MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995
This document, including the following discussion and analysis, contains statements that constitute “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and Section 27A of the Securities Act of 1933, as amended. All statements that are not statements of historical fact are forward-looking statements. Without limitation, when we use the words “believe,” “estimate,” “plan,” “expect,” “intend,” “anticipate,” “continue,” “may,” “project,” “probably,” “should,” “could,” “will” and similar expressions in this Quarterly Report on Form 10-Q, we are identifying forward-looking statements (as such term is defined in the Private Securities Litigation Reform Act of 1995). These statements appear in a number of places in this discussion and analysis and include statements regarding the intent, belief or current expectations of the Company, its directors or its officers with respect to, among other things, trends affecting the Company’s financial condition or results of operations, the USR Parent, Inc. proposals, the Company’s ability to achieve its strategic plans, including the proposed sale of the consumer business and the sale of CompuCom, and the high costs in connection with these transactions which may not be recouped if these transactions are not consummated, the CompuCom malware incident, the potential impact of the COVID-19 pandemic on our business, liquidity, suppliers, consumers, customers, and employees, disruptions or inefficiencies in our supply chain, our ability to mitigate or manage disruptions posed by COVID-19, uncertainties arising from the Russia-Ukraine conflict including its effect on the U.S. economy, changes in worldwide and U.S. economic conditions that materially impact consumer spending and employment and the demand for our products and services, and the outcome of contingencies such as litigation and investigations. Readers are cautioned that any forward-looking statements are not guarantees of future performance and involve risks and uncertainties. More information regarding these risks, uncertainties and other important factors that could cause actual results to differ materially from those in the forward-looking statements is set forth herein under “Risk Factors,” found in Other Information which supplements our discussion of “Risk Factors” within Other Key Information in our Annual Report on Form 10-K filed on February 23, 2022 (the “2021 Form 10-K”) with the SEC, Forward-Looking Statements, found in our 2021 Form 10-K.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to provide information to assist readers in better understanding and evaluating our financial condition and results of operations. We recommend reading this MD&A in conjunction with our Condensed Consolidated Financial Statements and the Notes to those statements included in the “Financial Statements” section of this Quarterly Report on Form 10-Q, as well as our 2021 Form 10-K.
OVERVIEW
THE COMPANY
We are a leading provider of business services and supplies, products and digital workplace technology solutions to small, medium-sized and enterprise businesses. We operate through our direct and indirect subsidiaries and maintain a fully integrated business-to-business (“B2B”) distribution platform of thousands of dedicated sales and technology service professionals, online presence and 1,032 retail stores. Through our banner brands Office Depot®, OfficeMax® and Grand & Toy®, as well as others, we offer our customers the tools and resources they need to focus on starting, growing and running their business.
As of March 26, 2022, our operations are organized into two reportable segments (or “Divisions”): Business Solutions Division and Retail Division. We sold our CompuCom Division through a single disposal group on December 31, 2021. Accordingly, that business is presented as discontinued operations.
The Business Solutions Division, or BSD, is the largest component of our integrated B2B distribution platform in terms of both revenue and customers, and provides our customers with nationally branded as well as our private branded office supply products and services. Additionally, BSD provides adjacency products and services including cleaning and breakroom supplies, personal protective equipment, technology services, copy and print services, and office furniture products and services in the United States, Puerto Rico, the U.S. Virgin Islands, and Canada through a dedicated sales force, catalogs, telesales, and electronically through our Internet websites. BSD includes the regional office supply distribution businesses we have acquired as part of our strategic transformation described in the section below.
The Retail Division includes our chain of retail stores in the United States, Puerto Rico and the U.S. Virgin Islands where we sell office supplies, technology products and solutions, business machines and related supplies, print, cleaning, breakroom supplies and facilities products, and furniture. In addition, our Retail Division offers a range of business-related services targeted to small businesses, technology support services as well as printing, copying, mailing and shipping services.
STRATEGIC TRANSFORMATION
We have been undergoing a strategic business transformation to pivot our Company into an integrated B2B distribution platform, with the objective of expanding our product offerings to include value-added services for our customers and capture greater market share. Using the flexibility afforded by our holding company restructuring that was previously completed, we are in the process of separating many of the operational components of our business in order to improve the alignment of the assets that support our B2B and consumer businesses.
22
In May 2021, our Board of Directors had unanimously approved a plan to pursue a separation of the Company into two independent, publicly traded companies, representing our B2B and consumer businesses, which was planned to be achieved through a spin-off of our consumer business. On January 14, 2022, we announced that our Board of Directors determined to delay the previously announced public company separation to evaluate a potential sale of our consumer business and that we had received a non-binding proposal from another third party, in addition to that previously received from USR Parent, Inc., to acquire our consumer business. Our Board of Directors is carefully reviewing both proposals with the assistance of its financial and legal advisors to determine the course of action that it believes is in the best interests of the Company and its shareholders. While we have previously been focusing on completing the public company separation during the first half of 2022, we have determined to delay further work on the spin-off while we focus on a potential sale of our consumer business. There can be no assurance that a sale of the consumer business will take place and the terms of any such sale.
As part of our transformation, we are evolving our B2B business and developing our new digital platform technology business, Varis. We aim to transform the B2B procurement and sourcing industry by filling the growing demand for a modern, trusted, digital B2B platform. In connection with our development efforts in this area, we had acquired BuyerQuest Holdings, Inc. in 2021, a business services software company with an eProcurement platform. BuyerQuest’s operating results are included in our Varis Division. We continue to invest in the capabilities of our Varis Division and its platform, and grow our customer and supplier relationships, in order to position us to drive future value in the large and growing business commerce market.
Our strategy continues to include expanding our reach and distribution network through acquisitions of profitable regional office supply distribution businesses, serving small and mid-market customers. Many of these customers are in geographic areas that were previously underserved by our network. These acquisitions have allowed for an effective and accretive means to expand our distribution reach, target new business customers and grow our offerings beyond traditional office supplies. During the first quarter of 2022, we did not have any acquisitions. In addition, we continue to invest in our supply chain, distribution, procurement and global sourcing operations supporting our businesses, as well as the logistics needs for other third parties.
Finally, we sold our CompuCom Division on December 31, 2021, which allows us to enhance our focus on our core capabilities and strategies discussed above. Refer to the “Dispositions” section below for more information on this sale.
DISPOSITIONS
The sale of CompuCom, which represented our former CompuCom Division, was completed on December 31, 2021. The transaction was structured and accounted for as an equity sale. The related Securities Purchase Agreement (“SPA”) provides for consideration consisting of a cash purchase price equal to $125 million (subject to customary adjustments, including for cash, debt and working capital), an interest-bearing promissory note in the amount of $55 million, and a holding fee (“earn-out”) provision providing for payments of up to $125 million in certain circumstances. The promissory note accrues interest at six percent per annum, payable on a quarterly basis in cash or in-kind, and is due in full on June 30, 2027. Under the earn-out provision, if the purchaser receives dividends or sale proceeds from the CompuCom business equal to (i) three (3) times its initial capital investment in the CompuCom business plus (ii) 15% per annum on subsequent capital investments, the Company will be entitled to 50% of any subsequent dividends or sale proceeds up to and until the Company has received an aggregate of $125 million. The Company also agreed to provide certain transitional services to the purchaser for a period of three to twelve months under a separate agreement after closing. The SPA contains customary warranties of the Company and the purchaser.
The sale of CompuCom represented a strategic shift that will have a major impact on our operations and financial results. Accordingly, the operating results and cash flows are classified as discontinued operations for all periods presented. Refer to Note 12. “Discontinued Operations” in Notes to Condensed Consolidated Financial Statements for additional information.
COVID-19 UPDATE
For a discussion of the impacts to our business from COVID-19, refer to “COVID-19 Update” included in Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations, certain risk factors included in Item 1A Risk Factors in our Annual Report on Form 10-K for the fiscal year ended December 25, 2021 and the information presented below within Operating Results by Division.
RECENT GLOBAL EVENTS
We are closely monitoring the unfolding events due to the Russia-Ukraine conflict and its regional and global ramifications. We do not have operations in Ukraine or Russia, and our supply chain has not been impacted. While we do have certain vendors that are based in Ukraine, we have not experienced an impact as a result of the conflict. Other impacts due to this rapidly evolving situation are currently unknown and the broader economic impacts could potentially subject our business to materially adverse consequences should the situation escalate beyond its current scope.
23
CONSOLIDATED RESULTS OF CONTINUING OPERATIONS AND LIQUIDITY
The following summarizes the more significant factors impacting our operating results for the 13-week period ended March 26, 2022 (also referred to as the “first quarter of 2022”) and March 27, 2021 (also referred to as the “first quarter of 2021”).
Our consolidated sales were flat in the first quarter of 2022 compared to the same period of the prior year. Sales in our Business Solutions Division increased $104 million, or 9%. This increase was driven by higher sales of $129 million to our business-to-business customers, which was partially offset by lower sales in our eCommerce platform. The increase in sales in our Business Solutions Division were mainly in product categories of cleaning, personal protective equipment, breakroom, office supplies, and furniture. Sales in our Retail Division decreased $96 million, or 9%, mainly as a result of planned store closures. Our Retail Division also had lower demand in certain product categories that had higher sales in the prior year comparable quarter driven by the needs of our customers to help address their challenges derived from the COVID-19 pandemic, such as facilitating the continued remote work and virtual learning environments.
Sales |
|
First Quarter |
|
(In millions) |
|
2022 |
|
|
2021 |
|
|
Change |
|
Business Solutions Division |
|
$ |
1,231 |
|
|
$ |
1,127 |
|
|
|
9 |
% |
Retail Division |
|
|
943 |
|
|
|
1,039 |
|
|
|
(9 |
)% |
Other |
|
|
4 |
|
|
|
8 |
|
|
|
(50 |
)% |
Total |
|
$ |
2,178 |
|
|
$ |
2,174 |
|
|
|
0 |
% |
OTHER SIGNIFICANT FACTORS IMPACTING TOTAL COMPANY RESULTS AND LIQUIDITY
|
• |
Total gross profit decreased by $11 million or 2% in the first quarter of 2022 when compared to the same period in 2021. Our Business Solutions Division had $14 million higher gross profit resulting from higher sales, which was more than offset by $24 million decrease in gross profit of our Retail Division. The decrease in the Retail Division gross profit is due to the flow through impact of lower sales, partially offset by lower operating lease costs due to store closures and improved product margin. |
|
• |
Total gross margin for the first quarter of 2022 was 22%, which was consistent with the gross margins in the comparative prior year period. While we incurred incremental costs related to trade tariffs on inventory we purchase from suppliers in China, certain actions, including changes to our contracting model, alternative sourcing strategies, and selective price increase pass-through efforts mitigated much of the impact of such trade tariffs to our results of operations. |
|
• |
Total selling, general and administrative expenses decreased by $5 million in the first quarter of 2022 when compared to the same period in 2021. The decrease was primarily due to a reduction in payroll and incentives and cost saving initiatives described below. Selling, general and administrative expenses as a percentage of total sales was flat in the first quarter of 2022 as compared to the prior period. |
|
• |
We recorded $2 million of asset impairment charges in the first quarter of 2022 primarily related to the impairment of operating lease ROU assets associated with our retail store locations. Refer to Note 10. “Fair Value Measurements” in Notes to Condensed Consolidated Financial Statements for additional information. |
|
• |
We recorded $10 million of merger, restructuring and other operating expenses, net in the first quarter of 2022. Merger, restructuring and other operating expenses in the first quarter of 2022 included $9 million of third-party professional fees associated with the planned separation of our consumer business, and $1 million of expenses associated with restructuring activities in the first quarter of 2022. We did not record any transaction and integration costs in the first quarter of 2022. Refer to Note 2. “Merger, Restructuring and Other Activity” in Notes to Condensed Consolidated Financial Statements for additional information. |
|
• |
In the first quarter of 2022, we recognized a tax benefit associated with stock-based compensation awards. This along with the impact of state taxes and the mix of income and losses across U.S. and non-U.S. jurisdictions, caused our effective tax rate of 26% to differ from the statutory rate of 21%. Our effective tax rate in the prior period was primarily impacted by the recognition of a large tax benefit associated with stock-based compensation awards and recognition of tax benefits due to an agreement reached with the IRS, state taxes, and the mix of income and losses across U.S. and non-U.S. jurisdictions. Refer to Note 5. “Income Taxes” in Notes to Condensed Consolidated Financial Statements for additional information. |
|
• |
Diluted earnings per share from continuing operations was $1.09 in the first quarter of 2022 compared to $1.12 in the first quarter of 2021. |
|
• |
There was no diluted earnings per share from discontinued operations in the first quarter of 2022 compared to diluted loss per share of $(0.17) in the first quarter of 2021. |
|
• |
Net diluted earnings per share was $1.09 in the first quarter of 2022 compared to $0.95 in the first quarter of 2021. |
24
|
• |
Our Board of Directors reviewed the existing capital allocation programs in connection with the sale of CompuCom, and on December 31, 2021, authorized an additional $200 million for share repurchases under the existing stock repurchase program, for a total authorization of $650 million. On November 16, 2021, the Company entered into an accelerated share repurchase agreement (“ASR”) to repurchase shares of the Company’s common stock in exchange for an up-front payment $150 million. The repurchase period runs through June 9, 2022. The Company did not purchase any shares of its common stock in the first quarter of 2022. As of March 26, 2022, $342 million remains available for additional repurchases under the current stock repurchase program. |
|
• |
In May 2020, in order to preserve liquidity during the COVID-19 pandemic and in light of the uncertainties as to its duration and economic impact, our Board of Directors suspended our quarterly cash dividend. There was no quarterly cash dividend declared and paid in the first quarter of 2022. Our quarterly cash dividend continues to be suspended. |
|
• |
At March 26, 2022, we had $557 million in cash and cash equivalents and $874 million of available credit under the Third Amended Credit Agreement, for a total liquidity of approximately $1.4 billion. Cash provided by operating activities of continuing operations was $30 million for the first quarter of 2022 compared to $103 million in the comparable prior year period. Refer to the “Liquidity and Capital Resources” section for further information on cash flows. |
OPERATING RESULTS BY DIVISION
Discussion of additional income and expense items, including material charges and credits and changes in interest and income taxes follows our review of segment results.
BUSINESS SOLUTIONS DIVISION
|
|
First Quarter |
|
(In millions) |
|
2022 |
|
|
2021 |
|
Sales |
|
$ |
1,231 |
|
|
$ |
1,127 |
|
% change |
|
|
9 |
% |
|
|
(16 |
)% |
Division operating income |
|
$ |
33 |
|
|
$ |
17 |
|
% of sales |
|
|
3 |
% |
|
|
2 |
% |
Sales in our Business Solutions Division increased 9% in the first quarter of 2022 compared to the corresponding quarter in 2021. During the first quarter of 2022, our Business Solutions Division experienced higher demand across the majority of our product categories which was driven by the continued recovery of our business-to-business customers, including those in the education sector, from the disruptions to their operations as a result of the impacts of the COVID-19 pandemic. The increase in demand resulted in $125 million higher sales across a majority of our offerings, including paper, toner, furniture, breakroom, school and office supplies, copy and print services, as well as personal protective equipment and cleaning supplies, which contributed $54 million to this increase. The higher demand from our business-to-business customers, was partially offset by $21 million lower sales in our eCommerce platform, as compared to 2021. The impact of acquisitions, while positive, was not material to the first quarter of 2022.
Our sales could be impacted in the near term related to numerous factors, among others, a weaker U.S. economy and higher unemployment and inflation that materially impact consumer spending, the demand for our products and services and the availability of supply. Specifically, we experienced supply constraints in some of our larger product categories such as ink and technology products, and we may continue to face delays or difficulty sourcing these products.
The impacts of the COVID-19 outbreak in 2022 and the magnitude by which sales of our Business Solutions Division will be affected will depend heavily on the duration of the pandemic through new variants, impact and speed of vaccination distributions, as well as the substance and pace of macroeconomic recovery. However, as discussed above, the impact has been material to the results of the Business Solutions Division in the first quarter of 2022 and could continue into the second quarter of 2022 and beyond. In addition, changes in work environments, such as a prolonged or permanent shift to hybrid or continued remote work arrangements could also have a material impact to the future results of the Business Solutions Division.
Our Business Solutions Division operating income was $33 million in the first quarter of 2022 compared to $17 million in the first quarter of 2021, an increase of 94%. As a percentage of sales, operating income increased approximately 120 basis points. Although we experienced increases in third-party transportation costs due to the impacts of COVID-19, which reduced our gross margin by approximately 10 basis points, this was more than offset by lower selling, general and administrative expenses as a percentage of our sales. The improvement in our selling, general and administrative expenses is attributable to cost saving initiatives of our Maximize B2B restructuring program, which reduced costs in payroll, advertising and other operating expenses.
25
RETAIL DIVISION
|
|
First Quarter |
|
(In millions) |
|
2022 |
|
|
2021 |
|
Sales |
|
$ |
943 |
|
|
$ |
1,039 |
|
% change |
|
|
(9 |
)% |
|
|
(10 |
)% |
Division operating income |
|
$ |
89 |
|
|
$ |
100 |
|
% of sales |
|
|
9 |
% |
|
|
10 |
% |
Sales in our Retail Division decreased 9% in the first quarter of 2022 compared to the corresponding period in 2021. As vaccination rates have increased since early in 2021 and the effects of the COVID-19 pandemic have begun to recede, more of our customers are transitioning into on-site work and in-person learning. As a result of this recovery, we experienced $7 million of increased sales in copy and print services. This was more than offset by fewer transactions in product categories such as technology products, furniture, office supplies, cleaning supplies and personal protective equipment, which were primarily impacted by planned store closures. In addition, these categories had experienced higher demand in the prior year, which was driven by the needs of our customers to help address their challenges derived from the COVID-19 pandemic, and included facilitating the continued remote work and virtual learning environments. Our sales could be impacted in the near term related to numerous factors, among others, a weaker U.S. economy and higher unemployment that materially impact consumer spending, the demand for our products and services and the availability of supply. Specifically, we experienced supply constraints in some of our larger product categories such as ink and technology products, and we may continue to face delays or difficulty sourcing these products.
Buy online pick up in store (“BOPIS”) transactions are included in our Retail Division results because they are fulfilled with retail store inventory and serviced by our retail store associates. Our BOPIS sales were $86 million in the first quarter of 2022 as compared to $89 million in the first quarter of 2021. We had a significant increase in BOPIS sales in the first quarter of 2021 due to an increase in online orders from the impact of the pandemic in the prior year.
Our business is considered to be essential by most local jurisdictions, and as a result, the substantial majority of our retail locations have remained open and operational with the appropriate safety measures in place during the COVID-19 pandemic, including a curbside pickup option. Since late in the first quarter of 2020, we have reduced our retail location hours by one to two hours daily, which continues to be in effect at the majority of our retail locations. We believe sales in our Retail Division may continue to be adversely impacted in the first quarter of 2022 and potentially longer. As there is uncertainty in the extent and duration of the impacts of the pandemic, we are unable to estimate the full impact at this time.
We have historically reported our comparable store sales, which relate to stores that have been open for at least one year. Stores are removed from the comparable sales calculation one month prior to closing, as sales during that period are mostly related to clearance activity. Stores are also removed from the comparable sales calculation during periods of store remodeling, store closures due to hurricanes, natural disasters or epidemics/pandemics, or if significantly downsized. Our measure of comparable store sales has been applied consistently across periods, but may differ from measures used by other companies. Due to the reduction in our retail location hours due to COVID-19 during late in the first quarter of 2020, and the variability in COVID-19 related restrictions imposed by state and local governments such as occupancy levels and business regulations that can affect demand for our in-store products and services, comparable store sales is not a meaningful metric for the first quarter of 2022, and therefore is not provided.
The Retail Division operating income was $89 million in the first quarter of 2022 compared to $100 million in in the first quarter of 2021, a decrease of 11% year-over-year. As a percentage of sales, operating income reduced by 1%. The comparative decrease in operating income in the first quarter of 2022 was mostly attributable to the flow-through impact of lower sales as compared to the first quarter of 2021, which more than offset lower selling, general and administrative expenses resulting from continuous efforts to optimize costs, lower operating lease costs recognized as a result of store closures, and improved product margin.
As of March 26, 2022, the Retail Division operated 1,032 retail stores in the United States, Puerto Rico and the U.S. Virgin Islands compared to 1,146 stores at the end of the first quarter of 2021. Charges associated with store closures as part of a restructuring plan are reported as appropriate in Asset impairments and Merger, restructuring and other operating expenses, net in the Condensed Consolidated Statements of Operations. In addition, as part of our periodic recoverability assessment of owned retail stores and distribution center assets, and operating lease ROU assets, we recognize impairment charges in the Asset impairments line item of our Condensed Consolidated Statements of Operations. These charges are reflected in Corporate reporting and are not included in the determination of Division operating income. Refer to the “Corporate” section below for additional information of expenses incurred to date.
26
OTHER
Certain operations previously included in the former International Division, including our global sourcing and trading operations in the Asia/Pacific region, which we have retained, are not significant and have been presented as Other. These operations primarily relate to the sale of products to former joint venture partners, and are not material in any period. The operating results of our Varis Division, which is our new digital platform technology business, are also not significant and presented as Other.
CORPORATE
The line items in our Condensed Consolidated Statements of Operations included as Corporate activities are Asset impairments and Merger, restructuring and other operating expenses, net. These activities are managed at the Corporate level and, accordingly, are not included in the determination of Division income for management reporting or external disclosures. In addition to these charges and credits, certain selling, general and administrative expenses are not allocated to the Divisions and are managed at the Corporate level. Those expenses are addressed in the section “Unallocated Expenses” below.
Asset impairments
We recognized asset impairment charges of $2 million in the first quarter of 2022 primarily related to impairment of operating lease ROU assets associated with our retail store locations. We recognized asset impairment charges of $12 million in the first quarter of 2021. Of the asset impairment charges in the first quarter of 2021, $10 million was related to impairment of operating lease ROU assets associated with our retail store locations, and the remainder was related to impairment of fixed assets.
We regularly review 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 inputs from retail operations and accounting and finance personnel. These inputs include our 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, which, by their nature, include judgments about how current initiatives will impact future performance. In the first quarter of 2022, the assumptions used within the recoverability analysis for the retail stores were updated to consider current quarter retail store operational results and formal plans for future retail store closures as part of our restructuring programs, including the probability of closure at the retail store level. While it is generally expected that closures will approximate the store’s lease termination date, it is possible that changes in store performance or other conditions could result in future changes in assumptions utilized. In addition, the assumptions used 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. If the undiscounted cash flows of a retail store cannot support the carrying amount of its assets, the assets are impaired and written down to estimated fair value. Our retail store assets recoverability analyses in the first quarter of 2022 also included the impact of the COVID-19 pandemic on the operations of our retail stores as described in the “Retail Division” section. As discussed above, there is uncertainty regarding the impact of the COVID-19 pandemic on the results of our operations in the second quarter of 2022 and beyond, which could result in future impairments of store assets if deemed unrecoverable.
We are monitoring the performance of our Contract reporting unit, which is a component of our Business Solutions Division segment. The operating performance and future outlook for the Contract reporting unit are in line with our revised forecasts used in determining the fair value estimates in the most recent quantitative annual impairment assessment, which it passed by a 16% margin. Accordingly, there are no impairment indicators identified for this reporting unit as of March 26, 2022. We also did not identify indicators of impairment related to our other reporting units, which mainly serve consumers through our retail stores and eCommerce platform and have been performing in accordance with our forecasts. We will continue to evaluate the recoverability of goodwill at the reporting unit level on an annual basis and whenever events or changes in circumstances indicate there may be a potential impairment. If the operating results of our reporting units deteriorate in the future, it may cause the fair value of one or more of the reporting units to fall below their carrying value, resulting in additional goodwill impairment charges. Further, while we are currently in a strong liquidity and capital position, a significant deterioration may have a material impact on our liquidity and capital in future periods.
Merger, restructuring and other operating expenses, net
We have taken actions to optimize our 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. In addition, we have also incurred costs related to our actions separate our consumer business through a potential sale. The expenses and any income recognized directly associated with these actions are included in Merger, restructuring and other operating 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 customers. These expenses are not included in the determination of Division operating income. Merger, restructuring and other operating expenses, net were $10 million in the first quarter of 2022, compared to $13 million in the first quarter of 2021. Refer to Note 2. “Merger, Restructuring and Other Activity” in Notes to Condensed Consolidated Financial Statements for an additional analysis of these Corporate charges.
27
Unallocated Expenses
We allocate to our Divisions functional support expenses that are considered to be directly or closely related to segment activity. These allocated expenses are included in the measurement of Division operating income. Other companies may charge more or less for functional support expenses to their segments, and our results, therefore, may not be comparable to similarly titled measures used by other companies. The unallocated expenses primarily consist of the buildings used for our corporate headquarters and personnel not directly supporting the Divisions, including certain executive, finance, legal, audit and similar functions. Unallocated expenses were $20 million in the first quarter of 2022 which was consistent with $21 million in the first quarter of 2021.
Other Income and Expense
|
|
First Quarter |
|
(In millions) |
|
2022 |
|
|
2021 |
|
Interest income |
|
$ |
1 |
|
|
$ |
— |
|
Interest expense |
|
|
(5 |
) |
|
|
(7 |
) |
Other income, net |
|
|
2 |
|
|
|
11 |
|
In April 2020, we entered into the Third Amended Credit Agreement which provided for an aggregate principal amount of up to $1.3 billion asset-based revolving credit facility and asset-based FILO Term Loan Facility, maturing in April 2025. We recorded $1 million of interest expense in the first quarter of 2022 and $1 million of interest expense in the first quarter of 2021 related to the Third Amended Credit Agreement. We also recorded interest expense related to our finance lease obligations and revenue bonds in all periods presented.
Other income, net includes the pension credit related to the frozen OfficeMax pension and other benefit plans, as well as the pension credit related to the pension plan in the United Kingdom that has been retained by us in connection with the sale of the European Business. We also recorded $7 million of other income, net related to the release of certain liabilities of our former European Business in the first quarter of 2021.
Income Taxes
During 2022 and 2021, the mix of income and losses across jurisdictions, although still applicable, has become less of a factor in influencing our effective tax rates due to limited international operations and improved operating results. Our effective tax rates were 26% and 14% for the first quarters of 2022 and 2021, respectively. In the first quarter of 2022, our effective rate was primarily impacted by the recognition of a tax benefit associated with stock-based compensation awards year-to-date. This along with the impact of state taxes and the mix of income and losses across U.S and non-U.S. jurisdictions, caused our effective tax rate to differ from the statutory rate of 21%. In the first quarter of 2021, our effective rate was primarily impacted by the recognition of a large tax benefit associated with stock-based compensation awards year-to-date and recognition of tax benefits due to an agreement reached with the IRS related to a prior tax position. These factors, along with the impact of state taxes and the mix of income and losses across U.S. and non-U.S. jurisdictions, caused our effective tax rate to differ from the statutory rate of 21%. Changes in pretax income projections and the mix of income across jurisdictions could impact the effective tax rates in future quarters.
We continue to have a U.S. valuation allowance for certain U.S. federal credits and state tax attributes, which relates to deferred tax assets that require certain types of income or for income to be earned in certain jurisdictions in order to be realized. We will continue to assess the realizability of our 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 sale of CompuCom resulted in us recognizing a capital loss of approximately $210 million, tax effected. A portion of this capital loss, approximately $20 million, is available to be carried back in several jurisdictions. The tax benefit of these carry back claims was reflected in the discontinued operations income tax expense at December 25, 2021. We have determined that it is more likely than not that the benefit from the excess capital loss of $190 million will not be realized at this time. In recognition of this risk, we have provided a full valuation allowance against the excess capital loss not carried back.
We file a U.S. federal income tax return and other income tax returns in various states and foreign jurisdictions. With few exceptions, we are no longer subject to U.S. federal and state and local income tax examinations for years prior to 2021 and 2014, 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. Generally, we are subject to routine examination for years 2013 and forward in our international tax jurisdictions.
It is anticipated that $1 million of tax positions will be resolved within the next 12 months. Additionally, we anticipate 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 at this time.
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Discontinued Operations
Refer to Note 12. “Discontinued Operations” in Notes to Condensed Consolidated Financial Statements for information regarding the CompuCom Division which is accounted for as discontinued operations.
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY
At March 26, 2022 and December 25, 2021, we had $557 million and $514 million in cash and cash equivalents, respectively, and $874 million and $877 million of available credit under the Third Amended Credit Agreement (as defined in Note 7. “Debt” in Notes to Condensed Consolidated Financial Statements), respectively, for a total liquidity of approximately $1.4 billion at the end of both periods. Despite the weaker global economic conditions and the uncertainties related to the impacts of the COVID-19 pandemic, we currently believe that as a result of our strong financial position, including our cash and cash equivalents on hand, availability of funds under the Third Amended Credit Agreement, and future year cash flows generated from operations, we will be able to fund our working capital, capital expenditures, debt repayments, common stock repurchases, dividends (if any), merger integration and restructuring expenses, the planned Separation of our consumer business, and future acquisitions consistent with our strategic growth initiatives for at least the next twelve months from the date of this Quarterly Report on Form 10-Q. From time to time, we may prepay outstanding debt and/or restructure or refinance debt obligations. As the impact of the COVID-19 pandemic on the global and national economies and our operations evolve, we will continue to assess our liquidity needs.
Financing
On April 17, 2020, as disclosed in Note 7. “Debt,” we 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 FILO 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 replaced our then existing amended and restated credit agreement that was due to mature in May 2021. During the first quarter of 2022, we reduced our asset-based revolving credit facility by $200 million to $1.0 billion and retired $43 million of outstanding FILO Term Loan Facility loans under the Third Amended Credit Agreement.
There were no revolving loans outstanding, $57 million of outstanding FILO Term Loan Facility loans, and $47 million of outstanding standby letters of credit under the Third Amended Credit Agreement at the end of the first quarter of 2022, and we were in compliance with all applicable covenants at March 26, 2022.
Strategic Transformation
In addition to the acquisitions disclosed herein, we have evaluated, and expect to continue to evaluate, possible acquisitions and dispositions of businesses and assets in connection with our strategic transformation. Such transactions may be material and may involve cash, our securities or the incurrence of additional indebtedness.
As further discussed in Strategic Transformation above, we expect to incur significant costs associated with separating our consumer business through a potential sale, which are expected to relate primarily to third-party professional fees, including legal fees. There can be no assurances that the sale transaction or a separation will be completed.
Capital Expenditures
We estimate capital expenditures in 2022 to be up to approximately $110 million, which includes investments to support our business priorities. These expenditures will be funded through available cash on hand and operating cash flows.
Capital Return Programs – Share Repurchases and Dividends
Our Board of Directors reviewed the existing capital allocation programs in connection with the sale of CompuCom, and on December 31, 2021, authorized an additional $200 million for share repurchases under the existing stock repurchase program, for a total authorization of $650 million. The new authorization may be suspended or discontinued at any time. The exact timing of share repurchases will depend on market conditions and other factors, and will be funded through available cash balances.
On November 16, 2021, the Company entered into an accelerated share repurchase agreement (“ASR”) to repurchase shares of the Company’s common stock in exchange for an up-front payment $150 million. The repurchase period runs through June 9, 2022. We did not repurchase any shares of our common stock in the first quarter of 2022.
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The stock repurchase authorization permits us to repurchase stock from time-to-time through a combination of open market repurchases, privately negotiated transactions, 10b5-1 trading plans, accelerated stock repurchase transactions and/or other derivative transactions. The exact number and timing of stock repurchases will depend on market conditions and other factors, and will be funded through available cash balances. Our Third Amended Credit Agreement permits restricted payments, such as common stock repurchases, but may be limited if we do not meet the required minimum liquidity or fixed charge coverage ratio requirements. The authorized amount under the stock repurchase program excludes fees, commissions or other expenses.
In May 2020, in order to preserve liquidity during the COVID-19 pandemic and in light of the uncertainties as to its duration and economic impact, our Board of Directors temporarily suspended the Company’s quarterly cash dividend beginning in the second quarter of fiscal 2020. There was no quarterly cash dividend declared and paid in the first quarter of 2022. Our quarterly cash dividend remains suspended. Prior to its suspension, dividends had been recorded as a reduction to additional paid-in capital as we are in an accumulated deficit position. Our Third Amended Credit Agreement permits restricted payments, such as dividends, but may be limited if we do not meet the required minimum liquidity or fixed charge coverage ratio requirements.
We will continue to evaluate our capital return programs as appropriate. Decisions regarding future share buybacks and dividends are within the discretion of our Board of Directors, and depend on a number of factors, including, general business and economic conditions, which includes the impact of COVID-19 on such conditions, and other factors which are discussed in this discussion and analysis and “Risk Factors” within Other Key Information in our 2021 Form 10-K.
CASH FLOWS
Continuing Operations
Cash provided by (used in) operating, investing and financing activities from continuing operations is summarized as follows:
|
|
First Quarter |
|
(In millions) |
|
2022 |
|
|
2021 |
|
Operating activities of continuing operations |
|
$ |
30 |
|
|
$ |
103 |
|
Investing activities of continuing operations |
|
|
(14 |
) |
|
|
(32 |
) |
Financing activities of continuing operations |
|
|
(64 |
) |
|
|
(30 |
) |
Operating Activities from Continuing Operations
In the first quarter of 2022, cash provided by operating activities from continuing operations was $30 million, compared to $103 million during the corresponding period in 2021. This decrease in cash flows from operating activities was primarily driven by $50 million more cash outflows from working capital and $27 million less net income after adjusting for non-cash charges, slightly offset by $4 million more usage of deferred tax assets against current obligations. Working capital is influenced by a number of factors, including period end sales, the flow of goods, credit terms, timing of promotions, vendor production planning, new product introductions and working capital management. For the first quarter of 2022, the primary driver for higher working capital usage was due to $29 million less cash inflows due to changes in our receivables, $10 million increase in cash outflows from our inventories, and $10 million more cash outflows due to changes in our trade payables and other liabilities. The remaining cash outflow of $1 million is related changes in various other asset balances. The change in our receivables is due to the impact of the COVID-19 pandemic on the sales of our Business Solutions Division in the prior year period, as well as the recovery we are observing in the first quarter of 2022. The change in our payables and other liabilities is reflective of the timing of payments. The change in inventories is mainly attributable to purchase volume.
For our accounting policy on cash management, refer to Note 1. “Summary of Significant Accounting Policies” in Notes to Condensed Consolidated Financial Statements.
Investing Activities
Cash used in investing activities from continuing operations was $14 million first quarter of 2022, compared to $32 million first quarter of 2021. The cash outflow in the first quarter of 2022 was driven by $21 million in capital expenditures associated with improvements in our service platform, distribution network, and eCommerce capabilities. These outflows were partially offset by proceeds from sale of assets of $6 million and the cash proceeds from our company-owned life insurance policies of $1 million. The cash outflow in the first quarter of 2021 was driven by $28 million in business acquisitions, net of cash acquired, and $12 million in capital expenditures associated with improvements in our service platform, distribution network, and eCommerce capabilities. These outflows were partially offset by the cash proceeds from our company-owned life insurance policies of $7 million and proceeds from sale of assets of $1 million.
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Financing Activities
Cash used in financing activities from continuing operations was $64 million first quarter of 2022, compared to $30 million first quarter of 2021. The cash outflow in the first quarter of 2022 primarily consisted of $6 million of net payments on long- and short-term borrowings activity related to our debt, $43 million payment on our FILO Term Loan Facility loans under the Third Amended Credit Agreement, and $14 million share purchases for taxes, net of proceeds, for employee share-based transactions. Cash used in the first quarter of 2021 primarily consisted of $6 million of net payments on long- and short-term borrowings activity related to our debt, and $23 million share purchases for taxes, net of proceeds, for employee share-based transactions.
Discontinued Operations
Cash provided by (used in) operating and investing activities from discontinued operations is summarized as follows:
|
|
First Quarter |
|
(In millions) |
|
2022 |
|
|
2021 |
|
Operating activities of discontinued operations |
|
$ |
— |
|
|
$ |
(17 |
) |
Investing activities of discontinued operations |
|
|
67 |
|
|
|
(1 |
) |
There was no cash flow related to operating activities of discontinued operations in the first quarter of 2022. Cash used in operating activities from discontinued operations was $17 million in the first quarter of 2021. The change in operating cash flows of discontinued operations in the comparative periods was primarily driven by the sale of our CompuCom Division on December 31, 2021.
Cash flows from investing activities from discontinued operations was $67 million in the first quarter of 2022, compared to cash used in investing activities from discontinued operations of $1 million in the first quarter of 2021. The change in investing cash flows of discontinued operations in the comparative periods reflects proceeds received from the sale of our CompuCom Division, net of cash sold and selling costs, on December 31, 2021.
NEW ACCOUNTING STANDARDS
For a description of new applicable accounting standards, refer to Note 1. “Summary of Significant Accounting Policies” in Notes to Condensed Consolidated Financial Statements of this Quarterly Report on Form 10-Q.
CRITICAL ACCOUNTING POLICIES
Our Condensed 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 and a description of accounting policies that are considered critical may be found in our 2021 Form 10-K, in Note 1 of the Notes to the Consolidated Financial Statements and the Critical Accounting Policies and Estimates section of the Management’s Discussion and Analysis of Financial Condition and Results of Operations. Except for our accounting policy updates described in Note 1 “Summary of Significant Accounting Policies” in Notes to Condensed Consolidated Financial Statements of this Quarterly Report on Form 10-Q, there have been no significant changes to our critical accounting policies since December 25, 2021.
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OTHER INFORMATION