recent second-quarter loss may be the least of investors' worries.
What's potentially more troubling is that the Florida attorney general's office has opened an investigation of the office-supplies retailer for alleged overcharging of government clients, but somehow Office Depot hasn't disclosed this information to investors.
While Office Depot may not have violated any laws relating to shareholder disclosure, the Florida investigation carries important ramifications for investors, especially because it could hamper a takeover of the company.
Office Depot's stock -- which is down more than 70% over the past year -- rallied briefly last week after Goldman Sachs analysts said that a merger with
would help stem the sector's troubles.
Delray Beach, Fla.-based Office Depot reported last week that it swung to a $2 million loss in the second quarter, down from a profit of $106 million a year ago. Analysts blamed sluggish sales and high fixed costs for the poor results.
Outside of the difficult business environment, Office Depot is also facing possible legal troubles related to its business of supplying office materials to government agencies.
The Florida attorney general's investigation relates to allegations from a whistle-blowing former Office Depot employee who described a bait-and-switch-like campaign by the company to overcharge state and local agencies purchasing materials.
The Florida attorney general's office declined to comment on the matter but confirmed that its investigation began in May of this year.
"Office Depot is disguising price increases to government accounts by fraudulently increasing list pricing, not correctly applying discounts, and switching customers to a higher-cost price plan without their knowledge," David Sherwin, a former Office Depot account manager turned whistleblower, tells
Sherwin estimates these policies resulted in a 5% to 10% overcharge annually on the $700 million agreement with government contracts, or about $35 million to $70 million annually. Many of these charges were in Florida, California and Georgia, but also took place in 43 other states, he says.
Curiously, Office Depot has still not disclosed the investigation to investors in its filings with the
Securities and Exchange Commission
, but the company did respond to
inquiry into the matter.
"The company intends to fully cooperate with the Attorney General's office in its investigation and to vigorously defend any allegations of wrong doing," Office Depot spokesman Jason Shockley said in an emailed statement.
"We believe the civil investigation being conducted by the Attorney General arises from allegations made by a former disgruntled employee, who was terminated for workplace misconduct," Shockley said. "Office Depot denies any allegations of intentional wrong doing, and we look forward to cooperating with the Attorney General's office in its review."
Earlier this year, the State of Georgia canceled a $40 million annual contract with Office Depot after a government agency said it warned the company about incorrectly priced items.
The California Legislature is currently exploring allegations of overcharges from Office Depot's $25 million annual contract with the state, according to a
South Florida Sun-Sentinel
article in early July.
So why hasn't the civil investigation by Florida Attorney General Bill McCollum that began in May been disclosed to investors?
"The SEC rules require only a description of 'material pending legal proceedings, other than ordinary routine litigation incident to the business,' " says Shockley, the Office Depot spokesman. "Government inquiries, including those from states' attorneys general, are not uncommon, and often resolve themselves at a preliminary stage. The referenced matter does not trigger mandated disclosure."
In its latest 10-Q filing, Office Depot said sales under government contracts amounts to less than 5% of its sales so far this year.
At this point, no one knows the ultimate ramifications -- if any -- from this investigation. But what's pretty clear is that it's hard to imagine how Office Depot and Office Max would consummate a merger before this dust cloud settles.