This report should be read in conjunction with the Notes to Condensed Consolidated Financial Statements herein and the Notes to Consolidated Financial Statements in the Office Depot, Inc. Annual Report on Form 10-K filed on February 26, 2020 (the “2019 Form 10-K”).
This report should be read in conjunction with the Notes to Condensed Consolidated Financial Statements herein and the Notes to Consolidated Financial Statements in the 2019 Form 10-K.
This report should be read in conjunction with the Notes to Condensed Consolidated Financial Statements herein and the Notes to Consolidated Financial Statements in the 2019 Form 10-K.
This report should be read in conjunction with the Notes to Condensed Consolidated Financial Statements herein and the Notes to Consolidated Financial Statements in the 2019 Form 10-K.
This report should be read in conjunction with the Notes to Condensed Consolidated Financial Statements herein and the Notes to Consolidated Financial Statements in the 2019 Form 10-K.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
Office Depot, Inc. including its consolidated subsidiaries (“Office Depot” or the “Company”), is a leading provider of business services and supplies, products and technology solutions to small, medium and enterprise businesses, through an integrated business-to-business (“B2B”) distribution platform of 1,295 retail stores, online presence, and dedicated sales professionals and technicians. Through its banner brands Office Depot®, OfficeMax®, CompuCom® and Grand&Toy®, as well as others, the Company offers its customers the tools and resources they need to focus on starting, growing and running their business. The Company’s corporate headquarters is located in Boca Raton, FL, and its primary website is www.officedepot.com.
At March 28, 2020, the Company had three reportable segments (or “Divisions”): Business Solutions Division, Retail Division and the CompuCom Division.
The Condensed Consolidated Financial Statements as of March 28, 2020, and for the 13-week period ended March 28, 2020 (also referred to as the “first quarter of 2020”) and March 30, 2019 (also referred to as the “first quarter of 2019”) are unaudited. However, in management’s opinion, these Condensed Consolidated Financial Statements reflect all adjustments of a normal recurring nature necessary to provide a fair presentation of the Company’s financial position, results of operations and cash flows for the periods presented. Business acquisitions in 2019 and 2020 are included prospectively from the date of acquisition, thus affecting the comparability of the Company’s financial statements for all periods presented in this report on Form 10-Q.
The Company has prepared the Condensed Consolidated Financial Statements included herein pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). Some information and note disclosures, which would normally be included in comprehensive annual financial statements prepared in accordance with accounting principles generally accepted in the United States (“GAAP”), have been condensed or omitted pursuant to those SEC rules and regulations. The preparation of these Condensed Consolidated Financial Statements requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. For a better understanding of the Company and its Condensed Consolidated Financial Statements, the Company recommends reading these Condensed Consolidated Financial Statements in conjunction with the audited financial statements, which are included in the Company’s 2019 Form 10-K. These interim results are not necessarily indicative of the results that should be expected for the full year.
CORPORATE REORGANIZATION
On March 31, 2020, the Board of Directors of the Company approved proceeding with the implementation of a reorganization (the “Reorganization”) of the Company's corporate structure into a holding company structure. When implemented, Office Depot will become a wholly owned subsidiary of a new holding company, The ODP Corporation, which will replace Office Depot as the public company trading on the NASDAQ Stock Market under Office Depot’s current ticker symbol “ODP”. Outstanding shares of Office Depot will be automatically converted into shares of common stock of The ODP Corporation. The holding company reorganization is intended to simplify the Company’s legal entity and tax structure, more closely align the Company’s operating assets to their respective operating channels within the legal entity structure, and increase its operational flexibility. It is not expected to result in a change in the directors, executive officers, management or business of the Company.
The Reorganization is intended to be a tax-free transaction for U.S. federal income tax purposes for the Company’s shareholders, and subject to obtaining required approvals or any other intervening developments, is expected to be completed on or about the end of the 13-week period ending June 27, 2020 (also referred to as the “second quarter of 2020”).
CASH MANAGEMENT
The cash management process generally utilizes zero balance accounts which provide for the settlement of the related disbursement and cash concentration accounts on a daily basis. Amounts not yet presented for payment to zero balance disbursement accounts of $31 million and $25 million at March 28, 2020 and December 28, 2019, respectively, are presented in Trade accounts payable and Accrued expenses and other current liabilities.
At March 28, 2020 and December 28, 2019, cash and cash equivalents held outside the United States amounted to $187 million and $190 million, respectively.
Restricted cash consists primarily of short-term cash deposits having original maturity dates of twelve months or less that serve as collateral to certain of the Company’s letters of credit. Restricted cash is valued at cost, which approximates fair value. At March 28, 2020 and December 28, 2019, restricted cash amounted to $2 million and is included in Prepaid expenses and other current assets in the Condensed Consolidated Balance Sheets.
8
OFFICE DEPOT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) – (Continued)
NEW ACCOUNTING STANDARDS
Standards that are not yet adopted:
Defined benefit plan: In August 2018, the Financial Accounting Standards Board (“FASB”) issued an accounting standards update that modifies the disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. This accounting update is effective for fiscal years beginning after December 15, 2020 and interim periods within those fiscal years, with early adoption permitted. The Company is evaluating the impact of this new standard and believes the adoption will not have a material impact on its Condensed Consolidated Financial Statements.
Income Taxes: In December 2019, the FASB issued an accounting standards update that simplifies the accounting for income taxes by eliminating certain exceptions to the guidance related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and the recognition of deferred tax liabilities for outside basis differences. The accounting standards update also simplifies aspects of the accounting for franchise taxes and enacted changes in tax laws or rates and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. This accounting update is effective for fiscal years beginning after December 15, 2020 and interim periods within those fiscal years, with early adoption permitted. The Company is evaluating the impact of this new standard and believes the adoption will not have a material impact on its Condensed Consolidated Financial Statements.
Standards that were adopted:
Financial Instruments – Credit Losses: In June 2016, the FASB issued an accounting standard update that modifies the measurement of expected credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. The update changes the accounting for credit impairment by adding an impairment model that is based on expected losses rather than incurred losses. In July 2018, the FASB approved an amendment to the new guidance that provides transition relief to the adopting entities and allows for an election of the fair value option on certain financial instruments.
The Company adopted this accounting standard on the first day of the first quarter of 2020, and recognized a cumulative effect adjustment of $1 million, net of tax, to its accumulated deficit related to increasing the allowance for doubtful accounts within its receivables. The adoption of this new guidance did not result in any other changes and did not have a material impact on the Company’s Condensed Consolidated Financial Statements.
Cloud computing arrangements: In August 2018, the FASB issued an accounting standard update that provides guidance regarding the accounting for implementation costs in cloud computing arrangements. The Company adopted this accounting standard update on the first day of the first quarter of 2020 with no material impact on its Condensed Consolidated Financial Statements.
9
OFFICE DEPOT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) – (Continued)
NOTE 2. ACQUISITIONS
Since 2017, the Company has been undergoing a strategic business transformation to pivot into an integrated B2B distribution platform, with the objective of expanding its product offerings to include value-added services for its customers and capture greater market share. As part of this transformation, the Company has been acquiring businesses to expand its reach and distribution network into geographic areas that were previously underserved. During the first quarter of 2020, the Company acquired three small independent regional office supply distribution businesses.
The aggregate total purchase consideration, including contingent consideration, for the three acquisitions completed in the first quarter of 2020 was approximately $20 million, subject to certain customary post-closing adjustments. The aggregate purchase price was primarily funded with cash on hand, with the remainder consisting of contingent consideration estimated to be $2 million, which will be paid in two installments in the second quarters of 2021 and 2022, respectively. The acquisitions were treated as purchases in accordance with ASC 805, Business Combinations (“ASC 805”) which requires allocation of the purchase price to the estimated fair values of assets and liabilities acquired in the transactions including goodwill and other intangible assets. The Company has performed a preliminary purchase price allocation of the aggregate purchase price to the estimated fair values of assets and liabilities acquired in the transactions, including $4 million of customer relationship intangible assets and $10 million of goodwill. An immaterial amount of the aggregate purchase price was allocated to working capital accounts. These assets and liabilities are included in the Condensed Consolidated Balance Sheet as of March 28, 2020. As additional information is obtained about these assets and liabilities within the measurement period (not to exceed one year from the dates of acquisition), the Company will refine its estimates of fair value to allocate the purchase price. The operating results of the acquired office supply distribution businesses are combined with the Company’s operating results subsequent to their purchase dates, and are included in the Business Solutions Division. Certain disclosures set forth under ASC 805, including supplemental pro forma financial information, are not disclosed because the operating results of the acquired businesses, individually and in the aggregate, are not material to the Company.
Based on new information received, the preliminary purchase price allocations of the companies acquired in 2019 have been adjusted during the respective measurement periods. These adjustments were insignificant individually and in the aggregate to the Company’s Condensed Consolidated Financial Statements. The measurement periods for acquisitions completed in the first quarter of 2019 closed within the first quarter of 2020.
Under the guidance on accounting for business combinations, merger and integration costs are not included as components of consideration transferred, instead, they are accounted for as expenses in the period in which the costs are incurred. Transaction-related expenses are included in the Merger and restructuring expenses, net line in the Condensed Consolidated Statements of Operations. Refer to Note 3 for additional information about the merger and restructuring expenses incurred during the first quarter of 2020.
NOTE 3. MERGER AND RESTRUCTURING ACTIVITY
Since 2017, the Company has taken actions to optimize its asset base and drive operational efficiencies. These actions include acquiring profitable businesses, closing underperforming retail stores and non-strategic distribution facilities, consolidating functional activities, eliminating redundant positions and disposing of non-strategic businesses and assets. The expenses and any income recognized directly associated with these actions are included in Merger and restructuring expenses, net on a separate line in the Condensed Consolidated Statements of Operations in order to identify these activities apart from the expenses incurred to sell to and service its customers. These expenses are not included in the determination of Division operating income. The table below summarizes the major components of Merger and restructuring expenses, net.
|
|
First Quarter
|
|
(In millions)
|
|
2020
|
|
|
2019
|
|
Merger and transaction related expenses
|
|
|
|
|
|
|
|
|
Severance and retention
|
|
$
|
—
|
|
|
$
|
1
|
|
Transaction and integration
|
|
|
7
|
|
|
|
7
|
|
Total Merger and transaction related expenses
|
|
|
7
|
|
|
|
8
|
|
Restructuring expenses
|
|
|
|
|
|
|
|
|
Professional fees
|
|
|
6
|
|
|
|
3
|
|
Facility closure, contract termination, and other expenses, net
|
|
|
3
|
|
|
|
3
|
|
Total Restructuring expenses
|
|
|
9
|
|
|
|
6
|
|
Total Merger and restructuring expenses, net
|
|
$
|
16
|
|
|
$
|
14
|
|
10
OFFICE DEPOT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) – (Continued)
MERGER AND TRANSACTION RELATED EXPENSES
In the first quarter of 2020, the Company incurred $7 million of merger and transaction related expenses. Severance and retention include expenses related to the integration of staff functions in connection with business acquisitions and are expensed through the severance and retention period. Transaction and integration include legal, accounting, and other third-party expenses incurred in connection with acquisitions and business integration activities primarily related to CompuCom. Facility closure, contract termination, and other expenses, net relate to facility closure accruals, contract termination costs, gains and losses on asset dispositions, and accelerated depreciation.
RESTRUCTURING EXPENSES
Business Acceleration Program
In May 2019, the Company’s Board of Directors approved a company-wide, multi-year, cost reduction and business improvement program to systematically drive down costs, improve operational efficiencies, and enable future growth investments. Under this program (the “Business Acceleration Program”), the Company has made and will continue to make organizational realignments stemming from process improvements, increased leverage of technology and accelerated use of automation. This has resulted and will continue to result in the elimination of certain positions and a flatter organization. In connection with the Business Acceleration Program, the Company also anticipates closing approximately 90 underperforming retail stores in 2020 and 2021, and 9 other facilities, consisting of distribution centers and sales offices. Twelve retail stores were closed in the first quarter of 2020, and 7 other facilities were closed as of the end of 2019. Total estimated costs to implement the Business Acceleration Program are expected to be approximately $109 million, comprised of:
|
(a)
|
severance and related employee costs of approximately $40 million;
|
|
(b)
|
recruitment and relocation costs of approximately $2 million;
|
|
(c)
|
retail store and facility closure costs of approximately $12 million;
|
|
(d)
|
third-party costs to facilitate the execution of the Business Acceleration Program of approximately $48 million; and
|
|
(e)
|
other costs of approximately $7 million.
|
Of the aggregate costs to implement the Business Acceleration Program, approximately $102 million are expected to be cash expenditures through 2021 funded primarily with cash on hand and cash from operations. The Company incurred $90 million in restructuring expenses to implement the Business Acceleration Program since its inception in 2019 through the end of the first quarter of 2020.
In the first quarter of 2020, the Company incurred $8 million in restructuring expenses associated with the Business Acceleration Program which consisted of $5 million in third-party professional fees, and $3 million of retail store and facility closure costs and other. The Company made cash expenditures of $10 million for the Business Acceleration Program in the first quarter of 2020.
Other
Included in restructuring expenses in the first quarter of 2019 were costs incurred in connection with the Comprehensive Business Review, a program the Company announced in 2016 and concluded at the end of 2019. These costs include severance, facility closure costs, contract termination, accelerated depreciation, relocation and disposal gains and losses, as well as other costs associated with retail store closures.
11
OFFICE DEPOT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) – (Continued)
MERGER AND RESTRUCTURING ACCRUALS
The activity in the merger and restructuring accruals in the first quarter of 2020 is presented in the table below. Certain merger and restructuring charges are excluded from the table because they are paid as incurred or non-cash, such as accelerated depreciation and gains and losses on asset dispositions.
|
|
Balance as of
|
|
|
|
|
|
|
|
|
|
|
Balance as of
|
|
|
|
December 28,
|
|
|
Charges
|
|
|
Cash
|
|
|
March 28,
|
|
(In millions)
|
|
2019
|
|
|
Incurred
|
|
|
Payments
|
|
|
2020
|
|
Termination benefits:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Merger-related accruals
|
|
$
|
1
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
1
|
|
Business Acceleration Program
|
|
|
13
|
|
|
|
—
|
|
|
|
(2
|
)
|
|
|
11
|
|
Lease and contract obligations, accruals for facilities
closures and other costs:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Merger-related accruals
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Comprehensive Business Review
|
|
|
3
|
|
|
|
—
|
|
|
|
(1
|
)
|
|
|
2
|
|
Business Acceleration Program
|
|
|
5
|
|
|
|
8
|
|
|
|
(8
|
)
|
|
|
5
|
|
Total
|
|
$
|
22
|
|
|
$
|
8
|
|
|
$
|
(11
|
)
|
|
$
|
19
|
|
The short-term and long-term components of these liabilities are included in Accrued expenses and other current liabilities and Deferred income taxes and other long-term liabilities, respectively, in the Condensed Consolidated Balance Sheets.
NOTE 4. REVENUE RECOGNITION
PRODUCTS AND SERVICES REVENUE
The following table provides information about disaggregated revenue by Division, and major products and services categories.
|
|
First Quarter of 2020
|
|
(In millions)
|
|
Business
Solutions
Division
|
|
|
Retail
Division
|
|
|
CompuCom
Division
|
|
|
Other
|
|
|
Total
|
|
Major products and services categories
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Products
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplies
|
|
$
|
754
|
|
|
$
|
420
|
|
|
$
|
—
|
|
|
$
|
2
|
|
|
$
|
1,176
|
|
Technology
|
|
|
317
|
|
|
|
482
|
|
|
|
63
|
|
|
|
—
|
|
|
|
862
|
|
Furniture and other
|
|
|
176
|
|
|
|
122
|
|
|
|
—
|
|
|
|
1
|
|
|
|
299
|
|
Services
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Technology
|
|
|
—
|
|
|
|
9
|
|
|
|
169
|
|
|
|
(3
|
)
|
|
|
175
|
|
Copy, print, and other
|
|
|
87
|
|
|
|
123
|
|
|
|
3
|
|
|
|
—
|
|
|
|
213
|
|
Total
|
|
$
|
1,334
|
|
|
$
|
1,156
|
|
|
$
|
235
|
|
|
$
|
—
|
|
|
$
|
2,725
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First Quarter of 2019
|
|
(In millions)
|
|
Business
Solutions
Division
|
|
|
Retail
Division
|
|
|
CompuCom
Division
|
|
|
Other
|
|
|
Total
|
|
Major products and services categories
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Products
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplies
|
|
$
|
771
|
|
|
$
|
443
|
|
|
$
|
—
|
|
|
$
|
3
|
|
|
$
|
1,217
|
|
Technology
|
|
|
326
|
|
|
|
485
|
|
|
|
62
|
|
|
|
1
|
|
|
|
874
|
|
Furniture and other
|
|
|
171
|
|
|
|
98
|
|
|
|
—
|
|
|
|
1
|
|
|
|
270
|
|
Services
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Technology
|
|
|
—
|
|
|
|
8
|
|
|
|
182
|
|
|
|
(2
|
)
|
|
|
188
|
|
Copy, print, and other
|
|
|
76
|
|
|
|
141
|
|
|
|
3
|
|
|
|
—
|
|
|
|
220
|
|
Total
|
|
$
|
1,344
|
|
|
$
|
1,175
|
|
|
$
|
247
|
|
|
$
|
3
|
|
|
$
|
2,769
|
|
12
OFFICE DEPOT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) – (Continued)
Products revenue includes the sale of:
|
•
|
Supplies such as paper, writing instruments, office supplies, cleaning and breakroom items;
|
|
•
|
Technology related products such as toner and ink, printers, computers, tablets and accessories, and electronic storage; and
|
|
•
|
Furniture and other products such as desks, seating, and luggage.
|
The Company sells its supplies, furniture and other products through its Business Solutions and Retail Divisions, and its technology products through all three Divisions. Customers can purchase products through the Company’s retail stores, electronically through its Internet websites, or through its call centers. Revenues from supplies, technology, and furniture and other product sales are recognized when the customer obtains control of the Company’s product, which occurs at a point in time, typically upon delivery to the customer.
Furniture and other products also include arrangements where customers can make special furniture interior design and installation orders that are customized to their needs. The performance obligations related to these arrangements are satisfied over time.
Services revenue includes the sale of:
|
•
|
Technology service offerings provided through the Company’s CompuCom Division, such as technology lifecycle management, end user computing and collaboration, service desk, remote technology monitoring and management, and information technology (“IT”) workforce solutions, as well as technology support services offerings provided in the Company’s retail stores, such as installation and repair, and;
|
|
•
|
Copy, print, and other service offerings such as managed print and fulfillment services, product subscriptions, and sales of third party software, gift cards, warranties, remote support as well as rental income on operating lease arrangements where the Company conveys to its customers the right to use devices and other equipment for a stated period.
|
The largest offering in the technology service category is end user computing, which provides on-site services to assist corporate end users with their IT needs. Services are either billed on a rate per hour or per user, or on a fixed monthly retainer basis. For the majority of technology service offerings contracts, the Company has the right to invoice the customer for an amount that directly corresponds with the value to the customer of the Company’s performance to date and as such the Company recognizes revenue based on the amount billable to the customer in accordance with the practical expedient provided by the current revenue guidance.
Substantially all of the Company’s other service offerings are satisfied at a point in time and revenue is recognized as such. The largest other service offering is copy and print services, which includes printing, copying, and digital imaging. The majority of copy and print services are fulfilled through retail stores and the related performance obligations are satisfied within a short period of time (generally within the same day).
REVENUE RECOGNITION AND SIGNIFICANT JUDGMENTS
Revenue is recognized upon transfer of control of promised products or services to customers for an amount that reflects the consideration the Company is entitled to receive in exchange for those products or services. For product sales, transfer of control occurs at a point in time, typically upon delivery to the customer. For service offerings, the transfer of control and satisfaction of the performance obligation is either over time or at a point in time. When performance obligations are satisfied over time, the Company evaluates the pattern of delivery and progress each reporting period and, if necessary, adjusts the measure of performance and related revenue recognition. Revenue is recognized net of allowance for returns and net of any taxes collected from customers, which are subsequently remitted to governmental authorities. Shipping and handling costs are considered fulfillment activities and are recognized within the Company’s cost of goods sold.
Contracts with customers could include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. Determining the standalone selling price also requires judgment. The Company did not have significant revenues generated from such contracts in the first quarters of 2020 and 2019.
Products are generally sold with a right of return and the Company may provide other incentives, such as rebates and coupons, which are accounted for as variable consideration when estimating the amount of revenue to recognize. The Company estimates returns and incentives at contract inception and includes the amount in the transaction price for which significant reversal is not probable. These estimates are updated at the end of each reporting period as additional information becomes available.
The Company offers a customer loyalty program that provides customers with rewards that can be applied to future purchases or other incentives. Loyalty rewards are accounted for as a separate performance obligation and deferred revenue is recorded in the amount of the transaction price allocated to the rewards, inclusive of the impact of estimated breakage. The estimated breakage of loyalty rewards is based on historical redemption rates experienced under the loyalty program. Revenue is recognized when the loyalty
13
OFFICE DEPOT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) – (Continued)
rewards are redeemed or expire. As of March 28, 2020 and December 28, 2019, the Company had $7 million and $12 million of deferred revenue related to the loyalty program, respectively, which is included in Accrued expenses and other current liabilities in the Condensed Consolidated Balance Sheets.
The Company recognizes revenue in certain circumstances before product delivery occurs (commonly referred to as bill-and-hold transactions). Revenue from bill-and-hold transactions is recognized when all specific requirements for transfer of control under a bill-and-hold arrangement have been met which include, among other things, a request from the customer that the product be held for future scheduled delivery. For these bill-and-hold arrangements, the associated product inventory is identified separately as belonging to the customer and is ready for physical transfer.
CONTRACT BALANCES
The timing of revenue recognition may differ from the timing of invoicing to customers. A receivable is recognized in the period the Company delivers goods or provides services, and is recorded at the invoiced amount, net of an allowance for doubtful accounts. A receivable is also recognized for unbilled services where the Company’s right to consideration is unconditional, and is recorded based on an estimate of time and materials. Payment terms and conditions vary by contract type, although terms generally include a requirement of payment within 20 to 60 days. In instances where the timing of revenue recognition differs from the timing of invoicing, the Company has determined that the contracts do not include a significant financing component. The primary purpose of the Company’s invoicing terms is to provide customers with simplified and predictable ways of purchasing its products and services.
The Company receives payments from customers based upon contractual billing schedules. Contract assets include amounts related to deferred contract acquisition costs (refer to the section “Costs to Obtain a Contract” below) and if applicable, the Company’s conditional right to consideration for completed performance under a contract. The short and long-term components of contract assets in the table below are included in Prepaid expenses and other current assets, and Other assets, respectively, in the Condensed Consolidated Balance Sheets. Contract liabilities include payments received in advance of performance under the contract, which are recognized as revenue when the performance obligation is completed under the contract, as well as accrued contract acquisition costs, liabilities related to the Company’s loyalty program and gift cards. The short and long-term components of contract liabilities in the table below are included in Accrued expenses and other current liabilities, and Deferred income taxes and other long-term liabilities, respectively, in the Condensed Consolidated Balance Sheets.
The following table provides information about receivables, contract assets and contract liabilities from contracts with customers:
|
|
March 28,
|
|
|
December 28,
|
|
(In millions)
|
|
2020
|
|
|
2019
|
|
Trade receivables, net
|
|
$
|
646
|
|
|
$
|
599
|
|
Short-term contract assets
|
|
|
21
|
|
|
|
23
|
|
Long-term contract assets
|
|
|
19
|
|
|
|
17
|
|
Short-term contract liabilities
|
|
|
44
|
|
|
|
52
|
|
Long-term contract liabilities
|
|
|
2
|
|
|
|
1
|
|
In the first quarters of 2020 and 2019, the Company did not have any contract assets related to conditional rights. The Company recognized revenues of $18 million and $19 million in the first quarters of 2020 and 2019, respectively, which were included in the short-term contract liability balance at the beginning of each respective period. There were no contract assets and liabilities that were recognized in the first quarters of 2020 and 2019 as a result of business combinations. There were no significant adjustments to revenue from performance obligations satisfied in previous periods and there were no contract assets recognized at the beginning of each respective period that transferred to receivables in the first quarters of 2020 and 2019.
A majority of the purchase orders and statements of work related to contracts with customers require delivery of the product or service within one year or less. For certain service contracts that exceed one year, the Company recognizes revenue at the amount to which it has the right to invoice for services performed. Accordingly, the Company has applied the optional exemption provided by the new revenue recognition standard relating to unsatisfied performance obligations and does not disclose the value of unsatisfied performance obligations for its contracts.
COSTS TO OBTAIN A CONTRACT
The Company recognizes an asset for the incremental costs of obtaining a contract with a customer if it expects the benefit of those costs to be longer than one year. The Company has determined that certain rebate incentive programs meet the requirements to be capitalized. These costs are periodically reviewed for impairment, and are amortized on a straight-line basis over the expected period of benefit. As of both March 28, 2020 and December 28, 2019, capitalized acquisition costs amounted to $40 million and are reflected in short-term contract assets and long-term contract assets in the table above. In the first quarters of 2020 and 2019, amortization expense was $7 million and $9 million, respectively. The Company had no asset impairment charges related to contract assets in the
14
OFFICE DEPOT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) – (Continued)
periods presented herein. There is uncertainty regarding the impacts of COVID-19, the novel coronavirus disease that has been declared a pandemic by the World Health Organization on March 11, 2020, on the global and national economies, which could negatively affect our customers and result in future impairments of contract assets.
NOTE 5. SEGMENT INFORMATION
At March 28, 2020, the Company had three reportable segments: Business Solutions Division, Retail Division and the CompuCom Division. The Business Solutions Division sells nationally branded as well as the Company’s private branded office supply and adjacency products and services to customers in the United States, Puerto Rico, the U.S. Virgin Islands, and Canada. Business Solutions Division customers are served through a dedicated sales force, catalogs, telesales, and electronically through the Company’s Internet websites. The Retail Division includes a chain of retail stores in the United States, Puerto Rico and the U.S. Virgin Islands, which sell office supplies, technology products and solutions, business machines and related supplies, cleaning, breakroom and facilities products, and office furniture as well as offer business services including copying, printing, mailing, shipping and technology support services. In addition, the print needs for retail and business customers are also facilitated through the Company’s regional print production centers. The CompuCom Division provides IT services and products to enterprise organizations in the United States and Canada, and offers a broad range of solutions including technology lifecycle management, end user computing and collaboration, service desk, remote technology monitoring and management, and IT workforce solutions.
The retained global sourcing operations previously included in the former International Division are not significant and have been presented as Other. Also included in Other is the elimination of intersegment revenues of $4 million in the first quarter of 2020, and $3 million in the first quarter of 2019.
The products and services offered by the Business Solutions Division and the Retail Division are similar, but the CompuCom Division’s offerings are focused on IT services and related products. The Company’s three operating segments are its three reportable segments. The Business Solutions Division, the Retail Division and the CompuCom Division are managed separately as they represent separate channels in the way the Company serves its customers, and they are managed accordingly. The accounting policies for each segment are the same as those described in Note 1. Division operating income is determined based on the measure of performance reported internally to manage the business and for resource allocation. This measure charges to the respective Divisions those expenses considered directly or closely related to their operations and allocates support costs. Certain operating expenses and credits are not allocated to the Business Solutions Division, the Retail Division or the CompuCom Division, including asset impairments and merger and restructuring expenses, as well as expenses and credits retained at the Corporate level, including certain management costs and legacy pension and environmental matters. Other companies may charge more or less of these items to their segments and results may not be comparable to similarly titled measures used by other entities. In addition, the Company regularly evaluates the appropriateness of the reportable segments based on how the business is managed, including decision-making about resources allocation and assessing performance of the segments, particularly in light of organizational changes, merger and acquisition activity and changing laws and regulations. Therefore, the current reportable segments may change in the future.
The following is a summary of sales and operating income (loss) by each of the Divisions and Other, reconciled to consolidated totals.
|
|
Sales
|
|
|
|
First Quarter
|
|
(In millions)
|
|
2020
|
|
|
2019
|
|
Business Solutions Division
|
|
$
|
1,334
|
|
|
$
|
1,344
|
|
Retail Division
|
|
|
1,156
|
|
|
|
1,175
|
|
CompuCom Division
|
|
|
235
|
|
|
|
247
|
|
Other
|
|
|
—
|
|
|
|
3
|
|
Total
|
|
$
|
2,725
|
|
|
$
|
2,769
|
|
|
|
Division Operating Income (Loss)
|
|
|
|
First Quarter
|
|
(In millions)
|
|
2020
|
|
|
2019
|
|
Business Solutions Division
|
|
$
|
40
|
|
|
$
|
46
|
|
Retail Division
|
|
|
87
|
|
|
|
67
|
|
CompuCom Division
|
|
|
3
|
|
|
|
(15
|
)
|
Other
|
|
|
—
|
|
|
|
—
|
|
Total
|
|
$
|
130
|
|
|
$
|
98
|
|
15
OFFICE DEPOT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) – (Continued)
A reconciliation of the measure of Division operating income to Consolidated income before income taxes is as follows:
|
|
First Quarter
|
|
(In millions)
|
|
2020
|
|
|
2019
|
|
Total Divisions operating income
|
|
$
|
130
|
|
|
$
|
98
|
|
Add/(subtract):
|
|
|
|
|
|
|
|
|
Asset impairments
|
|
|
(12
|
)
|
|
|
(29
|
)
|
Merger and restructuring expenses, net
|
|
|
(16
|
)
|
|
|
(14
|
)
|
Unallocated expenses
|
|
|
(22
|
)
|
|
|
(31
|
)
|
Interest income
|
|
|
3
|
|
|
|
6
|
|
Interest expense
|
|
|
(18
|
)
|
|
|
(23
|
)
|
Other income, net
|
|
|
1
|
|
|
|
2
|
|
Income before income taxes
|
|
$
|
66
|
|
|
$
|
9
|
|
The components of goodwill by segment are provided in the following table:
|
|
Business
Solutions
|
|
|
Retail
|
|
|
CompuCom
|
|
|
|
|
|
(In millions)
|
|
Division
|
|
|
Division
|
|
|
Division
|
|
|
Total
|
|
Balance as of December 28, 2019
|
|
$
|
410
|
|
|
$
|
78
|
|
|
$
|
456
|
|
|
$
|
944
|
|
Acquisitions
|
|
|
10
|
|
|
|
—
|
|
|
|
—
|
|
|
|
10
|
|
Foreign currency rate impact
|
|
|
—
|
|
|
|
—
|
|
|
|
(14
|
)
|
|
|
(14
|
)
|
Balance as of March 28, 2020
|
|
$
|
420
|
|
|
$
|
78
|
|
|
$
|
442
|
|
|
$
|
940
|
|
Refer to Note 2 for additional information on the acquisitions made during the first quarter of 2020.
As of March 28, 2020, the Company believes, based on an evaluation of events and circumstances, that an interim impairment test has not been triggered and that its goodwill and indefinite-lived intangible assets continue to be recoverable for all reporting units. The Company is monitoring the performance of its Contract reporting unit, a component of the Business Solutions Division segment, and its CompuCom reporting unit, which both passed the quantitative assessments performed in 2019 with margins in excess of those determined in the Company’s 2018 annual assessment. The Company has taken several actions to improve the future operating performance of CompuCom, including the use of automation and technology to further improve service efficiency, simplifying organizational structures to improve service velocity, and aligning sales efforts to better serve its customers and accelerate cross-selling opportunities. The anticipated impacts of these actions were reflected in key assumptions used in the 2019 quantitative assessment, and if not realized, could result in future impairment of goodwill and indefinite-lived intangible assets for the CompuCom reporting unit.
The CompuCom reporting unit has experienced a decline in project-based service revenue late in the first quarter of 2020 due to the impacts of COVID-19 on its customers. This decrease is primarily due to customer-imposed deferrals of projects into future periods and the Company does not expect it to result in a significant impact on its long-term forecast. However, its total operations could be impacted further depending on the severity of the disease, the duration of the pandemic and actions that may be taken by governmental authorities. Accordingly, the Company has performed a sensitivity analysis for this reporting unit using scenarios that factor in different durations of the pandemic, the possibility of declines in revenue beyond the deferral of project revenue and assumptions of the business returning to normal level of operations in future years. Based on the weighted evaluation of these different scenarios, which included adjusted risk profiles, the Company believes that it is not more likely than not that the fair value of its CompuCom reporting unit is less than its carrying amount as of March 28, 2020. Significant changes in these key assumptions due to future developments could result in future impairment of goodwill for this reporting unit up to its full value of $442 million.
The Contract reporting unit, which is a key part of the Company’s integrated B2B platform, has been negatively impacted by the varying degrees of restrictions imposed late in the first quarter of 2020 by federal, state and local authorities, in response to the rapid spread of the novel coronavirus. The restrictions include the temporary closure of nonessential businesses, which constitute a portion of this reporting unit’s customers, along with the transition of many other business customers to a work-from-home environment and has resulted in decreased demand for the Contract reporting unit’s core product and service offerings. The extent to which the COVID-19 pandemic will impact the operating results of the Contract Reporting unit in the future will depend on numerous evolving factors and future developments, including the severity of the disease, the duration of the pandemic and actions that may be taken by governmental authorities. The Company has performed a sensitivity analysis for this reporting unit using scenarios that factor in different durations of the pandemic and timing for its business-to-business customers returning back to levels of historical operations, as well as opportunities to increase sales in its cleaning and breakroom product category. Based on the weighted evaluation of these
16
OFFICE DEPOT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) – (Continued)
different scenarios which included adjusted risk profiles, the Company believes that it is not more likely than not that the fair value of its Contract reporting unit is less than its carrying amount as of March 28, 2020. Significant changes in these key assumptions due to future developments could result in future impairment of goodwill for this reporting unit up to its full value of $345 million.
NOTE 6. INCOME TAXES
The Company’s effective rate for the first quarter of 2020 differs from the statutory rate of 21% primarily due to the impact of state taxes, excess tax deficiencies associated with stock-based compensation awards and certain nondeductible items, adjustments to certain tax benefits and the mix of income and losses across U.S. and non-U.S. jurisdictions. The Company’s effective tax rates in prior periods have varied considerably as a result of several primary factors including the mix of income and losses across U.S. and non-U.S. jurisdictions, the impact of excess tax deficiencies associated with stock-based compensation awards and the derecognition of valuation allowances against deferred tax assets that were not more-likely-than-not realizable in the U.S. and certain non-U.S. jurisdictions. During 2020 and 2019, the mix of income and losses across jurisdictions, although still applicable, has become less of a factor in influencing the Company’s effective tax rates due to the dispositions of the international businesses and improved operating results. As a result, the Company’s effective tax rates are 32% for the first quarter of 2020, and 11% for the first quarter of 2019. Changes in pretax income projections and the mix of income across jurisdictions could impact the effective tax rate in future quarters.
The Tax Cuts and Jobs Act repealed the corporate Alternative Minimum Tax (“AMT”) and allows unutilized AMT credits to be refunded. For tax years 2018 through 2020, taxpayers could receive 50% of their uncredited balances as a cash refund with any remaining amounts refunded in full in 2021. As of the year end 2019, the Company determined it is more-likely-than-not that $22 million of its AMT credits will be refunded and is expected to be received in the fourth quarter of 2020. During the first quarter of 2020, the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”) was enacted. The CARES Act allows for the Company to refund 100% of its remaining AMT credits in 2020. The Company anticipates filing for the remaining $22 million in the second quarter of 2020 for a total refund of $44 million. The Company continues to evaluate the other provisions of the CARES Act to determine if they would have any material impact.
During the first quarter of 2020, the Company net settled its Timber notes receivable and Non-recourse debt. The Company has previously recorded a deferred tax liability related to the taxes deferred from the original transaction. The deferred liability was realized in the first quarter of 2020. It is anticipated that certain capital loss carryforwards, available tax credits and net operating losses will offset the resulting gain and no material cash income taxes will be due upon the realization.
The Company continues to have a U.S. valuation allowance for certain U.S. federal credits and state tax attributes, which relate to deferred tax assets that require certain types of income or for income to be earned in certain jurisdictions in order to be realized. The Company will continue to assess the realizability of its deferred tax assets in the U.S. and remaining foreign jurisdictions in future periods. Changes in pretax income projections could impact this evaluation in future periods.
The Company files a U.S. federal income tax return and other income tax returns in various states and foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal and state and local income tax examinations for years prior to 2017 and 2013, respectively. The acquired OfficeMax U.S. consolidated group is no longer subject to U.S. federal income tax examination, and with few exceptions, is no longer subject to U.S. state and local income tax examinations for years prior to 2013. The Company’s U.S. federal income tax return for 2017 is currently under review. Generally, the Company is subject to routine examination for years 2012 and forward in its international tax jurisdictions.
It is anticipated that $2 million of tax positions will be resolved within the next 12 months. Additionally, the Company anticipates that it is reasonably possible that new issues will be raised or resolved by tax authorities that may require changes to the balance of unrecognized tax benefits; however, an estimate of such changes cannot be reasonably made.
17
OFFICE DEPOT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) – (Continued)
NOTE 7. EARNINGS PER SHARE
The following table represents the calculation of earnings per common share – basic and diluted:
|
|
First Quarter
|
|
(In millions, except per share amounts)
|
|
2020
|
|
|
2019
|
|
Basic Earnings Per Share
|
|
|
|
|
|
|
|
|
Numerator:
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
45
|
|
|
$
|
8
|
|
Denominator:
|
|
|
|
|
|
|
|
|
Weighted-average shares outstanding
|
|
|
529
|
|
|
|
543
|
|
Basic earnings per share
|
|
$
|
0.09
|
|
|
$
|
0.01
|
|
Diluted Earnings Per Share
|
|
|
|
|
|
|
|
|
Numerator:
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
45
|
|
|
$
|
8
|
|
Denominator:
|
|
|
|
|
|
|
|
|
Weighted-average shares outstanding
|
|
|
529
|
|
|
|
543
|
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
Stock options and restricted stock
|
|
|
13
|
|
|
|
18
|
|
Diluted weighted-average shares outstanding
|
|
|
542
|
|
|
|
561
|
|
Diluted earnings per share
|
|
$
|
0.08
|
|
|
$
|
0.01
|
|
Awards of stock options and nonvested shares representing 5 million additional shares of common stock were outstanding for the first quarter of 2020, and 4 million for the first quarter of 2019, but were not included in the computation of diluted weighted-average shares outstanding because their effect would have been antidilutive.
As disclosed in the Company’s definitive proxy statement filed on March 26, 2020, if approved by the Company’s shareholders, the Company may implement a reverse stock split substantially concurrently with the consummation of the Reorganization. If implemented, all share and per share amounts will be retroactively adjusted to reflect the reverse stock split. The Reorganization is not a condition to the reverse stock split.
NOTE 8. DEBT
In connection with the consummation of the acquisition of CompuCom, the Company entered into a credit agreement, dated as of November 8, 2017 (the “Term Loan Credit Agreement”), which provides for a $750 million term loan facility with a maturity date of November 8, 2022. The Term Loan Credit Agreement was amended in November 2018. The Company was in compliance with all applicable financial covenants associated with the Term Loan Credit Agreement at March 28, 2020.
In May 2011, the Company entered into an amended and restated credit agreement, which was amended and restated in May 2016 for an additional five years, and was further amended in December 2016 and November 2017 (the Amended and Restated Credit Agreement including all amendments is referred to as the “Amended Credit Agreement”). The Amended Credit Agreement provides for a revolving credit facility of up to $1.2 billion and will mature on May 13, 2021. As provided in the Amended Credit Agreement, available amounts that can be borrowed are based on percentages of certain outstanding accounts receivable, credit card receivables, and inventory of the Company. At March 28, 2020, the Company had $851 million of available credit, and letters of credit outstanding totaling $62 million under the Amended Credit Agreement. There were no borrowings under the Amended Credit Agreement in the first quarter of 2020 and the Company was in compliance with all applicable financial covenants at March 28, 2020.
On April 17, 2020, the Company entered into the Third Amended and Restated Credit Agreement, which provides for a $1.2 billion asset-based revolving credit facility and a $100 million asset-based first-in, last-out term loan facility, for an aggregate principal amount of up to $1.3 billion (the “New Facilities”). The New Facilities mature in April 2025. The Third Amended and Restated Credit Agreement replaces the Company’s existing Amended Credit Agreement that was due to mature in May 2021. Upon the closing of the transaction, the Company made an initial borrowing in the amount of $400 million under the New Facilities. These proceeds, along with available cash on hand, were used to repay in full the remaining $388 million balance under the Term Loan Credit Agreement and terminate it and to repay approximately $66 million of other debt. The Company recognized $12 million of loss from extinguishment of debt related to this transaction in the second quarter of 2020, which primarily includes the amortization of the remaining discount and debt issuance costs of the Term Loan Credit Agreement as of the closing date of the transaction.
18
OFFICE DEPOT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) – (Continued)
NON-RECOURSE DEBT
The Installment Notes (the “Timber notes receivable”) and the related Bridge Loan (the “Non-recourse debt”), as defined in the 2019 Form 10-K, both matured on January 29, 2020. The Company received a net principal cash payment of $82.5 million upon maturity of the Installment Notes and the Bridge Loan on January 29, 2020, which were net settled as they were with the same third-party financial institution. Refer to Note 6 for additional information related to the tax impact of this transaction.
NOTE 9. STOCKHOLDERS’ EQUITY
Accumulated other comprehensive loss activity, net of tax, where applicable, is provided in the following table:
|
|
Foreign
|
|
|
Change in
|
|
|
|
|
|
|
|
Currency
|
|
|
Deferred
|
|
|
|
|
|
|
|
Translation
|
|
|
Pension and
|
|
|
|
|
|
(In millions)
|
|
Adjustments
|
|
|
Other
|
|
|
Total
|
|
Balance at December 28, 2019
|
|
$
|
(29
|
)
|
|
$
|
(37
|
)
|
|
$
|
(66
|
)
|
Other comprehensive loss activity
|
|
|
(41
|
)
|
|
|
(1
|
)
|
|
|
(42
|
)
|
Balance at March 28, 2020
|
|
$
|
(70
|
)
|
|
$
|
(38
|
)
|
|
$
|
(108
|
)
|
TREASURY STOCK
In November 2018, the Board of Directors approved a stock repurchase program of up to $100 million of its common stock effective January 1, 2019, which extends until the end of 2020 and may be suspended or discontinued at any time. In November 2019, the Board of Directors approved an increase in the authorization of the existing stock repurchase program of up to $200 million and extended the program through the end of 2021. The current authorization includes the remaining authorized amount under the existing stock repurchase program. The exact timing of share repurchases will depend on market conditions and other factors, and will be funded through available cash balances.
Under the stock repurchase program, the Company purchased approximately 13 million shares of its common stock at a cost of $30 million in the first quarter of 2020. As of March 28, 2020, approximately $131 million remains available for stock repurchases under the current stock repurchase authorization.
At March 28, 2020, there were 98 million common shares held in treasury. The Company’s Term Loan Credit Agreement and Amended Credit Facility included certain covenants on restricted payments such as common stock repurchases, based on the Company’s liquidity and borrowing availability. The Company’s ability to repurchase its common stock was also subject to certain restrictions under the Term Loan Credit Agreement prior to its termination in the second quarter of 2020. Refer to Note 8 for additional information about the termination of the Term Loan Credit Agreement.
DIVIDENDS ON COMMON STOCK
In the first quarter of 2020, the Company’s Board of Directors declared a quarterly cash dividend in the amount of $0.025 per share on its common stock, resulting in total cash payments of $13 million. Dividends have been recorded as a reduction to additional paid-in capital as the Company is in an accumulated deficit position. Payment of dividends is permitted under the Company’s Amended Credit Agreement provided that the Company has the required minimum liquidity or fixed charge coverage ratio, but may be limited if the Company does not meet the necessary requirements. Additionally, under the Company’s Term Loan Credit Agreement, payment of dividends was permitted subject to compliance with an annual limit, prior to its termination in the second quarter of 2020. Refer to Note 8 for additional information about the termination of the Term Loan Credit Agreement.
NOTE 10. EMPLOYEE BENEFIT PLANS
PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS – NORTH AMERICA
The components of net periodic pension expense (benefit) for the Company’s North America pension plans are as follows:
|
|
First Quarter
|
|
(In millions)
|
|
2020
|
|
|
2019
|
|
Service cost
|
|
$
|
—
|
|
|
$
|
2
|
|
Interest cost
|
|
|
7
|
|
|
|
9
|
|
Expected return on plan assets
|
|
|
(8
|
)
|
|
|
(10
|
)
|
Net periodic pension expense (benefit)
|
|
$
|
(1
|
)
|
|
$
|
1
|
|
19
OFFICE DEPOT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) – (Continued)
During the first quarter of 2020, $2 million of cash contributions were made to the North America pension plans. The Company expects to make additional cash contributions of approximately $8 million to the North America pension plans during the remainder of 2020.
PENSION PLAN – UNITED KINGDOM
The components of net periodic pension benefit for the Company’s UK pension plan are as follows:
|
|
First Quarter
|
|
(In millions)
|
|
2020
|
|
|
2019
|
|
Service cost
|
|
$
|
—
|
|
|
$
|
—
|
|
Interest cost
|
|
|
1
|
|
|
|
2
|
|
Expected return on plan assets
|
|
|
(1
|
)
|
|
|
(2
|
)
|
Net periodic pension benefit
|
|
$
|
—
|
|
|
$
|
—
|
|
The UK pension plan is in a net asset position. During the first quarter of 2020, cash contributions of $1 million were made to the UK pension plan. The Company is required to make an additional cash contribution of $1 million to the UK pension plan during the remainder of 2020.
Net periodic pension benefits for the North America and UK pension and other postretirement benefit plans (the “Plans”) are recorded at the Corporate level. The service cost for the Plans are reflected in Selling, general and administrative expenses, and the other components of net periodic pension benefits are reflected in Other income, net, in the Condensed Consolidated Statements of Operations.
NOTE 11. FAIR VALUE MEASUREMENTS
The Company measures fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. In developing its fair value estimates, the Company uses the following hierarchy:
Level 1:
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Quoted prices in active markets for identical assets or liabilities.
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Level 2:
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Observable market based inputs or unobservable inputs that are corroborated by market data.
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Level 3:
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Significant unobservable inputs that are not corroborated by market data. Generally, these fair value measures are model-based valuation techniques such as discounted cash flows or option pricing models using the Company’s own estimates and assumptions or those expected to be used by market participants.
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RECURRING FAIR VALUE MEASUREMENTS
In accordance with GAAP, certain assets and liabilities are required to be recorded at fair value on a recurring basis. The Company’s assets and liabilities that are adjusted to fair value on a recurring basis are money market funds that qualify as cash equivalents, and derivative financial instruments, which may be entered into to mitigate risks associated with changes in foreign currency exchange rates, fuel and other commodity prices and interest rates. Amounts associated with derivative instruments were not significant.
NONRECURRING FAIR VALUE MEASUREMENTS
In addition to assets and liabilities that are recorded at fair value on a recurring basis, the Company records certain assets and liabilities at fair value on a nonrecurring basis as required by GAAP. Generally, assets are recorded at fair value on a nonrecurring basis as a result of impairment charges. In the first quarter of 2020, the Company recognized asset impairment charges of $12 million. Of these asset impairment charges, $10 million, were related to impairment of operating lease right-of-use (“ROU”) assets associated with the Company’s retail store locations, with the remainder primarily relating to impairment of fixed assets. All impairment charges discussed in the sections below are presented in Asset impairments in the Condensed Consolidated Statements of Operations.
The Company regularly reviews retail store assets for impairment indicators at the individual store level, as this represents the lowest level of identifiable cash flows. When indicators of impairment are present, a recoverability analysis is performed which considers the estimated undiscounted cash flows over the retail store’s remaining life and uses input from retail operations and accounting and finance personnel. These inputs include management’s best estimates of retail store-level sales, gross margins, direct expenses, exercise of future lease renewal options when reasonably certain to be exercised, and resulting cash flows, by their nature, include judgments about how current initiatives will impact future performance. In the first quarter of 2020, the assumptions used within the
20
OFFICE DEPOT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) – (Continued)
recoverability analysis for the retail stores were updated to consider current quarter retail store operational results and formal plans for future retail store closures. These assumptions reflected declining sales over the forecast period, and gross margin and operating cost assumptions that are consistent with recent actual results and consider plans for future initiatives. The Company also analyzed the impact of the COVID-19 pandemic on store asset recoverability. Due to the nature of products sold, the retail stores were considered to be essential retail commerce by most local jurisdictions and as a result, the substantial majority of these stores remain open and operational with the appropriate safety measures in place during the COVID-19 outbreak. Late in the first quarter of 2020, the Company determined to temporarily reduce retail location hours by two hours daily and provide the option of curbside pickup at all locations, with a small number of locations solely providing curbside pickup. The Company’s recoverability assessment included evaluating the impact of these developments under scenarios of varying store-level sales and operating costs.
If the undiscounted cash flows of a retail store cannot support the carrying amount of its assets, the assets are impaired if necessary and written down to estimated fair value. The fair value of retail store assets is determined using a discounted cash flow analysis which uses Level 2 unobservable inputs that are corroborated by market data such as real estate broker’s opinions. Specifically, the analysis uses assumptions of potential rental rates for each retail store location which are based on market data for comparable locations. These estimated cash flows used in the first quarter of 2020 impairment calculation were discounted at a weighted average discount rate of 8%.
The Company will continue to evaluate initiatives to improve performance and lower operating costs. There is uncertainty regarding the impact of the COVID-19 pandemic on the future results of operations, including the forecast period used in the recoverability analysis. To the extent that forward-looking sales and operating assumptions are not achieved and are subsequently reduced, additional impairment charges may result. However, at the end of the first quarter of 2020, the impairment recognized reflects the Company’s best estimate of future performance.
OTHER FAIR VALUE DISCLOSURES
The fair values of cash and cash equivalents, receivables, trade accounts payable and accrued expenses and other current liabilities approximate their carrying values because of their short-term nature.
The following table presents information about financial instruments at the balance sheet dates indicated.
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March 28,
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December 28,
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2020
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2019
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Carrying
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Fair
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Carrying
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Fair
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(In millions)
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Amount
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Value
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Amount
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Value
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Financial assets:
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Timber notes receivable
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$
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—
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$
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—
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$
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819
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$
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819
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Company-owned life insurance
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92
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92
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91
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91
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Financial liabilities:
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Recourse debt:
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Term Loan, due 2022
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376
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361
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|
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393
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409
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Revenue bonds, due in varying amounts periodically
through 2029
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186
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|
|
|
183
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|
|
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186
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|
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186
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American & Foreign Power Company, Inc. 5% debentures,
due 2030
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15
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|
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15
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15
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14
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Non-recourse debt — Timber notes
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|
|
—
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|
|
|
—
|
|
|
|
735
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|
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735
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The following methods and assumptions were used to estimate the fair value of each class of financial instruments:
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•
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Timber notes receivable: Fair value is determined as the present value of expected future cash flows discounted at the current interest rate for loans of similar terms with comparable credit risk (Level 2 measure). The Timber notes receivable matured on January 29, 2020. Refer to Note 8 for additional information about the Timber notes receivable.
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•
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Company-owned life insurance: In connection with the 2013 OfficeMax merger, the Company acquired company-owned life insurance policies on certain former employees. The fair value of the company-owned life insurance policies is derived using determinable net cash surrender value, which is the cash surrender value less any outstanding loans (Level 2 measure).
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•
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Recourse debt: Recourse debt, for which there were no transactions on the measurement date, was valued based on quoted market prices near the measurement date when available or by discounting the future cash flows of each instrument using rates based on the most recently observable trade or using rates currently offered to the Company for similar debt instruments of comparable maturities (Level 2 measure).
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21
OFFICE DEPOT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) – (Continued)
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•
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Non-recourse debt: Fair value is estimated by discounting the future cash flows of the instrument at rates currently available to the Company for similar instruments of comparable maturities (Level 2 measure). The Non-recourse debt matured on January 29, 2020. Refer to Note 8 for additional information about the Non-recourse debt.
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NOTE 12. COMMITMENTS AND CONTINGENCIES
LEGAL MATTERS
The Company is involved in litigation arising in the normal course of business. While, from time to time, claims are asserted that make demands for a large sum of money (including, from time to time, actions which are asserted to be maintainable as class action suits), the Company does not believe that contingent liabilities related to these matters (including the matters discussed below), either individually or in the aggregate, will materially affect the Company’s financial position, results of operations or cash flows.
In addition, in the ordinary course of business, sales to and transactions with government customers may be subject to lawsuits, investigations, audits and review by governmental authorities and regulatory agencies, with which the Company cooperates. Many of these lawsuits, investigations, audits and reviews are resolved without material impact to the Company. While claims in these matters may at times assert large demands, the Company does not believe that contingent liabilities related to these matters, either individually or in the aggregate, will materially affect its financial position, results of operations or cash flows.
In May 2017, the Office of Attorney General, State of Texas (''Texas AG'') issued a Civil Investigative Demand (“CID”) to the Company requiring the Company to produce certain documents and materials and to answer certain interrogatories relating to PC Healthcheck, a software program manufactured by a third-party vendor and provided to the Company for its customers prior to December 31, 2016. The Company continues to cooperate with the Texas AG with respect to its investigation. At this time, it is difficult to predict the timing, the likely outcome, and/or potential range of loss, if any, of this matter.
In addition to the foregoing, OfficeMax is named as a defendant in a number of lawsuits, claims, and proceedings arising out of the operation of certain paper and forest products assets prior to those assets being sold in 2004, for which OfficeMax agreed to retain responsibility. Also, as part of that sale, OfficeMax agreed to retain responsibility for all pending or threatened proceedings and future proceedings alleging asbestos-related injuries arising out of the operation of the paper and forest products assets prior to the closing of the sale. The Company has made provision for losses with respect to the pending proceedings. Additionally, as of March 28, 2020, the Company has made provision for environmental liabilities with respect to certain sites where hazardous substances or other contaminants are or may be located. For these liabilities, our estimated range of reasonably possible losses was approximately $10 million to $20 million. The Company regularly monitors its estimated exposure to these liabilities. As additional information becomes known, these estimates may change, however, the Company does not believe any of these OfficeMax retained proceedings are material to the Company’s financial position, results of operations or cash flows.
22