business increased 66% during 2002 and additional growth is expected
in future years.
We launched our Office Depot contract business in the United Kingdom in 2000;
and in 2001, we began service in three new countries--Ireland, the Netherlands
and France. During 2002, we expanded to Italy and made startup investments in
Germany, in advance of our launch in early 2003. This channel targets medium- to
large-sized businesses and offers personalized service through a dedicated sales
force, individualized pricing and overnight fulfillment, using our existing
European logistics infrastructure.
At the end of 2002, our International Division sold office products and services
through either wholly owned operations, or through joint ventures or licensing
agreements, in Austria, Belgium, Costa Rica, France, Germany, Guatemala,
Hungary, Ireland, Israel, Italy, Japan, Luxembourg, Mexico, the Netherlands,
Poland, Portugal, Spain, Switzerland, Thailand and the United Kingdom. Nine of
these countries served retail customers through a total of 171 office supply
stores, of which 50 stores were wholly owned. This compares to 143 stores in
seven countries at the end of 2001, 39 of which were wholly owned. International
Division store and CSC operations, including facilities operated through
licensing and joint venture agreements, for the last three years are detailed
below.
Office Supply Stores
------------------------------------------------------
Open at Open
Beginning at End
of Period Opened Closed of Period
- ---------------------------------------------------------------------
2000 118 19 5 132
2001 132 15 4 143
2002 143 32 4 171
Customer Service Centers(1)
-------------------------------------------------------
Open at Open at
Beginning End
of Period Opened Closed of Period
- ---------------------------------------------------------------------
2000 17 -- -- 17
2001 17 4 1 20
2002 20 3 3 20
(1) The number of Customer Service Centers has been reduced to reflect
Australia as a discontinued operation.
In 2003, we plan to expand our International Division's retail presence by
opening five to 10 new retail stores in France and Japan, and six new retail
stores in Spain.
All of our European businesses are under the leadership of Rolf van Kaldekerken,
President, European Operations. Mr. van Kaldekerken reports directly to our
Chairman and CEO, Bruce Nelson. Richard Lepley, President, Office Depot Japan
leads our Japanese business and also reports directly to our Chairman and CEO.
RESULTS OF OPERATIONS
Over the last three years, our overall operations have improved and we have
expanded internationally; but we have been adversely affected by a generally
weak domestic economy, with related slowdowns in new business formations and
reductions in the number of employees by our large contract customers. During
this period, we have increased gross margins, operating profit, and net
earnings. Diluted earnings per share increased to $0.98 in 2002 from $0.66 in
2001 and $0.16 in 2000. These changes reflect shifts in our product mix away
from certain lower margin technology products, the benefit of warehouse
operating efficiencies, expansion in Europe, and in 2002, a strengthening of
European currencies. In addition, over the past three years, we have been highly
focused on reducing our operating expenses and increasing efficiencies in all
our operations, with the benefits somewhat offset by an increase in costs
incurred to seed our European growth.
14
OVERALL
(Dollars in millions) 2002 2001 2000
- ---------------------------------------------------------------------------------------------------------
Sales $11,356.6 100.0% $11,082.1 100.0% $11,495.5 100.0%
Cost of goods sold and occupancy costs 8,022.7 70.6% 7,940.1 71.6% 8,435.9 73.4%
- ---------------------------------------------------------------------------------------------------------
Gross profit 3,333.9 29.4% 3,142.0 28.4% 3,059.6 26.6%
Store and warehouse operating and
selling expenses 2,331.4 20.5% 2,322.6 21.0% 2,388.1 20.8%
Facility closure costs 6.7 0.1% 8.4 0.1% 110.0 0.9%
- ---------------------------------------------------------------------------------------------------------
Segment operating profit 995.8 8.8% 811.0 7.3% 561.5 4.9%
General and administrative expenses 486.3 4.3% 445.5 4.0% 447.8 3.9%
Other operating expenses 9.8 0.1% 12.1 0.1% 6.7 0.1%
- ---------------------------------------------------------------------------------------------------------
Operating profit $ 499.7 4.4% $ 353.4 3.2% $ 107.0 0.9%
=========================================================================================================
Our overall sales increased 2% in 2002 after a decrease of 4% in 2001. Fiscal
year 2000 included 53 weeks in accordance with our 52-53 week fiscal year.
Adjusting 2000 to a 52-week basis, sales decreased 2% in 2001. Sales from our
International Division and our Business Services Group increased each year,
while sales in our North American Retail Division declined. Comparable sales in
our North American Retail Division, measured as sales from stores that have been
open for one year or more, decreased 2% in both 2002 and 2001. This decline
reflects continued softness in small business and consumer purchases of office
products and an overall slowdown in the domestic economy. Additionally, the
decline in sales for our North American Retail Division reflects, in part, our
decision to close 73 stores during 2001, following our comprehensive business
review performed in the latter part of 2000. The increase in 2002 sales for our
BSG segment results from strengthening in our contract business, partially
offset by weaker catalog sales. Worldwide e-commerce sales have improved in all
periods, increasing to $2.1 billion in 2002 from $1.6 billion in 2001.
Sales by product group were as follows:
2002 2001 2000
- ------------------------------------------------------------------
General office supplies and services 43.2% 44.2% 41.7%
Technology and related products 47.9% 46.3% 47.5%
Office furniture 8.9% 9.5% 10.8%
- ------------------------------------------------------------------
100.0% 100.0% 100.0%
==================================================================
The general office supplies and services category includes paper, filing,
binders, writing instruments, adhesives, art supplies, copy center and related
products and services. The technology and related products category includes
hardware, software, business machines, machine supplies, including ink and
toner, and communications products. Within this category, hardware sales, which
includes desktop and laptop computers, printers, copiers and fax machines, have
declined in both 2002 and 2001. Hardware products are typically sold at gross
margins lower than most of the products we sell. The technology and related
products category, which also includes machine supplies, has increased in both
years. Sales of office furniture declined in 2002 and 2001, reflecting lower
volume and unit prices, as many business customers deferred large purchases
because of concerns about the economy.
Our overall gross profit percentages fluctuate as a result of numerous factors,
including competitive pricing pressures, changes in product, catalog and sales
mix, emergence of new technologies, suppliers' pricing changes, as well as our
ability to improve our net product costs through growth in total merchandise
purchases. Additionally, our occupancy costs may vary as we add stores and CSCs
in new markets with different rental and other occupancy costs, and as we
relocate and/or close existing stores in current markets.
Store and warehouse operating and selling expenses consist of personnel costs,
maintenance and other facility costs, advertising expenses, delivery and
transportation costs, credit card and bank charges and certain other operating
and selling costs. Freight costs incurred to bring merchandise to stores and
warehouses are included as a component of inventory and cost of goods sold.
Warehouse costs and freight costs incurred to ship merchandise primarily relate
to our delivery customers and are included in store and warehouse expenses.
Because of our multi-channel operations, and because some retail companies
include shipping, handling and other distribution costs as a component of cost
of goods sold, their measure of gross profit may not be comparable to ours.
Store and warehouse operating and selling expenses increased slightly in 2002
and decreased in 2001. The change in 2002 for North American Retail and
International reflects sales-related factors, while the change in BSG reflects
operating efficiencies. This category also includes costs associated with the
Company's decision to settle potential class action litigation in the state of
California in 2002 involving wage and hour claims by some of our store managers
and assistant managers. In 2001, we reduced our personnel-related costs in
response to weaker sales.
Our financial results were significantly affected in 2000, and to a lesser
extent in 2001, by charges and credits that do not relate to our ongoing sales
and service activities. During the latter half of 2000, we conducted a
comprehensive business review. Commitments made at that time resulted in a
significant change in the Company's strategic direction and led to modifications
of our important business practices. Among other things, the review resulted in
a decision to close 70 under-performing North American retail stores, relocate
two warehouses, invest in new warehouse technologies, reduce the number of
slower-moving SKUs in
15
our retail stores and North American warehouses and modify business practices to
increase efficiency. A total net charge of $260.6 million was recorded as a
result of this review and other events during the year. The net charge included
$110.0 million in facility closure costs, $63.0 million for asset impairments,
$38.4 million for inventory reductions, a net $10.5 million provision for sales
returns and allowances and $11.2 million for the disposal of certain fixed
assets. Also in 2000, we recorded $35.6 million in severance costs, primarily
related to changes in senior management, and a net $6.8 million credit to adjust
a previous merger accrual for improved estimates of actual costs. Outside of
operations, we recorded impairment charges of $11.1 million relating to Japan
and $45.5 million for other than temporary declines in the value of certain
Internet investments, the effect of which was offset by a $57.9 million gain on
the sale of certain Internet investments.
During 2001, we closed 73 stores, 70 of which were identified as part of our
comprehensive business review. We also identified ten additional
under-performing stores that were closed in 2002. Charges of $43.6 million were
recorded in 2001--$35.2 million for asset impairments relating to these ten
stores, and $8.4 million to adjust estimated lease termination costs recorded in
2000 based on a further softening in the market for retail space subleases.
These charges were partially offset by a $10.2 million gain on the sale of a
warehouse. We also recorded charges of $14.1 million, primarily to recognize an
additional decline in the value of certain Internet investments we entered into
primarily in 1999 and early 2000.
Because of continued softness in the market for vacant retail space during 2002,
we increased our accrual for facility closure costs by a net of $6.7 million,
primarily associated with the 70 store closures in 2001. We regularly monitor
our recorded commitments and adjust the balance for actual and anticipated
sublease arrangements based on market conditions for retail space.
Under new accounting rules that became effective at the start of 2002, companies
no longer amortize goodwill, but test recorded amounts annually for impairment.
Our testing indicated no impairment of the goodwill on our books. Amortization
of goodwill totaled $5.2 million in 2001 and $5.1 million in 2000.
In the Overall table above, we have provided a subtotal for segment operating
profit. We use this measure of performance to assess the operations of each
business unit, and we believe it is useful to investors, because it reflects the
sales and operating expenses directly related to the segment's activities. Our
general and administrative expenses primarily consist of personnel and related
costs associated with support functions. Because these functions support all
segments of our business, we do not consider these costs in determining our
segment profitability. Other companies, however, may charge more or less general
and administrative costs to their segments and our results therefore may not be
comparable to similarly titled measurements used by other entities. Our measure
of segment operating profit should not be considered as an alternative to
operating income or net earnings determined in accordance with generally
accepted accounting principles ("GAAP"). The table above reconciles segment
operating profit to consolidated operating profit determined in accordance with
GAAP.
NORTH AMERICAN RETAIL DIVISION
(Dollars in millions) 2002 2001 2000
- -----------------------------------------------------------------------------------------------------------
Sales $5,804.4 100.0% $5,842.6 100.0% $6,487.5 100.0%
Cost of goods sold and occupancy costs 4,351.2 75.0% 4,479.1 76.7% 5,065.0 78.1%
- -----------------------------------------------------------------------------------------------------------
Gross profit 1,453.2 25.0% 1,363.5 23.3% 1,422.5 21.9%
Operating and selling expenses 1,027.1 17.7% 1,046.8 17.9% 1,101.7 17.0%
Facility closure costs 6.4 0.1% 8.4 0.1% 103.8 1.6%
- -----------------------------------------------------------------------------------------------------------
Segment operating profit $ 419.7 7.2% $ 308.3 5.3% $ 217.0 3.3%
===========================================================================================================
Sales in our North American Retail Division decreased 1% in 2002 and 10% in
2001. Adjusting fiscal 2000 results to remove the 53rd week, sales decreased 8%
in 2001. Comparable sales in 2002 from the 848 stores that were open for more
than one year were down 2%. In 2001, comparable sales in the 816 stores that
were open for at least one year were down 8%. The decrease in 2002 reflects both
lower average transaction size and fewer comparable transactions. Weekend sales
declined more than weekday sales, and holiday sales during the fourth quarter
were below expectations. We experienced these declines despite enhancements to
store presentation, operations, and product selection, and we believe these
declines reflect an overall soft U.S. economy.
The product mix sales trends experienced in 2001 continued into 2002, as sales
shifted away from lower margin technology products in both periods. Comparable
sales of lower margin hardware products declined 10% in 2002 and 31% in 2001;
and business furniture comparable sales declined 6% in 2002 and 13% in 2001.
Sales of machine supplies, which includes ink and toner, and the contribution
from our copy centers increased in both periods. Sales and margin of core
supplies and paper were flat to slightly positive in both periods. We remain
focused on driving traffic and sales in our retail channel, but the outlook for
2003 is dampened by expectations for a continued soft economy for at least part
of the year.
Total operating and selling expenses in our North American Retail Division
declined in both 2002 and 2001. The largest components of this category are
personnel, facility maintenance, advertising, and credit card expenses.
Personnel-related costs, which represent over 50% of the total costs in this
caption, increased 1% in 2002. Increases in wage rates and in certain employee
benefit costs were partially offset by streamlining certain operational
processes. During 2001, payroll-related costs showed the largest decline as
staffing was adjusted down in response to lower sales and from a net reduction
in the number of stores. Facility maintenance expense decreased in both periods.
Lower sales in both
16
periods contributed to lower credit card fees. Operating and selling expenses in
2002 also include $14.4 million to settle the potential class action litigation
in the state of California relating to certain employee classifications as
exempt from overtime.
A significant portion of the comprehensive business review completed at the end
of 2000 was focused on the North American Retail Division. As a result of the
business review, we recorded $103.8 million as facility closure costs in 2000,
primarily relating to lease obligations for closed stores, net of anticipated
sublease income. During both 2002 and 2001, our obligation for future lease
commitments was adjusted because of changes in the real estate market that
impacted our ability to sublet these properties resulting in net charges of $6.4
million and $8.5 million, respectively. In addition to the facility closure
costs recorded in 2000, we recorded $57.8 million relating to asset impairments
and write-downs. Charges for asset impairments and closures were $5.4 million in
2002 and $35.2 million in 2001. We regularly review actual and projected store
performance and record any asset impairment charges as a component of store and
warehouse operating expenses.
BSG
(Dollars in millions) 2002 2001 2000
- -----------------------------------------------------------------------------------------------------
Sales $3,913.9 100.0% $3,763.0 100.0% $3,618.8 100.0%
Cost of goods sold and occupancy costs 2,684.7 68.6% 2,574.0 68.4% 2,526.6 69.8%
- -----------------------------------------------------------------------------------------------------
Gross profit 1,229.2 31.4% 1,189.0 31.6% 1,092.2 30.2%
Operating and selling expenses 864.3 22.1% 897.8 23.9% 910.8 25.2%
Facility closure costs 0.3 -- -- -- 4.1 0.1%
- -----------------------------------------------------------------------------------------------------
Segment operating profit $ 364.6 9.3% $ 291.2 7.7% $ 177.3 4.9%
=====================================================================================================
Sales in our BSG segment increased 4% in both 2002 and 2001. Adjusting fiscal
2000 to a 52-week basis, sales increased 6% in 2001. Sales in our contract
channel increased in both 2002 and 2001. Contract sales in the western U.S.
reversed the prior year's negative trend, resulting in increasingly positive
contributions over the last half of 2002. The sales trend for the eastern U.S.
was positive throughout 2002. The catalog channel decreased in both 2002 and
2001. E-commerce sales continued to increase, and the addition of 4Sure.com
during 2001, added to the BSG sales growth. We expect continued growth in our
Internet sales during 2003 as we allocate additional resources to that channel.
Sales of general supplies, paper, and machine supplies, the three largest
categories in BSG's sales mix, increased 3% in 2002 and 9% in 2001. Hardware
sales are a smaller portion of this segment's sales mix, but they increased 10%
in 2002 following a 5% decline in 2001. Office furniture sales declined 8% in
2002 and 11% in 2001.
Gross profit decreased in 2002, reflecting the increasing proportion of
4Sure.com sales, which operates primarily in the lower margin technology
business, and the impact of increased national account sales which tend to be at
lower margins. During 2001, gross margin was enhanced as we maintained stricter
adherence to volume-dependent pricing arrangements. We earn higher gross profit
percentages in our BSG than in our retail operations principally because of
lower occupancy costs and sales that include relatively fewer technology
products.
The 2000 comprehensive business review also covered our BSG operations and
included a number of initiatives to improve delivery operations, lower warehouse
costs and improve customer satisfaction. Included in fiscal year 2000 results
are net charges of $10.9 million for inventory adjustments and sales returns and
allowances, and $4.1 million of facility closure costs. No similar charges or
credits were recorded in 2001. During both 2002 and 2001, on-time deliveries,
order fill rates and quality index metrics all increased, and customer
complaints decreased significantly.
Personnel, facility and delivery expenses are the largest components of our BSG
operating expenses. Operating and selling expenses as a percentage of sales
decreased in 2002 as a result of lower costs in each of these categories and
increased sales. Call center modifications and improved warehouse efficiency
were significant contributors to lower personnel-related costs. Delivery costs
decreased 13% in 2002 and 9% in 2001 as we added technologies to streamline
operations and reduced our use of third-party vendors. Advertising expenses
increased in 2001, reflecting lower cooperative advertising payments received
from participating vendors.
INTERNATIONAL DIVISION
(Dollars in millions) 2002 2001 2000
- -------------------------------------------------------------------------------------------------------
Sales $1,641.4 100.0% $1,480.1 100.0% $1,393.2 100.0%
Cost of goods sold and occupancy costs 988.1 60.2% 888.4 60.0% 846.5 60.8%
- -------------------------------------------------------------------------------------------------------
Gross profit 653.3 39.8% 591.7 40.0% 546.7 39.2%
Operating and selling expenses 441.2 26.9% 379.5 25.7% 377.1 27.1%
Facility closure costs -- -- -- -- 2.2 0.1%
- -------------------------------------------------------------------------------------------------------
Segment operating profit $ 212.1 12.9% $ 212.2 14.3% $ 167.4 12.0%
- -------------------------------------------------------------------------------------------------------
17
Sales in our International Division grew 11% in 2002 and 6% in 2001. Adjusting
fiscal 2000 to a 52-week basis, sales increased 8% in 2001. Foreign currency
translations increased sales reported in U.S. dollars in 2002 and decreased
sales in U.S. dollars in 2001. Excluding the foreign currency effect, sales in
our International Division grew 6% in 2002 and 11% in 2001. Sales in 2002
reflect growth in all European countries where we do business. During the year,
we added catalog operations in three countries, increased our contract sales
force in four countries, initiated contract sales in Italy, added a net of seven
new stores in France, made several changes to our Japanese operation and
launched nine new web sites. We expect to continue to grow each sales channel in
our European operations. Although the Office Depot(R) brand continues to grow as
a percentage of the total sales in this segment, our Viking Office Products(R)
brand still accounts for the vast majority of our international business,
representing approximately 86% of all international sales in 2002 and 87% in
2001. Competitive, political, and economic conditions in international markets
in which we operate may impact our sales and profitability in the future. In
addition, the prospects for conflicts in the Gulf region of the Middle East may
be expected to have an impact on our international sales.
As noted above, sales in local currencies have substantially increased in recent
years. For U.S. reporting, these sales are translated into U.S. dollars at
average exchange rates experienced during the year. Future volatility in
exchange rates can affect translated sales and operating profit of our
International operations.
Gross profit as a percentage of sales decreased in 2002 as a result of increased
prospecting activity and the growth in our lower margin contract business.
During 2001, gross profit increased from pricing initiatives in certain machine
and general office supply categories, partially offset by the introduction of
the contract sales channel in certain European countries.
Operating and selling expenses as a percentage of sales are higher in our
International Division than in our other segments primarily because we use an
extensive marketing program to drive sales in existing markets, particularly in
our catalog business, and we have start-up activities in several new markets.
Similar to BSG, personnel and delivery expenses are significant components of
the International Division's operating and selling expenses. During 2002 and
2001, personnel, facility-related, advertising, and delivery expenses increased
because of the expansion of our business in Europe. The impact of these
increases was partially offset by continuing to leverage certain fixed operating
expenses. As our operations grow in a particular market, fixed operating
expenses decline relative to sales. For example, advertising costs in the form
of prospecting and delivery costs, which are affected by the density of the
delivery areas, decline as a percentage of sales as the market grows.
Fiscal 2001 includes a gain of $10.2 million from the sale of a London
warehouse, and fiscal 2000 includes charges of $2.2 million for facility closure
costs resulting from the 2000 comprehensive business review.
In August 2002, we decided to sell our operations in Australia. We conducted an
auction offering of the business and reached agreement with a purchaser in
December 2002. We closed the transaction in early January 2003 with no
significant impact on earnings. The Australian operations have been accounted
for as discontinued operations and all periods presented have been restated. In
addition to Europe, operations continue in Japan. We have focused the Japanese
business on a single brand offering and streamlined operations; however, sales
trends in Japan have been negative for each of the periods presented.
CORPORATE AND OTHER
Pre-Opening Expenses
(Dollars in thousands) 2002 2001 2000
- --------------------------------------------------------------------------
Pre-opening expenses $8,414 $10,172 $13,465
Office supply stores opened* 42 55 78
* Includes domestic and wholly owned international openings and relocations.
Our pre-opening expenses consist principally of personnel, property and
advertising expenses incurred in opening or relocating stores in our North
American Retail Division. Our pre-opening expenses also include, to a lesser
extent, expenses incurred to open or relocate facilities in our BSG and
International Division. We typically incur pre-opening expenses during a
six-week period prior to a store opening. Because we expense these items as they
are incurred, the amount of pre-opening expenses each year is generally
proportional to the number of new stores opened during the period. This has been
the primary contribution to the fluctuation in pre-opening expenses over the
three years presented. For 2002, our pre-opening expenses approximated $165,000
per domestic office supply store and $115,000 per international office supply
store. Our cost to open a new CSC varies significantly with the size and
location of the facility. We currently estimate costs to open a domestic or
international CSC to be approximately $1.0 million per facility.
GENERAL AND ADMINISTRATIVE EXPENSES
(Dollars in thousands) 2002 2001 2000
- -------------------------------------------------------------------------
General and administrative expenses $486,279 $445,538 $447,693
Percentage of sales 4.3% 4.0% 3.9%
Our general and administrative expenses consist primarily of personnel-related
costs associated with support functions. Because these functions typically
support all segments of our business, we do not consider these costs in
determining our segment profitability. The increase in 2002 reflects additional
professional fees to support operational process improvements, additional
benefits costs, and costs incurred to support expansion activities that were not
chargeable to segment operations. As noted above, other companies may charge
more or less of their general and administrative costs to their segments, and
comparisons to their operations could be affected.
OTHER INCOME AND EXPENSE
(Dollars in thousands) 2002 2001 2000
- ---------------------------------------------------------------------------------
Interest income $ 18,509 $ 12,980 $ 11,345
Interest expense (46,195) (43,339) (32,683)
Miscellaneous income (expense), net 7,183 (9,057) 4,632
Financing and investing activities are not included in determining segment
profitability. Average cash balances increased during 2001 and 2002,
contributing to the increase in interest income; however, interest rates
declined during the same time period, somewhat offsetting the
18
impact of larger balances. In July 2001, we issued $250 million of senior
subordinated notes that mature in 2008. Also during 2001, we entered into swap
agreements to convert these fixed rate notes to variable interest rates. In
September 2002, we terminated the swap agreements and received $18.8 million in
proceeds. This value is being amortized to interest expense over the remaining
life of the notes. The increase in interest expense in 2001 reflects a partial
year of interest relating to this additional borrowing.
When a facility is closed before the end of an operating lease commitment, we
record a liability at the present value of the lease obligation, offset by
anticipated sublease income. The imputed interest cost on the discounted
obligations is recognized as interest expense each period. The recorded
obligations primarily relate to the store closures following the 2000 business
review and totaled $60.4 million at December 28, 2002 and $76.7 million at
December 29, 2001.
Our net miscellaneous income (expense) consists of equity in the earnings of our
joint venture investments, royalty and franchise income that we generate from
licensing and franchise agreements, and realized gains and impairments of
investments. All of our equity investments involve operations outside of the
United States and Canada. Impairment charges for other than temporary declines
in the value of certain Internet investments were $3.0 million in 2002, $14.7
million in 2001, and $45.5 million in 2000. Fiscal year 2000 also included a
realized gain of $57.9 million from the sale of certain Internet investments and
$11.1 million of asset impairment in Japan.
INCOME TAXES
(Dollars in thousands) 2002 2001 2000
- --------------------------------------------------------------------------
Income Taxes $167,722 $112,296 $41,972
Effective income tax rate* 35% 36% 46%
* Income Taxes as a percentage of earnings before income taxes.
The effective income tax rate in 2002 declined to 35%, reflecting the impact of
increased international activity taxed at lower rates and the absence of
goodwill amortization. The effective tax rate may decline further during 2003.
Certain non-deductible merger-related and other charges incurred in 2000 created
a higher overall effective income tax rate than would have resulted from our
ongoing operations.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by (used in) our operating, investing and financing activities is
summarized as follows:
(Dollars in thousands) 2002 2001 2000
- ------------------------------------------------------------------
Operating activities $ 701,897 $ 745,941 $ 314,926
Investing activities (199,466) (233,071) (238,635)
Financing activities (212,625) (85,403) (134,093)
OPERATING AND INVESTING ACTIVITIES
Cash flows from operations have been our primary source of funds. The majority
of store sales are generated on a cash and carry basis, and our private label
credit card program is administered by a financial services company and
converted to cash daily. We retain receivables from our contract and certain
direct mail customers, and as we expand this business here and abroad, we
anticipate our accounts receivable portfolio will grow. Amounts due us under
rebate and cooperative advertising programs with our vendors comprised over 35%
of total receivables at the end of 2002 and 2001. These receivables tend to
fluctuate seasonally (growing during the second half of the year and declining
during the first half), because certain collections do not occur until specified
milestones are reached or the program year is complete. These receivables,
however, are typically high quality and are collected quickly after reaching
specified milestones. Our primary outflow of cash from operations is the
purchase of inventory, net of customary credit arrangements with vendors,
operational costs, and the payment of current taxes.
Cash flows provided by operating activities in 2002 reflect higher net income,
partially offset by an increase in overall inventory at the end of the year.
This increase in inventory reflects lower than expected sales in our North
American Retail Division during the fourth quarter, and an intentional build up
of certain products to ensure availability during the holidays. The inventory
added is not considered to add life cycle or obsolescence risk. This change in
inventory is consistent with a corresponding increase in accounts payable. The
increase in operating cash flows in 2001 is primarily attributable to an
improvement in operating profit and a focus on reducing certain components of
working capital. During 2001, both accounts receivable and inventory balances
decreased significantly, primarily from management actions. Inventory levels
held in stores and CSCs decreased because of improved inventory turnover, our
SKU reduction program and our focus on supply chain management.
The number of stores and CSCs we open or remodel each year represents a
significant portion of our capital investments. During 2002 we added or
relocated a total of 42 stores and added or relocated 3 CSCs worldwide.
Additionally, we more closely scrutinized capital expenditures with an emphasis
on improving our return on assets. During 2000, we also had significant
expenditures related to our Viking integration plans.
We currently plan to open approximately 40 stores in our North American Retail
Division and 11 to 16 stores in our International Division during 2003. We
estimate that our cash investing requirements will be approximately $1.0 million
for each new domestic office supply store. The $1.0 million includes
approximately $0.5 million for leasehold improvements, fixtures, point-of-sale
terminals and other equipment, and approximately $0.5 million for the portion of
our inventories that will not be financed by our vendors. In addition, our
average new office supply store requires pre-opening expenses of approximately
$0.2 million. We also plan to further consolidate Office Depot and Viking CSCs
and expand our European Business Service Division into new countries.
We have expanded our presence in the e-commerce marketplace by acquiring
Internet-based companies and entering into strategic business relationships with
several web-based providers of business-to-business e-commerce solutions. In
2001, we acquired the operations of 4Sure.com, an Internet-based technology
business. In prior years, we made non-controlling investments in
technology-related companies. This portfolio has been substantially reduced by
the sale of certain investments in 2000 generating a gain of $57.9 million and
by write-downs of $3.0 million in 2002, $14.7 million in 2001, and $45.5 million
in 2000 from an other
19
than temporary decline in value of the underlying investment. During 2002, we
added $2.1 million to the portfolio under a previous funding commitment; no
future funding commitments exist. The carrying value of these investments at
December 28, 2002 and December 29, 2001 was $14.4 million and $15.2 million,
respectively.
FINANCING ACTIVITIES
Our existing credit facility provides us with a maximum of $600 million in
funds, including up to $150 million for issuance of standby and trade letters of
credit. This facility is a 3-year, unsecured revolving credit agreement maturing
on April 24, 2005. The agreement provides for the availability of borrowings up
to the full amount of the facility in U.S. dollars, euros, British pounds, or
yen. Borrowings will bear interest at a benchmark variable rate plus a spread
determined at the time of usage. For U.S. dollar borrowings, interest will be
based on the then-current London Interbank Offering Rate (LIBOR). For
international borrowings, interest will be based on the then-current
Eurocurrency rate. We can specify interest periods to be one, two, three or six
months. Based on our current credit ratings, borrowings would include a spread
of 0.925%. As of December 28, 2002, we had outstanding yen borrowings equivalent
to $81.4 million, which had an effective interest rate of 1.05%, and outstanding
letters of credit totaling $75.5 million. The agreement contains restrictive
covenants relating to various financial statement ratios. We are in compliance
with all such covenants.
In July 2001, we issued $250 million of seven year, non-callable, senior
subordinated notes due on July 15, 2008. The notes contain provisions that, in
certain circumstances, place financial restrictions or limitations on our
Company. The notes have a coupon interest rate of 10.00%, payable semi-annually
on January 15 and July 15. In August 2001, we entered into LIBOR-based variable
rate swap agreements with notional amounts aggregating $250 million. In
September 2002, we terminated the swap agreements and received a payment of
$18.8 million plus accrued interest receivable. The proceeds from settlement are
being amortized as a partial offset to interest expense over the remaining life
of the notes, lowering the effective interest rate on these borrowings to 8.7%.
In July 1999, we entered into term loan and revolving credit agreements with
several Japanese banks (the "yen facilities") to provide financing for our
operating and expansion activities in Japan. The yen facilities provided for
maximum aggregate borrowings of (Y)9.76 billion (the equivalent of $74.5 million
at December 29, 2001) at an interest rate of 0.875% over the Tokyo Interbank
Offered Rate ("TIBOR"). These facilities were scheduled to terminate in July
2002, and therefore were classified as current liabilities on our balance sheet
at December 29, 2001. Yen borrowings are now under the credit facility that
extends through 2005 and are classified as long-term at December 28, 2002.
In late 2001, our Board of Directors authorized the Company to repurchase up to
$50 million of its common stock each year, subject to their annual review, until
rescinded by the Board. The repurchased shares are to be added to the Company's
treasury shares and will effectively offset a portion of the Company's near-term
requirements for its stock option plans. Under this program, we purchased
approximately 2.9 million shares of our stock during 2002 at a total cost of
$45.9 million and 252,000 shares during 2001 at a cost of $4.2 million.
During 2000, under a program approved by our Board of Directors, we purchased
35.4 million shares of our stock at a total cost of $300.8 million.
In August and September 2002, we exercised our option and redeemed all of the
outstanding shares of Liquid Yield Option Notes ("LYONs(R)"), originally issued
in 1992 and 1993. The shares were redeemed at original issue price plus accrued
interest, totaling $243.3 million. The LYONs(R) were zero coupon, convertible
subordinated notes maturing in 2007 and 2008. During 2000, the majority of the
holders of our 1993 LYONs(R) required us to purchase their shares at the issue
price plus accrued original issue discount, totaling $249.2 million. The 1992
LYONs(R) had a similar provision whereby the holders could require us to
purchase the notes at the issue price plus accrued original issue discount on
December 11, 2002. Accordingly, these obligations totaling $233.5 million were
classified as a current liability at December 29, 2001.
Our 2001 net cash used in financing activities consisted mainly of long- and
short-term debt payments of $400.5 million to pay off our domestic credit
facility debt that accumulated during the fourth quarter of 2000, mainly to
support the repurchase of our 1993 LYONs(R). These payments were partially
offset by proceeds received in 2001 from the issuance of $250 million in senior
subordinated notes as discussed above. For 2000, our stock repurchase and the
repurchase of our 1993 LYONs(R) made up the majority of cash used in financing
activities. We continually review our financing options. Although we currently
anticipate that we will finance our 2003 operations, 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 as appropriate for market conditions.
The following table summarizes the Company's long-term obligations at December
28, 2002:
CONTRACTUAL CASH OBLIGATIONS
Payments due by Period
------------------------------------------------------------
Less than After 5
(Dollars in millions) Total 1 year 1-3 years 4-5 years years
- ---------------------------------------------------------------------------------------------------
Long-term debt $ 348.5 $ 1.6 $ -- $ -- $ 346.9
Capital lease obligations 121.0 20.2 22.5 13.6 64.7
Operating leases 2,694.9 390.8 662.0 523.8 1,118.3
Unconditional purchase obligations 3.6 3.6 -- -- --
- ---------------------------------------------------------------------------------------------------
Total contractual cash obligations $3,168.0 $416.2 $684.5 $537.4 $1,529.9
====================================================================================================
20
Additionally, we have Letters of Credit totaling $75.5 million outstanding at
the end of the year, and we have recourse for private label credit card
receivables transferred to a third party. We record a fair value estimate for
losses on these receivables in our financial statements. The total outstanding
amount transferred to a third party at the end of the year was approximately
$265 million.
CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America.
Preparation of these statements requires management to make judgments and
estimates. Some accounting policies have a significant impact on amounts
reported in these financial statements. A summary of significant accounting
policies can be found in Notes to the Consolidated Financial Statements as Note
A. We have also identified certain accounting policies that we consider critical
to understanding our business and our results of operations and have provided
below additional information on those policies.
VENDOR ARRANGEMENTS
At the beginning of each year, the Company enters into purchase arrangements
with its vendors. Generally, our product costs per unit declines as higher
volumes of purchases are reached. Often, our vendor agreements require the
Company to pay higher per unit costs prior to reaching a predetermined
milestone, at which time the vendor rebates the per unit differential.
We value inventory and cost of goods sold at the cost paid to the vendor, net of
any anticipated cost recovery. If the anticipated volume of purchases is not
reached, or we believe it is not likely to be reached, cost of goods sold and
the remaining inventory balances are adjusted. The Company reviews sales
projections and related purchases against estimates on a regular basis and
adjusts these balances accordingly. We also receive payments from vendors for
activities that lower the cost of product shipment. Such receipts are recognized
as a reduction of our cost of goods sold. Substantially all vendor program
receivables outstanding at the end of the year are collected within the three
months immediately following year-end. If these vendor program arrangements were
materially less beneficial, we could either increase the selling price of the
vendor's product, which may impact sales volume, or experience a decline in
profitability.
Vendors also benefit from promotional activities, including having their
products included in our advertisements. In return, vendors may commit to pay
some portion of our advertising spend. Such cooperative arrangements are used to
reduce advertising expense for the period. The Company recognized approximately
$218 million in 2002, $251 million in 2001, and $277 million in 2000 as a
reduction of our total advertising cost in those years. The decline reflects
lower retail sales, lower advertising spending and variability in the types of
advertising programs. Advertising is a component of store and warehouse
operating and selling expenses.
The Financial Accounting Standards Board's Emerging Issues Task Force released a
consensus ruling in November 2002 for application in 2003 that requires
companies to classify amounts received from vendors as a reduction of product
cost unless certain criteria can be met. One such requirement is that the
amounts received from vendors represent a reimbursement of costs incurred by the
company in selling the vendor's products. A change in the accounting for
cooperative advertising arrangements could increase gross profit and increase
advertising expense. It could also reduce product cost in inventory and thereby
impact the timing of recognition through cost of goods sold. We have not yet
completed our assessment of whether, or to what extent, this ruling will impact
our results of operations.
While agreements reached with vendors generally cover at least one year, vendor
program and cooperative advertising arrangements can change between years. These
arrangements can be influenced by increases or reductions in inventory purchases
compared to company plans and programs offered by the vendors. While there are
long-standing volume and pricing conventions in the office products business,
such program arrangements are regularly renegotiated, and as such, are subject
to change.
INVENTORY VALUATION
Our selling model is predicated on breadth and availability of product
assortment, and our profitability is dependent on high inventory turnover rates.
Our merchants monitor inventory on hand by location, particularly as it relates
to trailing and projected sales trends. As considered appropriate, we record a
charge to reduce the product cost to our assessment of the lower of cost or
market. This assessment is based on the quality of the merchandise, the rate of
sale, and our assessment of the market conditions. Additional cost adjustments
and sales mark-downs will be taken as considered appropriate. Estimates and
judgments are required in determining what items to stock and at what level, and
what items to discontinue and how to value them prior to sale.
CLOSED STORE RESERVES AND ASSET IMPAIRMENTS
The Company assesses each store's sales trend against historic patterns and
projects future profitability on a regular basis. Inherent in this process is
significant management judgment as to the projected cash flows. Judgments are
also made as to whether lower-performing stores should be closed. At the end of
2000, for example, the Company decided to close 70 under-performing stores
following a comprehensive business review. During 2002, 13 stores were closed.
The costs associated with closing stores typically relate to a provision for the
remaining term on the lease, adjusted for any anticipated sublease income,
personnel-related costs, and costs associated with vacating the premises. Costs
associated with facility closures are typically included in store and warehouse
operating expenses. However, facility closure costs associated with the store
closures identified in the 2000 business review were reported as a separate
component of operating expenses. During 2002 and 2001, additional charges were
recorded to reflect changes in sublease activity related to these closures.
In addition to the decision whether or not to close a store, store assets are
regularly reviewed for potential impairment. Even if a decision has been made
not to close a lower-performing store, the assets at that
21
location might be impaired. Management judgment is required to ensure the
projected cash flow assumptions are based on reasonable and appropriate
assumptions. If different assumptions were used, the extent and timing of
facility closure costs and asset impairments could be affected. Any impairment
charges required are included as a component of the related segment's operating
and selling expenses.
SIGNIFICANT TRENDS, DEVELOPMENTS AND UNCERTAINTIES
Over the years, we have seen continued development and growth of competitors in
all segments of our business. In particular, mass merchandisers and warehouse
clubs have increased their assortment of home office merchandise, attracting
additional back-to-school customers and year-round casual shoppers. We also face
competition from other office supply superstores that compete directly with us
in numerous markets. This competition is likely to result in increased
competitive pressures on pricing, product selection and services provided. Many
of these retail competitors, including discounters, warehouse clubs, and even
drug stores and grocery chains, carry at least limited numbers of basic office
supply products, including ink jet and toner cartridges, printer paper and other
basic supplies. Some of them have also begun to feature technology products.
Many of them price these offerings lower than we do, but they have not shown an
indication of greatly expanding their somewhat limited product offerings at this
time. This trend towards a proliferation of retailers offering a limited
assortment of office products is a potentially serious trend in our industry,
and one that our management is watching closely.
We have also seen growth in new and innovative competitors that offer office
products over the Internet, featuring special purchase incentives and one-time
deals (such as close-outs). Through our own successful Internet and
business-to-business web sites, we believe that we have positioned ourselves
competitively in the e-commerce arena.
MARKET SENSITIVE RISKS AND POSITIONS
We have market risk exposure related to interest rates and foreign currency
exchange rates. Market risk is measured as the potential negative impact on
earnings, cash flows or fair values resulting from a hypothetical change in
interest rates or foreign currency exchange rates over the next year. We manage
the exposure to market risks at the corporate level. The portfolio of
interest-sensitive assets and liabilities is monitored and adjusted to provide
liquidity necessary to satisfy anticipated short-term needs. The percentage of
fixed and variable rate debt is managed to fall within a desired range. Our risk
management policies allow the use of specified financial instruments for hedging
purposes only; speculation on interest rates or foreign currency rates is not
permitted.
INTEREST RATE RISK
We are exposed to the impact of interest rate changes on cash equivalents and
debt obligations. The impact on cash and short-term investments held at the end
of 2002 for a hypothetical 10% decrease in interest rates would be a decrease in
interest income of approximately $2 million in 2003.
Market risk associated with our debt portfolio is summarized below:
2002 2001
------------------------------------ --------------------------------------
Carrying Fair Risk Carrying Fair Risk
(Dollars in thousands) Value Value Sensitivity Value Value Sensitivity
- -----------------------------------------------------------------------------------------------------------------
Fixed interest rate debt(1) $262,213 $279,625 $6,174 $481,107 $531,602 $6,770
Variable interest rate debt(1) $ 81,415 $ 81,415 $ 407 $ 74,509 $ 74,509 $ 373
- -----------------------------------------------------------------------------------------------------------------
(1) Including current maturities.
The risk sensitivity of fixed rate debt reflects the estimated increase in fair
value from a 50 basis point decrease in interest rates, calculated on a
discounted cash flow basis. The sensitivity of variable rate debt reflects the
possible increase in interest expense during the next period from a 50 basis
point change in interest rates prevailing at year-end.
During 2001, we entered into an interest rate swap agreement to receive fixed
and pay floating rates, converting the equivalent of $250 million of this
portfolio to variable rate debt through 2008. The fair value of this agreement
at December 29, 2001 was immaterial and the swap agreement was terminated during
2002.
FOREIGN EXCHANGE RATE RISK
We conduct business in various countries outside the United States where the
functional currency of the country is not the U.S. dollar. This results in
foreign exchange translation exposure when results of these foreign operations
are translated into U.S. dollars in our consolidated financial statements. The
effect of changes in value of the U.S. dollar compared to other currencies,
primarily the euro and British pound, has been to increase reported sales and
operating profit when the U.S. dollar weakens and reduce these amounts when the
dollar strengthens. While we look for opportunities to reduce our exposure to
foreign currency fluctuation against the U.S. dollar, at this point we have
determined not to pursue hedging opportunities generally. As of December 28,
2002, a 10% change in the applicable foreign exchange rates would result in an
increase or decrease in our operating profit of approximately $10 million.
We are also subject to foreign exchange transaction exposure when our
subsidiaries transact business in a currency other than their own functional
currency. This exposure arises primarily from a limited amount of inventory
purchases in a foreign currency. The introduction of the euro and our decision
to consolidate our European purchases has greatly reduced these exposures. At
each period during 2002, foreign exchange forward contracts to hedge certain
inventory exposures totaled less than $39 million.
22
INFLATION AND SEASONALITY
Although we cannot determine the precise effects of inflation on our business,
we do not believe inflation has a material impact on our sales or the results of
our operations. We consider our business to be somewhat seasonal, with sales in
our North American Retail Division and Business Services Group slightly higher
during the first and third quarters of each year, and sales in our International
Division slightly higher in the first and fourth quarters.
NEW ACCOUNTING STANDARDS
In July 2001, the Financial Accounting Standards Board (FASB) issued Statement
No. 143, Accounting for Asset Retirement Obligations. This Statement requires
capitalizing asset retirement costs as part of the total cost of the related
long-lived asset and subsequently allocating the total expense to future periods
using a systematic and rational method. Our adoption of this Statement, at the
beginning of fiscal year 2003, did not have a material impact on our results of
operations.
In April 2002, the FASB issued Statement No. 145, Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Correction.
This Statement eliminates extraordinary accounting treatment for reporting gain
or loss on debt extinguishment, and amends other existing authoritative
pronouncements to make various technical corrections, clarify meanings, or
describe their applicability under changed conditions. Our adoption of this
Statement, at the beginning of fiscal year 2003, did not have a material impact
on our results of operations.
In June 2002, the FASB issued Statement No. 146, Accounting for Costs Associated
with Exit or Disposal Activities. This Statement requires recording costs
associated with exit or disposal activities at their fair values when a
liability has been incurred. Under previous guidance, certain exit costs were
accrued upon management's commitment to an exit plan, which is generally before
an actual liability has been incurred. The adoption of this Statement, at the
beginning of fiscal year 2003 had no immediate impact, but will affect the
timing of future exit or disposal activities reported by the Company.
In November 2002, the FASB issued Interpretation 45, Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others. This Interpretation expands the disclosures to be made
by a guarantor about its obligations under certain guarantees and requires that,
at the inception of a guarantee, a guarantor recognize a liability for the fair
value of the obligation undertaken in issuing the guarantee. The disclosure
requirements are effective immediately and are provided in Note H. The initial
recognition and measurement provisions of this Interpretation are effective for
guarantees issued or modified after December 31, 2002. We do not expect the
adoption of the initial recognition and measurement provisions of this
Interpretation to have a material effect on our results of operations.
In November 2002, the Emerging Issues Task Force (EITF) of the FASB reached a
consensus on EITF 02-16, Accounting by a Reseller for Cash Consideration
Received from a Vendor. Among other conclusions reached, EITF 02-16 requires
that consideration received from a vendor be presumed to be a reduction of the
cost of the vendor's products or services. This presumption can be overcome if
the consideration can be shown to represent either a payment for assets or
services delivered to the vendor or a reimbursement of costs incurred by the
reseller to sell the vendor's products. This treatment is effective for
arrangements entered into or modified on or after January 1, 2003. As indicated
in the Critical Accounting Policies section, cooperative advertising programs
offset a portion of our advertising costs. Any change to our accounting for
cooperative advertising arrangements could result in receipts from vendors being
used to lower product costs in inventory and therefore impact the timing of
recognition through our cost of goods sold. This change could increase gross
profit and increase advertising expense. We have not yet completed our
assessment of whether, or to what extent, this ruling will impact our results of
operations.
23
CAUTIONARY STATEMENTS FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
CAUTIONARY STATEMENTS
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 under certain
circumstances, provided that the public company discloses with specificity the
risk factors that may impact its future results. We want to take advantage of
the "safe harbor" provisions of the Act. In doing so, we have disclosed these
forward-looking statements by informing you in the following specific cautionary
statements of certain circumstances which may cause the information in these
statements not to transpire as expected.
This Annual Report contains both historical information and other information
that you can use to infer future performance. Examples of historical information
include our annual financial statements and the commentary on past performance
contained in our MD&A. While we have specifically identified certain information
as being forward-looking in the context of its presentation, we caution you
that, with the exception of information that is CLEARLY HISTORICAL, all the
information contained in this Annual Report 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," "believe," "anticipate," "continue" 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 that we discuss in more detail below and in our report on Form 10-K,
filed with the Securities & Exchange Commission. This information is based on
various factors and important assumptions about future events that may or may
not actually come true. As a result, 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 Annual Report. In particular, the factors
we discuss below and in our Form 10-K could affect our actual results and could
cause our actual results in 2003 and in future years to differ materially from
those expressed in any forward-looking statement made by us or on our behalf in
this Annual Report. We believe that the following risk factors should be
considered by persons reading our Annual Report and Form 10-K and hereby qualify
those filings by the inclusion of these cautionary statements regarding future
performance:
COMPETITION--RETAIL: We compete with a variety of retailers, dealers and
distributors in a highly competitive marketplace that includes such competitors
as high-volume office supply chains (so-called "office supplies superstores"),
warehouse clubs, computer stores, contract stationers and well-established mass
merchant retailers. Even grocery and drugstore chains have begun to carry at
least limited supplies of basic office supplies and technology items, including
printer supplies such as ink cartridges and toner cartridges. Well-established
mass merchant retailers have the financial and distribution ability to compete
very effectively with us should they choose to enter the office superstore
retail category, Internet office supply or contract stationer business or
substantially expand their offering in their existing retail outlets. In
addition, there is substantial competition on the Internet from other merchants
who may or may not have a "brick and mortar" presence. There is a possibility
that any or all of these competitors could become more aggressive in the future,
thereby increasing the number and breadth of our competitors, potentially having
a material adverse effect on our business and results of our operations.
COMPETITION--CONTRACT AND COMMERCIAL: We compete with a number of contract
stationers, mail order and Internet operators and retailers who supply office
products and services to large and small businesses, both nationally and
internationally. In order to achieve and maintain expected profitability levels,
we must continue to grow this segment of the business while maintaining the
service levels and aggressive pricing necessary to retain existing customers.
There can be no assurance we will be able to continue to expand our contract and
commercial business while retaining our base of existing customers, and any
failure to do so could have a material adverse effect on our profitability. We
are also working on various initiatives to improve margin levels in this
business segment, but there is no assurance that these initiatives will prove
successful. Some of our competitors operate only in the contract and/or
commercial channels and therefore may be able to focus more attention on the
business services segment, thereby providing formidable competition. Our failure
to adequately address this segment of our business could put us at a competitive
disadvantage relative to these competitors. In addition, we have reached maximum
capacity in some of our distribution centers that serve our contract and
commercial customers. The economic problems of the past several years have had
an adverse impact on a number of our contract and commercial customers,
resulting in some cases in cutbacks in expenditures of our existing customers
for office supplies and other items we sell to them.
24
INTERNET: As mentioned above, many Internet-based merchandisers also compete
with us. This competition is expected to increase in the future as these
companies proliferate and continue to expand their operations. Many startup
operations that are heavily focused on Internet sales may be able to compete
with us very effectively in the areas of price and selection. While most of
these companies cannot offer the levels of service and stability of supply that
we provide, they nevertheless may be formidable competitors, particularly for
customers who are willing to look for the absolute lowest price without regard
to the other attributes of our business model, including advice and service. In
addition, certain manufacturers of computer hardware, software and peripherals,
including certain of our suppliers, have expanded their own direct marketing of
products, particularly over the Internet. The number of these direct sellers has
increased in recent years. Even as we expand our own Internet efforts, our
ability to anticipate and adapt to the developing Internet marketplace and the
capabilities of our network infrastructure to efficiently handle our rapidly
expanding operations are of critical importance. Failure to execute well in any
of these key areas could have a material adverse effect on our future sales
growth and profitability.
EXECUTION OF EXPANSION PLANS: We plan to open approximately 40 stores in the
United States and Canada and 11 to 16 stores in our International Division
during 2003. We consider our expansion program to be an integral part of our
plans to achieve anticipated operating results in future years. Circumstances
outside our control, such as adverse weather conditions affecting construction
schedules, unavailability of acceptable sites or materials, labor disputes and
similar issues could impact anticipated store openings. At times in the past,
our expansion activities have been hampered by less than optimal selection of
real estate locations, resulting in some stores that have failed to meet their
planned financial results. Our future expansion plans also include opening
retail stores of different sizes (generally smaller) than our traditional
superstore models and using different store formats and layouts. We cannot
determine with certainty whether these newly sized or formatted stores will be
successful. The failure to expand by opening new stores as planned and/or the
failure to generate the anticipated sales growth in markets where new stores are
opened (including the opening of new sizes and formats of stores) could have a
material adverse effect on our future sales growth and profitability.
CANNIBALIZATION OF SALES IN EXISTING OFFICE DEPOT STORES: As we expand the
number of our stores in existing markets, sales of existing stores may suffer
from cannibalization (as customers of our existing stores begin shopping at our
new stores). Our new stores typically require an extended period of time to
reach the sales and profitability levels of our existing stores. Moreover, the
opening of new stores does not ensure that those stores will ever be as
profitable as existing stores, particularly when new stores are opened in highly
competitive markets or markets in which other office supply superstores may have
achieved "first mover" advantage. Our comparable sales are affected by a number
of factors, including the opening of additional Office Depot stores; the
expansion of our contract stationer business in new and existing markets;
competition from other office supply chains, mass merchandisers, warehouse
clubs, computer stores, other contract stationers and Internet-based businesses;
and regional, national and international economic conditions. In addition, our
profitability would be adversely affected if our competitors were to attempt to
capture market share by reducing prices. Any or all of these circumstances could
have a material adverse effect on our anticipated future revenue and
profitability models.
COSTS OF REMODELING AND RE-MERCHANDISING STORES: The remodeling and
re-merchandising of our stores has contributed to increased store expenses, and
these costs are expected to continue impacting store expenses throughout 2003
and beyond. While a necessary aspect of maintaining a fresh and appealing image
to our customers, the expenses associated with such activities could result in a
significant impact on our net income in the future. In addition, there is no
guarantee that these changes will generate any of the benefits that we have
anticipated. Furthermore, our growth, through both store openings and
acquisitions, will continue to require the expansion and upgrading of our
informational, operational and financial systems, as well as necessitate the
hiring of new managers at the store and supervisory level.
HISTORICAL FLUCTUATIONS IN PERFORMANCE: Fluctuations in our quarterly operating
results have occurred in the past and may occur in the future. A variety of
factors could contribute to this quarter-to-quarter variability, including new
store openings which require an outlay of pre-opening expenses, generate lower
initial profit margins and cannibalize existing stores; timing of warehouse
integration; competitors' pricing; changes in our product mix; fluctuations in
advertising and promotional expenses; the effects of seasonality; acquisitions
of contract stationers; competitive store openings; an increase in activity by
non-traditional resellers of office supplies, technology or other products we
sell, or other events. Such quarterly fluctuations could have a material adverse
effect on our financial results and/or the price of our securities.
25
VIKING MERGER AND INTEGRATION: On August 26, 1998, we merged with Viking. While
we have made progress in the integration of Viking into Office Depot, we
anticipate that costs related to completing the integration of Viking's
warehouse facilities and technologies with our delivery network will continue to
negatively impact our warehouse expenses in 2003 and beyond. Moreover,
integrating the operations and management of Office Depot and Viking has been,
and continues to be, a complex process. There can be no assurance that this
integration process will be completed as rapidly as we anticipate or that, even
if achieved as anticipated, it will result in all of the anticipated synergies
and other benefits we expect to realize. The integration of the two companies
continues to require significant management attention, which may temporarily
distract us from other matters. In 2003, we anticipate moving a significant
portion of our Viking operations from Los Angeles, California to our
headquarters campus in Delray Beach, Florida. Among other risks, loss of key
personnel, disruption during the course of this relocation and related factors
may adversely affect our Viking business in the coming year. Our inability to
successfully complete the integration of the operations of Office Depot and
Viking could have a material adverse effect on our future sales growth and
profitability.
INTERNATIONAL ACTIVITY: We have operations in a number of international markets.
We intend to enter additional international markets as attractive opportunities
arise. Each entry could take the form of a startup, acquisition of stock or
assets or a joint venture or licensing arrangement. We have made a decision to
accelerate our growth in Europe, increasing more rapidly than originally planned
the number of countries in which we operate. In addition to the risks described
above (in our domestic operations), internationally we face such risks as
foreign currency fluctuations, unstable political and economic conditions, and,
because some of our foreign operations are not wholly owned, compromised
operating control in certain countries. Recent world events have served to
underscore even further the risks and uncertainties of operating in other parts
of the world. Risks of civil unrest, war and economic crisis in portions of the
world outside North America in which we operate represent a more significant
factor than may have been the case in the past. Also, we have experienced
significant fluctuations in foreign currency exchange rates in 2002, which
affected the sales and earnings in our International Division. Our results may
continue to be affected by these fluctuations, both positive and negative, in
the future as the value of the U.S. dollar changes against other currencies. In
addition, we do not have a large group of managers experienced in international
operations and will need to recruit additional management resources to
successfully compete in many foreign markets. All of these risks could have a
material adverse effect on our financial position or our results from
operations. Moreover, as we increase the relative percentage of our business
that is operated globally, we also increase the impact these factors have on our
future operating results. Our startup operation in Japan, in particular, has
proven to be disappointing to date and has generated losses that have materially
affected our financial results in the past and may do so in the future. Because
of differing commercial practices, laws and other factors, our ability to use
the Internet and electronic commerce to substantially increase sales in
international locations may not progress at the same rate as in North America.
GLOBAL SOURCING OF PRODUCTS/PRIVATE LABEL: In recent years, we have
substantially increased the number and types of products which we sell under our
own Office Depot(R), Viking(TM), and other private label brands. We expect this
trend to continue in the future. We source many of these products from outside
the United States, particularly in the Far East. While these products have
attractive margins and enhance our brand image, the increased reliance on
foreign sourced products introduces its own set of risks and uncertainties.
Sources of supply may prove to be unreliable, or the quality of the sourced
products may vary from our expectations. Economic and civil unrest in areas of
the world where we source such products could adversely impact the availability
or cost of such products, or both. Moreover, this increased reliance on globally
sourced products also subjects our Company to other risks, such as the
protracted dockworkers strike on the U.S. West Coast that adversely impacted
imported products for a substantial period of time in 2002. Any of these
circumstances could have a material adverse effect on our financial performance
in the future.
SOURCES AND USES OF CASH: We believe that our current level of cash and cash
equivalents, future operating cash flows, lease financing arrangements and funds
available under our credit facilities and term loans should be sufficient to
fund our planned expansion, integration and other operating cash needs for at
least the next year. However, there can be no assurance that additional sources
of financing will not be required during the next twelve months as a result of
unanticipated cash demands, opportunities for expansion, acquisition or
investment, changes in growth strategy, changes in our warehouse integration
plans or adverse operating results. We could attempt to meet our financial needs
through the capital markets in the form of either equity or debt financing.
Alternative financing will be considered if market conditions make it
financially attractive. There can be no assurance that any additional funds
required by us, whether within the next twelve months or thereafter, will be
available to us on satisfactory terms. Our inability to access needed financial
resources could have a material adverse effect on our financial position or
operating results.
26
M&A ACTIVITY: In the past, since the Viking merger in 1998, we have limited our
merger and acquisition activity to relatively small acquisitions. As we seek
ways to more aggressively expand and grow our business, it appears more likely
that we will increase our interest in M&A activity both domestically and
internationally. While the opportunities from such activity cannot be ignored,
neither can the clear reality that many acquisitions do not measure up to the
expectations of the acquiring company, for a host of reasons. M&A activity may
divert attention of our executive management team away from our existing core
businesses. We may do a less than optimal job of due diligence or evaluation of
target companies, and, as our experience with Viking serves to indicate, the
task of integrating two substantial businesses can prove daunting. Failure to
grow our businesses through M&A activity, or failure to execute M&A activity in
a satisfactory manner could have a significant and material adverse effect on
our future business prospects and/or our financial performance in the future.
EFFECTS OF CERTAIN ONE-TIME CHARGES: Since our merger with Viking and our
comprehensive business review in 2000, we have recorded additional charges and
credits to adjust past estimates, such as facility closure costs, to reflect
current conditions. There can be no assurance that additional charges of this
nature will not be required in the future as well. In particular, we expect that
a retail store chain, such as our Retail Stores Division, should expect to close
a certain number of stores each year, while remodeling and/or relocating a
number of other stores. We cannot be certain that our decisions to close,
remodel and/or relocate stores will have the desired favorable results on our
financial performance, nor can we anticipate the size and nature of
non-recurring charges associated with such matters. Such charges, if any, could
have a materially adverse impact on our financial position or operating results
in the future.
IMPACT OF NEW LEGISLATION AND NEW ACCOUNTING RULES: In July 2002, the United
States Congress passed, and President Bush signed into law, legislation that has
been called the most comprehensive set of reforms of public companies in over a
half century. Moreover, the implementation of this legislation (the
Sarbanes-Oxley Act of 2002 ("SOA")) is dependent upon the adoption of a host of
new regulations by the Securities and Exchange Commission ("SEC") and the newly
created Public Company Accounting Oversight Board. New regulations may
dramatically change the manner in which the Company is required to report its
results of operations, balance sheet items and other aspects of financial
accounting in the future. While Office Depot believes that it has been at all
times in material compliance with laws and regulations pertaining to the proper
recording and reporting of our financial results, there can be no assurance that
future regulations, implementing SOA and otherwise, will not have a material
adverse impact on our reported results as compared with prior reporting periods.
Certain policy issues, such as the expensing of stock options issued to our
employees, could, for example, have a dramatic impact on our reported results of
operations, depending upon the outcome of current discussions regarding which,
if any, of these policy issues should or will change. Any or all of the
foregoing could have a material adverse impact on our reported financial
results. The Financial Accounting Standards Board (the "FASB") has promulgated
several new accounting standards and is considering others, some of which could
have a material impact on our reported results. In particular, our Company is
required to assess the continuing value of goodwill and long-lived assets. This
assessment requires judgment and estimates about future cash flows, which may or
may not be realized. Changes in facts or assumptions could cause the write-down
or write-off of long-lived assets or goodwill associated with our operations in
Japan, as well as in our newly acquired subsidiary, 4Sure.com, Inc. Reflecting
the slow economy in general and the slowdown in technology sales in particular,
this subsidiary has not performed as we had anticipated at the time we acquired
that company. The impact of any required write-off of goodwill associated with
these or other units of the Company could have a material adverse impact on our
reported financial results in future periods. Additionally, the FASB has begun a
project to address revenue recognition concepts. Results of this project may
affect how companies, including Office Depot, measure and report sales. A change
to the practices currently followed could have a significant impact on the
amount of revenue recognized.
CONTINUED ECONOMIC DOWNTURN: In the decade of the 1990's, the favorable United
States economy contributed to the expansion and growth of retailers. Our country
experienced low inflation, relatively low interest rates, low unemployment and
an escalation of new businesses. Since the turn of the 21st century, however,
the economy has been in a downturn which has seen increased unemployment,
stagnant business growth rates and a substantial decrease in the formation of
new businesses. All of these factors have combined to negatively affect our
businesses, especially in the United States and Japan. The Federal Reserve
continued to dramatically reduce interest rates throughout 2002 in recognition
of the economic downturn--or recession--in an effort to address that downturn.
The overall stock market has been in a period of poor performance throughout
since 2000. The retail industry, in particular, continues to display signs of a
slowdown, with several
27
specialty retailers, both in and outside our industry segment, reporting
earnings warnings throughout 2002. One major discount retailer in the Fortune 50
filed for bankruptcy protection early in 2002, further indicating that the slow
economy is having an impact on the retail industry. The depth and duration of
this general economic slowdown may adversely impact our business and the results
of our operations in the future.
EFFECT OF POSSIBLE WAR: Among the chief uncertainties facing our nation and
world, and as a result our business, is the possibility of a war in the Middle
East. Obviously no one can predict with certainty whether such an eventuality
will occur, or if it does, what the overall economic impact will be. Clearly,
such an event or series of events could have a very serious adverse impact on
our business in 2003 and beyond.
EXECUTIVE MANAGEMENT: Since the appointment of our new Chief Executive Officer
in July 2000, we have continued to evolve our management organization to better
address the future goals of our Company. In 2002, we filled key positions by
adding Executive Vice Presidents in the areas of Information Technology,
Merchandising and Marketing. These new senior executives, in turn, have made
significant changes in their respective business organizations. In many cases,
new executives have joined our Company midway through 2002 or even later. While
most key positions have been filled, not all such critical positions are filled
at this time. Various searches are underway to identify the best individuals to
fill these positions. Furthermore, our new leadership team, and the new
management structure we have adopted, may prove not to be ideal for our Company
and may not result in the benefits expected; and, as a result, may materially
and adversely affect our future operating results.
DISCLAIMER OF OBLIGATION TO UPDATE
We assume no obligation (and specifically disclaim any such obligation) to
update these Cautionary Statements or any other forward-looking statements
contained in this Annual Report to reflect actual results, changes in
assumptions or other factors affecting such forward-looking statements.
28
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of Office Depot, Inc.
We have audited the accompanying consolidated balance sheets of Office Depot,
Inc. (the "Company") as of December 28, 2002 and December 29, 2001 and the
related consolidated statements of earnings, stockholders' equity and cash flows
for each of the three years in the period ended December 28, 2002. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Office Depot, Inc. as of December
28, 2002 and December 29, 2001 and the results of its operations and its cash
flows for each of the three years in the period ended December 28, 2002 in
conformity with accounting principles generally accepted in the United States of
America.
/S/ DELOITTE & TOUCHE LLP
Certified Public Accountants
Miami, Florida
February 13, 2003
29
CONSOLIDATED BALANCE SHEETS
December 28, December 29,
(In thousands, except share and per share amounts) 2002 2001
- ---------------------------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 877,088 $ 565,388
Short-term investments 6,435 --
Receivables, net of allowances of $29,149 in 2002 and $32,228 in 2001 771,632 774,175
Merchandise inventories, net 1,305,589 1,253,420
Deferred income taxes 143,073 148,490
Prepaid expenses and other current assets 105,898 81,908
- ---------------------------------------------------------------------------------------------------------------------
Total current assets 3,209,715 2,823,381
Property and equipment, net 1,118,062 1,099,618
Goodwill 257,797 242,762
Other assets 180,238 165,882
- ---------------------------------------------------------------------------------------------------------------------
Total assets $ 4,765,812 $ 4,331,643
=====================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,173,973 $ 1,058,436
Accrued expenses and other current liabilities 662,490 617,210
Income taxes payable 139,431 107,347
Current maturities of long-term debt 16,115 318,521
- ---------------------------------------------------------------------------------------------------------------------
Total current liabilities 1,992,009 2,101,514
Deferred income taxes and other credits 64,721 64,139
Long-term debt, net of current maturities 411,970 315,331
Zero coupon, convertible subordinated notes -- 2,221
Commitments and contingencies
Stockholders' equity:
Common stock--authorized 800,000,000 shares of $.01 par value;
issued 393,905,052 in 2002 and 385,538,340 in 2001 3,939 3,855
Additional paid-in capital 1,118,028 1,007,088
Unamortized value of long-term incentive stock grant (1,295) (2,578)
Accumulated other comprehensive income (loss) 1,165 (71,273)
Retained earnings 2,028,442 1,717,734
Treasury stock, at cost--85,389,591 shares in 2002 and 82,443,170 shares in 2001 (853,167) (806,388)
- ---------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 2,297,112 1,848,438
- ---------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 4,765,812 $ 4,331,643
=====================================================================================================================
The accompanying notes are an integral part of these statements.
30
CONSOLIDATED STATEMENTS OF EARNINGS
(In thousands, except per share amounts) 2002 2001 2000
- ---------------------------------------------------------------------------------------------------------------
Sales $ 11,356,633 $ 11,082,112 $ 11,495,493
Cost of goods sold and occupancy costs 8,022,663 7,940,067 8,435,928
- ---------------------------------------------------------------------------------------------------------------
Gross profit 3,333,970 3,142,045 3,059,565
Store and warehouse operating and selling expenses 2,331,384 2,322,577 2,388,108
General and administrative expenses 486,279 445,538 447,693
Facility closure costs 6,744 8,436 110,038
Other operating expenses 9,855 12,125 6,733
- ---------------------------------------------------------------------------------------------------------------
Operating profit 499,708 353,369 106,993
Other income (expense):
Interest income 18,509 12,980 11,345
Interest expense (46,195) (43,339) (32,683)
Miscellaneous income (expense), net 7,183 (9,057) 4,632
- ---------------------------------------------------------------------------------------------------------------
Earnings from continuing operations before income taxes 479,205 313,953 90,287
Income taxes 167,722 112,296 41,972
- ---------------------------------------------------------------------------------------------------------------
Earnings from continuing operations 311,483 201,657 48,315
Discontinued operations (775) (614) 1,017
- ---------------------------------------------------------------------------------------------------------------
Net earnings $ 310,708 $ 201,043 $ 49,332
- ---------------------------------------------------------------------------------------------------------------
Earnings per share from continuing operations:
Basic $ 1.02 $ 0.68 $ 0.16
Diluted 0.98 0.66 0.16
- ---------------------------------------------------------------------------------------------------------------
Net earnings per share:
Basic $ 1.01 $ 0.67 $ 0.16
Diluted 0.98 0.66 0.16
- ---------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these statements.
31
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Unamortized Accumu-
value lated
of long- other
term compre- Compre-
Common Common Additional incentive hensive hensive
(In thousands, stock Stock paid-in stock Income income Retained Treasury
except share amounts) shares amount capital grant (loss) (loss) earnings stock
- ----------------------------- ----------- ------ --------- ------------ ----------- --------- ---------- ---------
Balance at December 25, 1999 376,212,439 $3,762 $ 926,295 $(4,065) $ 15,730 $1,467,359 $(501,361)
Comprehensive income:
Net earnings $ 49,332 49,332
Foreign currency
translation adjustment (7,093) (7,093)
Realized gain on investment
securities, net of tax (62,127) (62,127)
---------
Comprehensive (loss) $ (19,888)
=========
Acquisition of treasury stock (300,797)
Grant of long-term
incentive stock 25,000 199 (199)
Cancellation of long-term
incentive stock (50,000) (819) 600
Exercise of stock options
(including income
tax benefits) 424,809 4 (1,984)
Issuance of stock under
employee stock
purchase plans 1,372,566 14 9,713
Matching contributions
under 401(k) and deferred
compensation plans 703,545 7 5,810
Amortization of long-term
incentive stock grant 871
----------- ------ ---------- ------- -------- --------- ---------- ---------
Balance at December 30, 2000 378,688,359 3,787 939,214 (2,793) (53,490) 1,516,691 (802,158)
Comprehensive income:
Net earnings $ 201,043 201,043
Foreign currency
translation adjustment (17,783) (17,783)
---------
Comprehensive income $ 183,260
=========
Acquisition of treasury stock (4,194)
Grant of long-term
incentive stock 80,000 1 764 (764)
Exercise of stock options
(including income tax
benefits) 5,604,810 55 56,430 (60)
Issuance of stock under
employee stock
purchase plans 751,400 8 6,712
Matching contributions
under 401(k) and
deferred compensation plans 413,771 4 3,957
Direct Stock Purchase Plans 11 24
Amortization of long-term
incentive stock grant 979
----------- ------ ---------- ------- -------- --------- ---------- ---------
Balance at December 29, 2001 385,538,340 3,855 1,007,088 (2,578) (71,273) 1,717,734 (806,388)
Comprehensive income:
Net earnings $ 310,708 310,708
Foreign currency
translation adjustment 72,438 72,438
---------
Comprehensive income $ 383,146
=========
Acquisition of treasury stock (45,869)
Grant of long-term
incentive stock 15,000 218 (218)
Cancellation of long-term
incentive stock (73,524) (549) 284
Exercise of stock options
(including income
tax benefits) 8,195,441 82 108,478 (965)
Issuance of stock under
employee stock
purchase plans 139,773 1 1,097
Matching contributions
under 401(k) and
deferred compensation plans 90,022 1 1,663
Direct Stock Purchase Plans 33 55
Amortization of long-term
incentive stock grant 1,217
----------- ------ ---------- ------- -------- ---------- ---------
Balance at December 28, 2002 393,905,052 $3,939 $1,118,028 $(1,295) $ 1,165 $2,028,442 $(853,167)
=========== ====== ========== ======= ======== ========== =========
The accompanying notes are an integral part of these statements.
32
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands) 2002 2001 2000
- -------------- --------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings $ 310,708 $ 201,043 $ 49,332
--------- --------- ---------
Adjustments to reconcile net earnings to net cash provided by operating
activities:
Discontinued operations 775 614 (1,017)
Depreciation and amortization 200,747 198,223 204,253
Charges for losses on inventories and receivables 93,220 108,690 118,651
Net earnings from equity method investments (9,279) (10,892) (9,436)
Accreted interest on zero coupon, convertible subordinated notes 7,558 11,308 19,203
Employee stock benefit plans 2,616 5,001 6,469
Deferred income taxes (9,994) 196 (81,814)
Net loss (gain) on investment securities 2,998 14,100 (12,414)
Loss (gain) on disposal of property and equipment 1,465 (5,273) 10,585
Facility closure costs and impairment charges 12,130 43,623 114,343
Other operating activities 24,660 -- --
Changes in assets and liabilities:
Decrease (increase) in receivables 11,668 83,581 (85,979)
(Increase) decrease in merchandise inventories (99,487) 75,238 (67,347)
Net (increase) decrease in prepaid expenses and other assets (18,169) 8,961 (23,951)
Net increase in accounts payable, accrued expenses and deferred credits 170,281 11,528 74,048
--------- --------- ---------
Total adjustments 391,189 544,898 265,594
--------- --------- ---------
Net cash provided by operating activities 701,897 745,941 314,926
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of short-term investments (6,435) -- --
Purchases of investment securities (2,151) -- (30,112)
Proceeds from sale of investment securities -- -- 54,006
Acquisitions -- (45,960) --
Capital expenditures (202,218) (208,056) (266,998)
Proceeds from sale of property and equipment 11,338 20,945 4,469
--------- --------- ---------
Net cash used in investing activities (199,466) (233,071) (238,635)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from exercise of stock options and sale of stock under employee
stock purchase plans 88,898 52,962 12,388
Repurchase of common stock for treasury (45,869) (4,193) (300,797)
Proceeds from issuance of long-term debt -- 266,286 430,522
Payments on long- and short-term borrowings (12,350) (400,458) (27,015)
Repurchase of zero coupon, convertible subordinated notes (243,304) -- (249,191)
--------- --------- ---------
Net cash used in financing activities (212,625) (85,403) (134,093)
--------- --------- ---------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS 21,894 (8,537) (10,587)
--------- --------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 311,700 418,930 (68,389)
Cash and cash equivalents at beginning of period 565,388 146,458 214,847
--------- --------- ---------
Cash and cash equivalents at end of period $ 877,088 $ 565,388 $ 146,458
========= ========= =========
The accompanying notes are an integral part of these statements.
33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS: Office Depot, Inc. (the "Company") is a global supplier of
office products and services, with sales in 20 countries outside the United
States and Canada under the Office Depot(R), Viking Office Products(R), Viking
Direct(R), and 4Sure.com(R) brand names. Products and services are offered
through wholly owned retail stores, contract business-to-business sales
relationships, commercial catalogs and multiple web sites providing a wide range
of office products, computers and technical support functions.
BASIS OF PRESENTATION: The consolidated financial statements of Office Depot,
Inc. and its subsidiaries have been prepared in accordance with accounting
principles generally accepted in the United States of America. All intercompany
transactions have been eliminated in consolidation. Non-controlling investments
in joint ventures selling office products and services in Mexico and Israel are
accounted for using the equity method. The Company's share of joint ventures'
operations is included in the Consolidated Statements of Earnings in
miscellaneous income (expense), net.
Certain prior year amounts have been reclassified to conform to current year
presentation.
FISCAL PERIODS: Fiscal years are based on a 52- or 53-week period ending on the
last Saturday in December. The 2000 financial statements consist of 53 weeks;
all other periods presented consist of 52 weeks.
ESTIMATES AND ASSUMPTIONS: Preparation of these financial statements in
conformity with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect
amounts reported in the financial statements and related notes. Actual results
may differ from those estimates.
FOREIGN CURRENCY TRANSLATION: Assets and liabilities of international operations
are translated into U.S. dollars using the exchange rate at the balance sheet
date. Revenues and expenses are translated at average monthly exchange rates.
Translation adjustments resulting from this process are recorded in
stockholders' equity as a component of other comprehensive income (loss).
CASH EQUIVALENTS: Highly liquid securities with maturities of three months or
less from the date of acquisition are classified as cash equivalents.
RECEIVABLES: Trade receivables, net, totaled $482.5 million and $454.5 million
at December 28, 2002 and December 29, 2001, respectively. An allowance for
doubtful accounts has been recorded to reduce receivables to an amount expected
to be collectible from customers. The allowance recorded at December 28, 2002
and December 29, 2001 was approximately $29.1 million and $32.2 million,
respectively. Receivables generated through a private label credit card program
are transferred to a financial services company with recourse to Office Depot.
The Company's exposure to credit risk associated with trade receivables is
limited by having a large customer base that extends across many different
industries and geographic regions. However, the Company's receivables may be
adversely affected by an economic slowdown in the U.S. or internationally.
Other receivables, totaling $289.1 million and $319.7 million as of December 28,
2002 and December 29, 2001, respectively, consist primarily of amounts due from
vendors under purchase rebate, cooperative advertising and various other
marketing programs. Amounts expected to be received from vendors relating to
purchases of merchandise inventories are recognized as a reduction of cost of
goods sold as the merchandise is sold. Amounts relating to cooperative
advertising and marketing programs are recognized as a reduction of advertising
expense in the period that the related expenses are recognized.
MERCHANDISE INVENTORIES: Inventories are stated at the lower of cost or market
value. The weighted average method is used to determine the cost of over 90% of
inventories and the first-in-first-out method is used for the remainder of our
inventories, primarily in our International Division.
INCOME TAXES: Income tax expense is recognized at applicable U.S. or
international tax rates. Certain revenue and expense items may be recognized in
one period for financial statement purposes and a different period's income tax
return. The tax effects of such differences are reported as deferred income
taxes.
Essentially all earnings of foreign subsidiaries are expected to be reinvested
in overseas expansion. Accordingly, no provision has been made for incremental
U.S. taxes on undistributed earnings considered permanently invested. Cumulative
undistributed earnings of our foreign subsidiaries for which no Federal income
taxes have been provided was $778.7 million and $582.0 million as of December
28, 2002 and December 29, 2001, respectively.
PROPERTY AND EQUIPMENT: Property and equipment additions are recorded at cost.
Depreciation and amortization is recognized over their estimated useful lives
using the straight-line method. The useful lives of depreciable assets is
estimated to be 15-30 years for buildings and 3-10 years for furniture, fixtures
and equipment. Leasehold improvements are amortized over the shorter of the
terms of the underlying leases or the estimated useful lives of the
improvements.
INVESTMENTS: In prior years the Company made various investments in
Internet-based companies and funds. Certain of these investments were recorded
as investments at cost while others were considered available for sale and,
accordingly, were carried at their estimated fair value with any changes in fair
value being recorded as a separate component of stockholders' equity, net of
applicable taxes. In fiscal 2000, investments considered available for sale were
sold. The remaining investments are carried at cost and their value is
periodically monitored. If a decline in value is considered other than
temporary, an impairment charge is recognized in earnings in the period when the
determination is made. At December 28, 2002 and December 29, 2001, the portfolio
totaled $14.4 million and $15.2 million, respectively.
GOODWILL: Goodwill represents the excess of the purchase price and related costs
over the value assigned to net tangible and identifiable intangible assets of
businesses acquired and accounted for under the
34
purchase method. Under accounting rules that became effective at the beginning
of 2002, goodwill is no longer amortized, but it is tested annually for possible
impairment. See Note E for goodwill balances and related information.
Impairment of Long-Lived Assets: Long-lived assets are reviewed for possible
impairment whenever events or changes in circumstances indicate that the
carrying amount of such assets may not be recoverable. Impairment is assessed at
the location level, considering the estimated undiscounted cash flows over the
asset's remaining life. If estimated cash flows are insufficient to recover the
investment, an impairment loss is recognized based on the fair value of the
asset less any costs of disposition. Beginning with fiscal year 2002, we adopted
Statement of Financial Accounting Standard No. 144, Accounting for the
Impairment and Disposal of Long-Lived Assets. Impairment losses of $5.4 million
and $19.3 million were recognized in 2002 and 2001 relating to certain
under-performing retail stores. Impairment charges of $63.0 million were also
recognized in 2000.
Facility Closure Costs: The Company regularly reviews store performance against
expectations and closes stores not meeting investment requirements. Costs
associated with closures resulting from such ongoing performance reviews,
principally lease cancellation costs, have historically been accrued when the
decision to close is made. New accounting rules that became effective at the
beginning of fiscal year 2003 will generally delay recognition of lease
termination costs from the date of closure commitment to the date the facility
is no longer used in an operating capacity. See Note C for discussion of
facility closures in 2000 and related adjustments.
Fair Value of Financial Instruments: The estimated fair values of financial
instruments recognized in the Consolidated Balance Sheets or disclosed within
these Notes to our Consolidated Financial Statements have been determined using
available market information, information from unrelated third-party financial
institutions and appropriate valuation methodologies. However, considerable
judgment is required when interpreting market information and other data to
develop estimates of fair value. Accordingly, the estimates presented are not
necessarily indicative of the amounts that could be realized in a current market
exchange.
Short-Term Assets and Liabilities: The fair values of cash and cash equivalents,
short-term investments, receivables and accounts payable approximate their
carrying values because of their short-term nature.
Notes Payable: The fair values of the zero coupon, convertible subordinated
notes and senior subordinated notes were determined based on quoted market
prices.
Interest Rate Swaps and Foreign Currency Contracts: The fair values of our
interest rate swaps and foreign currency contracts are the amounts receivable or
payable to terminate the agreements at the reporting date, taking into account
current interest and exchange rates. No amounts were outstanding at the end of
2002, and amounts at the end of 2001 were immaterial.
There were no significant differences as of December 28, 2002 and December 29,
2001 between the carrying values and fair values of the financial instruments
except as disclosed below:
2002 2001
-------------------- ----------------------
(Dollars in thousands) Carrying Fair Carrying Fair
Value Value Value Value
- ------------------------- ---------- -------- ---------- --------
Zero coupon, convertible
subordinated notes $ -- $ -- $235,747 $258,794
Senior subordinated notes 262,213 279,625 245,360 271,250
---------- -------- ---------- --------
Accounting for Stock-Based Compensation: The Company accounts for its
stock-based compensation plans under Accounting Principles Board ("APB") Opinion
No. 25, Accounting for Stock Issued to Employees, and related Interpretations.
Essentially all employee stock options are issued at market value on the date of
grant. Under APB 25, no compensation expense is recognized for such options. The
compensation cost charged against income for restricted shares issued under the
Long-Term Equity Incentive Plan and Long-Term Incentive Stock Plan, as well as
the Company's match under the retirement savings plans totaled $9.4 million,
$4.9 million and $6.4 million in 2002, 2001 and 2000, respectively. Had
compensation cost for awards under our stock-based compensation plans been
determined using the fair value method prescribed by Statement of Financial
Accounting Standard ("FAS") No. 123, Accounting for Stock-Based Compensation,
the Company would have recognized additional compensation expense, net of
related tax effects, of approximately $29.4 million, $36.7 million and $39.5
million in 2002, 2001 and 2000, respectively. The Company prepares this pro
forma disclosure based on the assumptions listed below, as well as an assumption
of forfeiture rates for unvested options. As provided in FAS 123, pro forma
compensation expense is adjusted at the end of the vesting period for
differences between estimated and actual forfeitures. The decline in pro forma
compensation expense presented for 2002 reflects higher than anticipated
forfeitures of unvested options issued in 1999. This decline relates to these
pro forma disclosures only and did not affect expenses presented in the
Consolidated Statements of Earnings. The pro forma information below is based on
provisions of FAS 123, as amended by FAS 148, Accounting for Stock-Based
Compensation-- Transition and Disclosure, issued in December 2002.
(In thousands, except per share amounts) 2002 2001 2000
- ----------------------------------------- -------- -------- -------
Net earnings
As reported $310,708 $201,043 $49,332
Pro forma 281,332 164,335 9,794
Net earnings per share--Basic
As reported $ 1.01 $ 0.67 $ 0.16
Pro forma 0.92 0.55 0.03
Net earnings per share--Diluted
As reported $ 0.98 $ 0.66 $ 0.16
Pro forma 0.89 0.54 $ 0.03
-------- -------- -------
35
The fair value of each stock option granted is established on the date of the
grant using the Black-Scholes option-pricing model, with the following weighted
average assumptions for grants in 2002, 2001 and 2000:
- -- Risk-free interest rates of 4.69% for 2002, 4.58% for 2001 and 6.37%
for 2000
- -- Expected lives of 4.4, 4.9 and 5.6 years for 2002, 2001 and 2000,
respectively
- -- A dividend yield of zero for all three years
- -- Expected volatility of 40% for all three years
Revenue Recognition: Revenue is recognized at the point of sale for retail
transactions and at the time of successful delivery for contract, catalog and
Internet sales. An allowance for sales returns has been recorded based on past
experience. Revenue from sales of extended warranty service plans is either
recognized at the point of sale or over the warranty period, depending on the
determination of legal obligor status. All performance obligations and risk of
loss associated with such contracts are transferred to an unrelated third-party
administrator at the time the contracts are sold. Costs associated with these
contracts are recognized in the same period as the related revenue.
Shipping and Handling Fees and Costs: Income generated from shipping and
handling fees is classified as revenues for all periods presented. The costs
related to shipping and handling are included as a component of store and
warehouse operating and selling expenses. These costs were $717.8 million in
2002, $740.8 million in 2001 and $747.8 million in 2000.
Advertising: Advertising costs are either charged to expense when incurred or,
in the case of direct marketing advertising, capitalized and amortized in
proportion to the related revenues. We participate in cooperative advertising
programs with our vendors in which they reimburse us for a portion of our
advertising costs. Advertising expense, net of cooperative advertising
allowances, amounted to $317.6 million in 2002, $309.5 million in 2001 and
$287.9 million in 2000.
Pre-Opening Expenses: Pre-opening expenses related to opening new stores and
warehouses or relocating existing stores and warehouses are expensed as incurred
and included in other operating expenses.
Self-Insurance: Office Depot is primarily self-insured for workers'
compensation, auto and general liability and employee medical insurance
programs. Self-insurance liabilities are based on claims filed and estimates of
claims incurred but not reported. These liabilities are not discounted.
Comprehensive Income (Loss): Comprehensive income (loss) represents the change
in stockholders' equity from transactions and other events and circumstances
arising from non-stockholder sources. Comprehensive income (loss) consists of
net earnings, foreign currency translation adjustments and realized or
unrealized gains (losses) on investment securities that are available for sale,
net of applicable income taxes.
Derivative Financial Instruments: Certain derivative financial instruments may
be used to hedge the exposure to foreign currency exchange rate and interest
rate risks, subject to established risk management policies. Such approved
financial instruments include swaps, options, caps, forwards and futures. Use of
derivative financial instruments for trading or speculative purposes is
prohibited by Company policies.
New Accounting Standards: In July 2001, the Financial Accounting Standards Board
(FASB) issued Statement No. 143, Accounting for Asset Retirement Obligations.
This Statement requires capitalizing asset retirement costs as part of the total
cost of the related long-lived asset and subsequently allocating the total
expense to future periods using a systematic and rational method. Our adoption
of this Statement, at the beginning of fiscal year 2003, did not have a material
impact on our results of operations.
In April 2002, the FASB issued Statement No. 145, Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Correction.
This Statement eliminates extraordinary accounting treatment for reporting gain
or loss on debt extinguishment, and amends other existing authoritative
pronouncements to make various technical corrections, clarify meanings, or
describe their applicability under changed conditions. Our adoption of this
Statement, at the beginning of fiscal year 2003, did not have a material impact
on our results of operations.
In June 2002, the FASB issued Statement No. 146, Accounting for Costs Associated
with Exit or Disposal Activities. This Statement requires recording costs
associated with exit or disposal activities at their fair values when a
liability has been incurred. Under previous guidance, certain exit costs were
accrued upon management's commitment to an exit plan, which is generally before
an actual liability has been incurred. The adoption of this Statement, at the
beginning of fiscal year 2003 had no immediate impact, but will affect the
timing of future exit or disposal activities reported by the Company.
In November 2002, the FASB issued Interpretation 45, Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others. This Interpretation expands the disclosures to be made
by a guarantor about its obligations under certain guarantees and requires that,
at the inception of a guarantee, a guarantor recognize a liability for the fair
value of the obligation undertaken in issuing the guarantee. The disclosure
requirements are effective immediately and are provided in Note H.The initial
recognition and measurement provisions of this Interpretation are effective for
guarantees issued or modified after December 31, 2002. We do not expect the
adoption of the initial recognition and measurement provisions of this
Interpretation to have a material impact on our results of operations.
In November 2002, the Emerging Issues Task Force (EITF) of the FASB reached a
consensus on EITF 02-16, Accounting by a Reseller for Cash Consideration
Received from a Vendor. Among other conclusions reached, EITF 02-16 requires
that consideration received from a vendor be presumed to be a reduction of the
cost of the vendor's products or services. This presumption can be overcome if
the consideration can be shown to represent either a payment for assets or
services delivered to the vendor or a reimbursement of costs incurred by the
reseller to sell the vendor's products. This treatment is effective for
arrangements entered into or modified on or after January 1, 2003. As stated
above, cooperative advertising programs offset a portion of our advertising
costs. A change
36
to the accounting for cooperative advertising arrangements could result in
receipts from vendors being applied to lower product costs in inventory and
therefore impact the timing of recognition through the cost of goods sold. This
change could increase gross profit and increase advertising expense. We have not
yet completed our assessment of whether, or to what extent, this ruling will
impact our results of operations.
NOTE B--DISCONTINUED OPERATIONS
In August 2002, the Company announced its decision to sell its Australian
operations. Accordingly, the Australian portion of the Company's business is
reported as a discontinued operation in the International segment disclosure and
the consolidated financial statements. Prior periods presented have been
restated to reflect this classification. The sale was completed in January 2003
with no significant impact on net earnings.
Australia's sales and pre-tax profit (loss), respectively, were $80.9 million
and $(1.0) million for 2002; $72.0 million and $0.2 million for 2001; and $74.2
million and $2.2 million for 2000. Diluted earnings per share was not affected
by discontinued operations in the three years presented. Basic (loss) per share
amounts were $(0.01) and $(0.01), for 2002 and 2001, respectively. Australia's
assets and liabilities have been classified as held for sale and at December 28,
2002 and December 29, 2001, respectively, $33.0 million and $29.6 million are
included in prepaid expenses and other current assets and $7.0 million and $6.9
million are included in accrued expenses and other current liabilities in the
accompanying Consolidated Balance Sheets.
NOTE C--2000 COMPREHENSIVE BUSINESS REVIEW
During the second half of 2000, the Company performed a comprehensive review of
the business. As a result of this review, a significant number of facilities
were closed, assets were written down and employees were severed. Separate from
this review, other charges and credits were recorded so that the net charge
recorded for the year 2000 totaled $260.6 million. Activity relating to the
business review included facility closure costs of $110.0 million; asset
impairments of $63.0 million; inventory write-downs of $38.4 million; write-off
of corporate assets of $11.2 million; goodwill impairment of $11.1 million; and
severance costs of $35.6 million. Additionally, the Company recorded a $10.5
million net charge to establish a reserve for sales returns and allowances, a
$45.5 million charge to recognize declines in the value of investments, realized
a $57.9 million gain on the sale of investments, and recorded a $6.8 million net
credit to adjust prior period accrued merger costs.
The accrual for lease termination costs identified above was based on the future
commitments under contract, adjusted for anticipated sublease and termination
benefits. During 2002 and 2001, additional net charges of $6.7 million and $8.4
million, respectively, were recorded because of lower than anticipated
recoveries resulting from a softening in the market for sublease space. Future
changes in the market for real estate subleases may cause our current estimates
to change, therefore resulting in additional charges or credits to our future
results.The accrued balance relating to our future commitments under operating
leases of our closed stores was $60.4 million and $76.7 million at December 28,
2002 and December 29, 2001, respectively.
NOTE D--PROPERTY AND EQUIPMENT
Property and equipment consisted of:
DECEMBER 28, December 29,
(Dollars in thousands) 2002 2001
- -----------------------------------------------------------------
Land $ 79,253 $ 87,055
Buildings 253,930 239,012
Leasehold improvements 630,442 608,004
Furniture, fixtures and 1,098,897 960,831
equipment
- -----------------------------------------------------------------
2,062,522 1,894,902
Less accumulated depreciation (944,460) (795,284)
- -----------------------------------------------------------------
$1,118,062 $1,099,618
- -----------------------------------------------------------------
The above table of property and equipment includes assets held under capital
leases as follows:
DECEMBER 28, December 29,
(Dollars in thousands) 2002 2001
- -----------------------------------------------------------------
Buildings Furniture, $ 55,975 $55,975
fixtures and equipment 45,410 37,731
- -----------------------------------------------------------------
101,385 93,706
Less accumulated depreciation (40,590) (30,321)
- -----------------------------------------------------------------
$ 60,795 $ 63,385
- -----------------------------------------------------------------
NOTE E--GOODWILL AND INTANGIBLE ASSETS
The components of goodwill by segments are listed below:
DECEMBER 28, December 29,
(Dollars in thousands) 2002 2001
- -----------------------------------------------------------------
Goodwill:
North American Retail $ 1,470 $ 1,424
Business Services Group 229,950 213,269
International 26,377 28,069
- -------------------------------------------------------------------
Total goodwill $257,797 $242,762
The increase in goodwill reflects an election made during 2002 relating to the
tax treatment of the 4Sure.com acquisition. The election resulted in the use of
acquired net operating loss carryforwards and the related portion of goodwill
being deductible over 15 years for tax purposes. This treatment had no impact on
the results of operations or current period cash flows. The remaining change in
the value of goodwill reflects the impact of accounting for the Australian
business as a discontinued operation, as well as fluctuations in foreign
currency exchange rates. Under accounting rules that went into effect at the
beginning of 2002, goodwill and indefinite life intangible assets are no longer
amortized but are tested annually for impairment. Goodwill amortization in 2001
and 2000 was $5.2 million and $5.1 million, respectively. Without this
amortization, pro forma earnings per share would have increased by $0.02 for
both 2001 and 2000.
The net book value of intangible assets totaled $12.5 million at December 28,
2002 and $10.9 million at December 29, 2001 and is included in other assets in
the Consolidated Balance Sheets. Amortization of intangible assets was $1.5
million in 2002, $2.0 million in 2001, and $2.1 million in 2000. It is
anticipated that amortization expense will continue at approximately $1.5
million for 2003, $0.9 million for 2004, and $0.4 million per year for the three
years thereafter.
37
NOTE F--DEBT
The debt components consisted of the following:
DECEMBER 28, December 29,
(Dollars in thousands) 2002 2001
- ----------------------------------------------------------------------
Current maturities of long-term debt:
Capital lease obligations $14,469 $ 10,486
Zero coupon, convertible
subordinated notes -- 233,526
Yen borrowings -- 74,509
Other 1,646 --
- ----------------------------------------------------------------------
$16,115 $318,521
- ----------------------------------------------------------------------
Long-term debt, net of current maturities:
Yen borrowings $ 81,415 $ --
Senior subordinated notes 262,213 245,360
Capital lease obligations 65,095 69,971
Other 3,247 --
- ----------------------------------------------------------------------
$411,970 $315,331
- ----------------------------------------------------------------------
In April 2002, the Company replaced its 364-day credit agreement, domestic
credit facility, and its yen facility with a single credit facility through a
syndicate of banks. This new revolving credit facility provides for borrowings
in the aggregate amount of $600 million, including up to $150 million for
issuance of standby and trade letters of credit. This agreement is a three-year,
unsecured revolving credit facility maturing on April 24, 2005. Borrowings up to
the full amount of the facility are allowed in U.S. dollars, euros, British
pounds, or yen and will bear interest at a benchmark variable rate plus a spread
determined at the time of usage. For U.S. dollar borrowings, interest will be
based on the then-current London Interbank Offering Rate (LIBOR). For
international borrowings, interest will be based on the then-current
Eurocurrency rate. The Company can specify the benchmark rates for periods of
one, two, three or six months. Based on the Company's current credit ratings,
all borrowings would include a spread of 0.925%. The facility contains
restrictive covenants relating to various financial ratios. As of December 28,
2002, yen borrowings equivalent to $81.4 million were outstanding with an
average effective interest rate of 1.05%, and outstanding letters of credit
totaled $75.5 million.
Based on the termination date of the credit agreement outstanding at December
29, 2001, yen facility borrowings were classified as current maturities of
long-term debt in the Company's Consolidated Balance Sheet. Under the existing
facility, outstanding yen borrowings at December 28, 2002 are classified as
long-term debt.
In July 2001, the Company issued $250 million of seven year, non-callable,
senior subordinated notes due on July 15, 2008. The notes have a coupon interest
rate of 10.00%, payable semi-annually on January 15 and July 15. In August 2001,
the Company entered into LIBOR-based variable rate swap agreements to convert
the fixed interest rate on these notes. In September 2002, the Company
terminated these interest rate swap agreements and received proceeds of $18.8
million. The benefit associated with these proceeds is being amortized over the
remaining term of the notes, lowering the effective interest rate on this
borrowing to 8.7%.
In 1992 and 1993 the Company issued two series of zero coupon, convertible
subordinated notes (Liquid Yield Options Notes (LYONs(R))).The 1992 LYONs(R) had
an original maturity of December 2007 and contained an option feature allowing
each holder to put the security to the Company on December 11, 2002. Because of
the holder's option, the 1992 LYONs(R) were included in current maturities of
long-term debt in the accompanying Consolidated Balance Sheet as of December
29, 2001. In August 2002, the Company redeemed all of the 1992 LYONs(R) for $241
million, representing the original issue price plus accrued interest. In
September 2002, the Company also exercised its option to redeem the remaining
1993 LYONs(R)for $2.3 million, representing the remaining original issue price
plus accrued interest.
The Company is in compliance with all restrictive covenants included in the
above debt agreements.
Under capital lease agreements, the Company is required to make certain monthly,
quarterly or annual lease payments through 2020. The aggregate minimum capital
lease payments for the next five years and beyond, with their present value as
of December 28, 2002, are as follows:
December 28,
(Dollars in thousands) 2002
- ------------------------------------------------------------------
2003 $ 20,159
2004 13,193
2005 9,341
2006 6,790
2007 6,888
Thereafter 64,669
- ------------------------------------------------------------------
Total minimum lease payments 121,040
Less amount representing interest at 5.00% to 10.27% 41,476
- ------------------------------------------------------------------
Present value of net minimum lease payments 79,564
Less current portion 14,469
- ------------------------------------------------------------------
Long-term portion $ 65,095
- ------------------------------------------------------------------
NOTE G--INCOME TAXES
The income tax provision consisted of the following:
(Dollars in thousands) 2002 2001 2000
- ----------------------------------------------------------------------
Current:
Federal $114,420 $ 66,074 $ 71,407
State 14,181 12,904 22,616
Foreign 29,127 33,122 29,763
Deferred 9,994 196 (81,814)
- ----------------------------------------------------------------------
Total provision for income taxes $167,722 $112,296 $41,972
- ----------------------------------------------------------------------
The components of earnings from continuing operations before income taxes
consisted of the following:
(Dollars in thousands) 2002 2001 2000
- ----------------------------------------------------------------------
North America $352,645 $176,711 $ 6,710
International 126,560 137,242 83,577
- ----------------------------------------------------------------------
Total $479,205 $313,953 $90,287
- ----------------------------------------------------------------------
38
The tax-effected components of deferred income tax assets and liabilities
consisted of the following:
DECEMBER 28, December 29,
(Dollars in thousands) 2002 2001
- ---------------------------------------------------------------------
Self-insurance accruals $ 26,049 $ 28,020
Inventory 34,125 25,150
Vacation pay and other
accrued compensation 31,558 29,670
Reserve for bad debts 4,585 12,724
Reserve for facility closings 52,637 56,151
Merger costs 4,934 5,304
Unrealized loss on investments 20,279 19,266
Foreign and state net operating
loss carryforwards 86,281 88,006
Other items, net 39,545 23,451
- ---------------------------------------------------------------------
Gross deferred tax assets 299,993 287,742
Valuation allowance (86,281) (72,605)
- ---------------------------------------------------------------------
Deferred tax assets 213,712 215,137
- ---------------------------------------------------------------------
Basis difference in fixed assets 81,016 71,880
Capitalized leases 5,417 5,573
Excess of tax over book amortization 3,356 3,641
Other items, net 1,730 1,856
- ---------------------------------------------------------------------
Deferred tax liabilities 91,519 82,950
- ---------------------------------------------------------------------
Net deferred tax assets $122,193 $132,187
=====================================================================
As of December 28, 2002, we had approximately $148 million of foreign and $751
million of state net operating loss carryforwards. Of these carryforwards,
approximately $19 million will expire in 2003, $10 million will carry over
indefinitely, and the balance will expire between 2004 and 2022. The valuation
allowance has been developed to reduce our deferred tax asset to an amount that
is more likely than not to be realized, and is based upon the uncertainty of
the realization of certain foreign and state deferred tax assets relating to
net operating loss carryforwards. Also, during 2002, we made an election that
resulted in the utilization of acquired net operating losses associated with
4Sure.com. This election reduced deferred tax assets and increased goodwill
(see Note E), with no impact on results of operations or current period cash
flow. This and certain other non-cash items have been removed for cash flow
presentation.
The following is a reconciliation of income taxes at the Federal statutory rate
to the provision for income taxes:
(Dollars in thousands) 2002 2001 2000
- --------------------------------------------------------------------------
Federal tax computed
at the statutory rate $167,721 $109,945 $ 32,361
State taxes, net of
Federal benefit 8,526 13,333 6,899
Non-deductible
goodwill amortization -- 1,834 1,744
Foreign income taxed
at rates other than Federal (12,656) (14,534) (1,822)
Other items, net 4,131 1,718 2,790
- --------------------------------------------------------------------------
Provision for income taxes $167,722 $112,296 $ 41,972
==========================================================================
NOTE H--COMMITMENTS AND CONTINGENCIES
OPERATING LEASES: Office Depot leases facilities and equipment under agreements
that expire in various years through 2029. Substantially all such leases
contain provisions for multiple renewal options. In addition to minimum
rentals, there are certain executory costs such as real estate taxes, insurance
and common area maintenance on most of our facility leases. Certain leases
contain provisions for additional rent to be paid if sales exceed a specified
amount. The table below shows future minimum lease payments due under
non-cancelable leases as of December 28, 2002. These minimum lease payments
include facility leases that were accrued as store closure costs (See Note C).
(Dollars in thousands)
- ----------------------------------------
2003 $ 390,771
2004 353,042
2005 308,916
2006 272,697
2007 251,148
Thereafter 1,118,332
- ----------------------------------------
2,694,906
Less sublease income 90,718
- ----------------------------------------
$2,604,188
========================================
The Company is in the process of opening new stores and CSCs in the ordinary
course of business, and leases signed subsequent to December 28, 2002 are not
included in the above described commitment amounts. Rent expense, including
equipment rental, was approximately $404.9 million, $398.1 million and $393.5
million in 2002, 2001, and 2000, respectively. Included in this rent expense
was approximately $0.7 million, $0.7 million, and $1.1 million of contingent
rent, otherwise known as percentage rent, in 2002, 2001, and 2000,
respectively. Rent expense was reduced by sublease income of approximately $2.9
million in 2002, $3.0 million in both 2001 and 2000.
GUARANTEE OF PRIVATE LABEL CREDIT CARD RECEIVABLES: Office Depot has private
label credit card programs that are managed by a financial services company.
The Company acts as the guarantor of all loans between our commercial customers
and the financial services company. The difference between the transfer amount
and the amount received is recognized in store and warehouse operating and
selling expense. Maximum exposure to off-balance sheet credit risk is
represented by the outstanding balance of private label credit card receivables
transferred, less reserves held by the financial services company which are
funded by us. At December 28, 2002, the transferred amount totaled
approximately $265.4 million. The fair value liability associated with risk of
loss is included in accrued expenses.
OTHER: We are involved in litigation arising in the normal course of business.
In our opinion, these matters will not materially affect our financial position
or results of operations.
NOTE I--EMPLOYEE BENEFIT PLANS
LONG-TERM EQUITY INCENTIVE PLAN
The Long-Term Equity Incentive Plan, which was approved by the Company's
stockholders, effective October 1, 1997. This plan provides
39
for the grants of stock options and other incentive awards, including
restricted stock, to directors, officers and key employees. Under this plan,
stock options must be granted at an option price that is greater than or equal
to the market price of the stock on the date of the grant. If an employee owns
at least 10% of the Company's outstanding common stock, the option price must
be at least 110% of the market price on the date of the grant. Options granted
under this plan become exercisable from one to five years after the date of
grant, provided that the individual is continuously employed with the Company.
All options granted expire no more than 10 years following the date of grant.
To date under this plan, 331,193 shares of restricted stock were issued at no
cost to the employees, 63,565 of which have been canceled and 170,000 remain
outstanding but restricted. The fair market value of these awards approximated
$4.1 million at the date of the grants. Restricted stock issued under this plan
may have vesting periods of up to four years from the date of grant.
Compensation expense is recognized on a straight-line basis over the vesting
period.
In April 2002, stockholders approved an amendment to the plan allowing the
Compensation Committee of the Board of Directors to grant performance-based
shares to our senior executives and directors. Performance-based shares are
used as an incentive to increase shareholder returns with actual awards based
on the Company's Total Shareholder Return over a three-year period, compared
against the industry peer group. Compensation expense for the anticipated
number of shares to be issued, if any, will be recognized over the vesting
period. Depending on actual Company performance, shares issued may be more or
less than amounts assigned. As of December 28, 2002, target awards of 252,500
shares have been assigned, but no performance-based shares have been issued.
Tax benefits are recorded based on an estimate of stock options activity. Each
year, the prior year's estimated tax benefit is adjusted based on the actual
stock sold during the year. Tax benefits received in excess of compensation
expense recorded on nonqualified stock options are credited to additional
paid-in capital.
LONG-TERM INCENTIVE STOCK PLAN
Prior to our merger with Viking Office Products ("Viking") in 1998, Viking's
Long-Term Incentive Stock Plan allowed awards of up to 2,400,000 restricted
shares of common stock to key Viking employees. Under this plan, 1,845,000
shares were issued at no cost to employees, of which 1,380,000 have been
canceled or the restrictions satisfied, leaving 465,000 restricted shares
outstanding. Pursuant to the merger agreement, shares issued under this plan
were converted to Office Depot common stock, and no additional shares may be
issued under the plan. The fair market value of these restricted stock awards
approximated $10.0 million at the date of the grants. Prior to the merger, the
vesting period was 15 years. Because of the plan's change in control provision,
however, the employees now vest in their stock ratably over the 15-year period.
Compensation expense is recognized on a straight-line basis over the vesting
period.
A summary of the status of and changes in our stock option plans for the last
three years is presented below.
2002 2001 2000
----------------------- ---------------------- ----------------------
WEIGHTED Weighted Weighted
AVERAGE Average Average
EXERCISE Exercise Exercise
SHARES PRICE Shares Price Shares Price
- ---------------------------------------------------------------------------------------------------------------------
Outstanding at beginning of year 35,750,521 $13.46 36,406,229 $12.81 33,507,066 $15.31
Granted 6,926,250 16.39 7,509,000 10.63 9,937,750 8.73
Canceled (3,014,831) 14.74 (2,642,428) 13.99 (6,608,072) 16.45
Exercised (8,162,308) 10.80 (5,522,280) 7.93 (430,515) 6.18
- ---------------------------------------------------------------------------------------------------------------------
Outstanding at end of year 31,499,632 $14.69 35,750,521 $13.46 36,406,229 $12.81
=====================================================================================================================
As of December 28, 2002, the weighted average fair values of options granted
during 2002, 2001, and 2000 were $6.38, $4.21, and $4.18, respectively.
The following table summarizes information about options outstanding at
December 28, 2002.
Options Outstanding Options Exercisable
------------------------------------------------------ -----------------------------------
Weighted Average Weighted Weighted
Range of Number Remaining Contractual Average Number Average
Exercise Prices Outstanding Life (in years) Exercise Price Exercisable Exercise Price
- -----------------------------------------------------------------------------------------------------------------
$ 0.17-$ 1.95 5,400 2.5 $ 0.17 5,400 $ 0.17
1.96- 2.94 -- -- -- -- --
2.95- 4.42 3,000 -- 4.04 3,000 4.04
4.43- 6.64 375,360 6.9 6.30 235,983 6.24
6.65- 9.97 7,326,314 7.5 8.49 2,153,301 8.71
9.98- 14.96 6,101,702 5.8 11.66 4,183,239 11.98
14.97- 22.45 15,707,776 6.2 17.76 8,563,456 18.37
22.46- 25.00 1,980,080 5.7 24.19 1,649,580 24.20
- -----------------------------------------------------------------------------------------------------------------
$ 0.17-$25.00 31,499,632 6.4 $14.16 16,793,959 $15.93
=================================================================================================================
40
EMPLOYEE STOCK PURCHASE PLAN
The Employee Stock Purchase Plan, which was approved by the Company's
stockholders, effective July 1999, permits eligible employees to purchase our
common stock at 85% of its fair market value. A similar plan is available to
employees in the United Kingdom. Effective April 2002, share needs under this
plan are now satisfied through open market purchases. However, the Company is
authorized to issue up to 1,862,843 shares under this plan.
RETIREMENT SAVINGS PLANS
The Office Depot retirement savings plan, which was approved by the Board of
Directors, allows eligible employees to contribute up to 18% of their salary,
commissions and bonuses, up to $11,000 annually, to the plan on a pretax basis
in accordance with the provisions of Section 401(k) of the Internal Revenue
Code. Matching contributions of common stock that are made into the plan are
equivalent to 50% of the first 6% of an employee's contributions. However,
discretionary matching common stock contributions in addition to the normal
match may be made. A separate, but identical, retirement savings plan is
offered to employees of 4Sure.com. The Company also has a deferred compensation
plan that permits eligible employees who are limited in the amount they can
contribute to the 401(k) plan to alternatively make tax-deferred contributions
of up to 18% of their salary, commissions and bonuses to this plan. Matching
contributions to the deferred compensation plan are similar to those under our
401(k) retirement savings plan described above. During 2002, 2001, and 2000,
$8.4 million, 4.0 million and 5.8 million, respectively, was recorded as
compensation expense under these programs.
The following is a summary of the Company's equity compensation plans:
Number of securities to be issued Number of securities
upon exercise of outstanding Weighted average remaining available
Plan options, warrants, and rights exercise price for future issuance
- ----------------------------------------------------------------------------------------------------------------------------------
Long-Term Equity Incentive Plan (including the
Long-Term Incentive Stock Plan)(1) 31,499,632 $14.69 9,436,540
- ----------------------------------------------------------------------------------------------------------------------------------
Employee Stock Purchase Plan (ESPP) Not Applicable Not Applicable 1,862,843(2)
- ----------------------------------------------------------------------------------------------------------------------------------
Retirement Savings Plans Not Applicable Not Applicable Not Applicable(2)
==================================================================================================================================
(1) Outstanding options under the Long-Term Incentive Stock Plan are satisfied
upon exercise with available securities from the Long-Term Equity
Incentive Plan.
(2) Effective April 2002, the Company now settles share needs under the ESPP,
the 401(k) Plan, and related deferred compensation plan, by open market
purchases through the respective plan administrators.
NOTE J--CAPITAL STOCK
PREFERRED STOCK
As of December 28, 2002, there were 1,000,000 shares of $.01 par value
preferred stock authorized of which none are issued or outstanding.
STOCKHOLDER RIGHTS PLAN
Effective September 4, 1996, the Company adopted a Stockholder Rights Plan (the
"Rights Plan"). Under this Rights Plan, each stockholder is issued one right to
acquire one one-thousandth of a share of Junior Participating Preferred Stock,
Series A at an exercise price of $63.33, subject to adjustment, for each
outstanding share of Office Depot common stock they own. These rights are only
exercisable if a single person or company were to acquire 20% or more of our
outstanding common stock or if the Company announced a tender or exchange offer
that would result in 20% or more of our common stock being acquired.
If the Company were acquired, each right, except those of the acquirer, can be
exchanged for shares of common stock in the Company with a market value of
twice the exercise price of the right. In addition, if the Company becomes
involved in a merger or other business combination where (1) the Company was
not the surviving company, (2) the Company's common stock was changed or
exchanged, or (3) 50% or more of the Company's assets or earning power was
sold, then each right, except those of the acquirer, and an amount equal to the
exercise price of the right can be exchanged for shares of the Company's common
stock with a market value of twice the exercise price of the right.
The Company may redeem the rights for $0.01 per right at any time prior to an
acquisition.
TREASURY STOCK
During 2000, under a program approved by the Board of Directors, the Company
repurchased 35.4 million shares of stock at a total cost of $300.8 million. In
2001, the Board approved stock repurchases of up to $50 million per year until
cancelled by the Board, subject to their annual review. Approximately 252,000
shares were purchased under this program in 2001 for a total cost of $4.2
million. During 2002, 2.9 million shares were purchased under this program at a
total cost of $45.9 million.
NOTE K--EARNINGS PER SHARE
Basic earnings per share is based on the weighted average number of shares
outstanding during each period. Diluted earnings per share further assumes that
the zero coupon, convertible subordinated notes, if outstanding and dilutive,
are converted as of the beginning of the period and that, under the treasury
stock method, dilutive stock options are exercised. Net earnings under this
assumption have been adjusted for interest on the zero coupon, convertible
subordinated notes when outstanding, net of the related income tax effect.
41
The information required to compute basic and diluted net earnings per share is
as follows:
(In thousands) 2002 2001 2000
- ------------------------------------------------------------------------------
Basic:
Weighted average number of
common shares outstanding 306,778 298,054 309,301
- ------------------------------------------------------------------------------
Diluted:
Net earnings $310,708 $201,043 $ 49,332
Interest expense related to
convertible notes, net of tax 4,795 7,238 --
- ------------------------------------------------------------------------------
Adjusted net earnings $315,503 $208,281 $ 49,332
- ------------------------------------------------------------------------------
Weighted average number of
common shares outstanding 306,778 298,054 309,301
Shares issued upon assumed
conversion of convertible notes 9,033 13,846 --
Shares issued upon assumed
exercise of stock options 6,389 4,524 1,930
- ------------------------------------------------------------------------------
Shares used in computing diluted
net earnings per common share 322,200 316,424 311,231
- ------------------------------------------------------------------------------
For 2000, the zero coupon convertible subordinated notes would have been
anti-dilutive, and therefore the shares (23.0 million) and related interest
expense ($12.1 million) were excluded from our calculation of diluted earnings
per share. Options to purchase 17.5 million shares of common stock were not
included in our computation of diluted earnings per share for 2002 because
their effect would have been anti-dilutive.
NOTE L--SUPPLEMENTAL INFORMATION ON OPERATING, INVESTING AND FINANCING
ACTIVITIES
Additional supplemental information related to the Consolidated Statements of
Cash Flows is as follows:
(Dollars in thousands) 2002 2001 2000
- --------------------------------------------------------------------------
Cash paid for:
Interest $ 47,114 $16,905 $ 7,880
Taxes 111,597 13,080 132,504
Non-cash asset additions
under capital leases 10,395 8,256 12,569
Additional paid-in capital related
to tax benefit on stock options
exercised (See Note I) 20,453 10,218 (4,640)
===========================================================================
NOTE M--SEGMENT INFORMATION
Office Depot operates in three reportable segments: North American Retail
Division, Business Services Group ("BSG"), and International Division. Each of
these segments is managed separately primarily because it serves different
customer groups. The accounting policies for each segment are the same as those
described in the summary of significant accounting policies (see Note A).
The following is a summary of the significant accounts and balances by segment,
reconciled to the consolidated totals.
North American
Retail International Eliminations Consolidated
(Dollars in Thousands) Division BSG Division and Other* Total
- ----------------------------------------------------------------------------------------------------------------------
Sales 2002 $5,804,449 $3,913,902 $1,641,411 $ (3,129) $11,356,633
2001 5,842,648 3,763,006 1,480,103 (3,645) 11,082,112
2000 6,487,522 3,618,768 1,393,154 (3,951) 11,495,493
- ----------------------------------------------------------------------------------------------------------------------
Segment Operating Profit 2002 $ 419,738 $ 364,624 $ 212,127 $ (647) $ 995,842
2001 308,300 291,208 212,179 (655) 811,032
2000 216,975 177,286 167,382 (224) 561,419
- ----------------------------------------------------------------------------------------------------------------------
Capital Expenditures 2002 $ 50,149 $ 28,524 $ 67,551 $ 55,994 $ 202,218
2001 76,337 44,087 57,509 30,123 208,056
2000 106,646 55,690 32,264 72,398 266,998
- ----------------------------------------------------------------------------------------------------------------------
Depreciation and Amortization 2002 $ 88,737 $ 39,336 $ 16,487 $ 56,187 $ 200,747
2001 88,227 45,699 15,973 48,324 198,223
2000 92,276 42,588 16,853 52,536 204,253
- ----------------------------------------------------------------------------------------------------------------------
Charges for Losses on 2002 $ 36,627 $ 36,991 $ 19,602 -- $ 93,220
Receivables and Inventories 2001 35,739 53,712 19,239 -- 108,690
2000 30,121 57,628 30,902 -- 118,651
- ----------------------------------------------------------------------------------------------------------------------
Net Earnings from 2002 -- -- $ 9,279 -- $ 9,279
Equity Method Investments 2001 -- -- 10,892 -- 10,892
2000 -- -- 9,436 -- 9,436
- ----------------------------------------------------------------------------------------------------------------------
Assets 2002 $1,695,907 $1,115,586 $ 771,734 $1,182,585 $ 4,765,812
2001 1,802,278 1,138,200 621,059 770,106 4,331,643
======================================================================================================================
* Amounts included in "Eliminations and Other" consist of inter-segment sales,
which are generally recorded at the cost to the selling entity, and assets
(including all cash and equivalents) and depreciation related to corporate
activities.
42
Senior management evaluates the performance of each business segment based on
segment operating profit, which is defined as sales less cost of sales, store
and warehouse operating expenses, and facility closure costs. General and
administrative expenses, financing costs and certain other items are not
allocated to the business segments because they are viewed as corporate
functions that support all activities and the cost of allocation would exceed
the benefit received. A reconciliation of the measure of segment operating
profit to consolidated earnings from continuing operations before income taxes
follows.
(Dollars in thousands) 2002 2001 2000
- ---------------------------------------------------------------------------------
Segment operating profit $ 995,842 $811,032 $ 561,419
(Add)/subtract:
General and administrative 486,279 445,538 447,693
expenses
Other operating expenses 9,855 12,125 6,733
Interest expense, net 27,686 30,359 21,338
Miscellaneous (income) expense (7,183) 9,057 (4,632)
- ---------------------------------------------------------------------------------
Earnings from continuing
operations before income taxes $479,205 $313,953 $ 90,287
- ---------------------------------------------------------------------------------
The Company sells office products and services through either wholly owned
operations or through joint ventures or licensing arrangements, in Austria,
Belgium, Canada, Costa Rica, France, Germany, Guatemala, Hungary, Ireland,
Israel, Italy, Japan, Luxembourg, Mexico, the Netherlands, Poland, Portugal,
Spain, Switzerland, Thailand, the United Kingdom and the United States. There
is no single country outside of the United States in which we generate 10% or
more of our total revenues. Geographic financial information relating to our
business is as follows.
Sales Long-Lived Assets
------------------------------------------------- ----------------------------
(Dollars in thousands) 2002 2001 2000 2002 2001
- ---------------------------------------------------------------------------------------------------------------
United States $ 9,575,457 $ 9,452,453 $ 9,901,975 $ 874,247 $ 913,987
International 1,781,176 1,629,659 1,593,518 243,815 185,631
- ---------------------------------------------------------------------------------------------------------------
Total $11,356,633 $11,082,112 $11,495,493 $1,118,062 $1,099,618
- ---------------------------------------------------------------------------------------------------------------
NOTE N--QUARTERLY FINANCIAL DATA (UNAUDITED)
(In thousands, except per share amounts) First Quarter Second Quarter Third Quarter Fourth Quarter
- -----------------------------------------------------------------------------------------------------------------------------
Fiscal Year Ended December 28, 2002
Net sales $ 3,021,873 $ 2,622,259 $ 2,870,781 $ 2,841,720
Gross profit 876,096 763,397 850,429 844,048
Earnings from continuing operations 102,062 56,869 87,131 65,421
Net earnings 102,710 56,943 88,172 62,883
Earnings per share from continuing operations:
Basic $ 0.34 $ 0.18 $ 0.28 $ 0.21
Diluted 0.32 0.18 0.27 0.21
Earnings per share from discontinued operations:
Basic $ -- $ 0.01 $ 0.01 $ (0.01)
Diluted -- -- 0.01 (0.01)
Net earnings per share:
Basic $ 0.34 $ 0.19 $ 0.29 $ 0.20
Diluted 0.32 0.18 0.28 0.20
Fiscal Year Ended December 29, 2001
Net sales $ 3,001,827 $ 2,534,558 $ 2,763,318 $ 2,782,409
Gross profit 799,941 731,194 801,079 809,831
Earnings from continuing operations 55,668 41,381 62,113 42,495
Net earnings 56,329 41,974 62,460 40,280
Earnings per share from continuing operations:
Basic $ 0.19 $ 0.14 $ 0.21 $ 0.14
Diluted 0.18 0.14 0.20 0.14
Earnings per share from discontinued operations:
Basic $ -- $ -- $ -- $ (0.01)
Diluted 0.01 -- -- (0.01)
Net earnings per share:
Basic $ 0.19 $ 0.14 $ 0.21 $ 0.13
Diluted 0.19 0.14 0.20 0.13
- -----------------------------------------------------------------------------------------------------------------------------
43
CORPORATE & STOCKHOLDER INFORMATION
CORPORATE OFFICES
2200 Old Germantown Road
Delray Beach, FL 33445
(561) 438-4800
web site: www.officedepot.com
ANNUAL MEETING
May 1, 2003 at 10:00 a.m. (ET)
Deerfield Beach/Boca Raton Hilton
100 Fairway Drive
Deerfield Beach, Florida 33441
PH: (954) 427-7700
CERTIFIED PUBLIC ACCOUNTANTS
Deloitte & Touche LLP
Miami, FL
TRANSFER AGENT & REGISTRAR
Mellon Investor Services, LLC
P.O. Box 3315
South Hackensack, NJ 07606
(800) 681-8059
web site: www.mellon-investor.com
TRUSTEE FOR 10% SENIOR SUBORDINATED NOTES DUE 2OO8
SunTrust Bank
777 Brickell Avenue
Miami, FL 33131
COMMON STOCK
Office Depot's common stock is quoted on the New York Stock Exchange under the
symbol ODP. As of December 28, 2002, there were 3,825 stockholders of record.
This number excludes individual stockholders holding stock under nominee
security position listings.
DIRECT STOCK PURCHASE PLAN
New investors and current stockholders of record may acquire shares of Office
Depot's common stock through the Company's direct stock purchase plan.
Enrollment materials, including the prospectus, are available on the Company's
web site, under Company Information/Investor Relations/Stock Purchase, or call
Mellon Investor Services at (800) 681-8059.
DIVIDEND POLICY
The Company has never declared or paid cash dividends on its common stock and
does not intend to pay cash dividends, under current tax laws, in the
foreseeable future.
FORM 1O-K
A Form 10-K is available without charge on-line at www.officedepot.com, or
through www.sec.gov.
It is also available upon written request to:
Investor Relations
Office Depot, Inc.
2200 Old Germantown Road
Delray Beach, FL 33445
(561) 438-7641
QUARTERLY STOCKHOLDER REPORTS
Office Depot's quarterly stockholders' information is provided on the Company's
web site (www.officedepot.com) under Company Information/Investor Relations/SEC
Filings.
QUARTERLY STOCK PRICE RANGE
The following table sets forth, for the periods indicated, the high and low
sales prices of the Company's common stock quoted on the NYSE Composite Tape.
These prices do not include retail mark-ups, mark-downs or commissions:
2002 High Low
- ------------------------------------------------
First Quarter $20.400 $15.500
Second Quarter $21.960 $15.460
Third Quarter $17.000 $10.600
Fourth Quarter $18.090 $10.700
2001 High Low
- ------------------------------------------------
First Quarter $10.200 $ 7.125
Second Quarter $10.650 $ 8.250
Third Quarter $14.250 $ 9.740
Fourth Quarter $18.580 $13.330
44