Office Depot, Inc. (ODP Quick QuoteODP - Free Report) reported better-than-expected earnings for the second consecutive quarter, when the company came out with fourth-quarter 2016 numbers. This came on the back of strategic measures the office supplies retailer has undertaken to bring itself back on growth trajectory following the ruling out of its merger with Staples, Inc. .

Following, the result the company shares surged nearly 16% on Mar 1. In fact, in the past six months the company’s shares have gained nearly 30%, outperforming the Zacks categorized Retail-Miscellaneous/Diversified industry which has witnessed a decline of nearly 5%.

Overall Quarterly Performance

Office Depot posted adjusted earnings per share from continuing operations of 11 cents that came a penny ahead of the Zacks Consensus Estimate and also jumped 83.3% from 6 cents in the prior-year quarter. Including one-time items, the company delivered earnings of 3 cents per share from continuing operations in comparison with 6 cents in the prior-year period.

However, the company’s top-line continues to struggle, missing the Zacks Consensus Estimate for the tenth-consecutive quarter. Further, its revenues of $2,725 million lagged the Zacks Consensus Estimate of $2,743 million and declined 2% year over year. Excluding the impact of the U.S. retail store closures, foreign currency translation and the 53rd week, sales dipped 4%.

Analysts pointed out that demand for office products (paper-based) has been decreasing due to technological advancements. Smartphones, tablets and laptops are fast emerging as viable substitutes for paper-based office supplies. Moreover, there has been persistent weakness in the office products sector. Further, stiff competition from online retailers such as Amazon.com, Inc. (AMZN Quick QuoteAMZN - Free Report) has been playing spoilsport for Office Depot.

Nevertheless, the company is closing underperforming stores, reducing exposure to higher dollar-value inventory items, shuttering non-critical distribution facilities, concentrating on eCommerce platforms as well as focusing on offering innovative products and services.

Gross profit fell 0.5% year over year to $653 million, while gross margin expanded 30 basis points (bps) to 24%. Adjusted operating income came in at $111 million, up 33.7% from the year-ago period, while adjusted operating margin expanded 110 bps to 4.1%.

Segment Performance

In the reported quarter, the North American Retail division’s revenues fell 2.8% to $1,366 million due to the planned closure of stores. While excluding the impact of 53rd week and store closures the company’s sales fell 3%. Comparable-store sales dipped 4% year over year on account of lower store traffic.

The segment reported operating income of $62 million, down 1.6% from the prior-year quarter. The decline is attributable to favorable legal settlements registered in the year-ago period, a lower gross margin rate, and decline in sales partly mitigated by a fall in selling, general and administrative expenses. Segment operating margin came in at 4.5%, flat year over year.

Total store count at the North American Retail division was 1,441 at quarter end. During the quarter, the company shut down 65 outlets.

Revenues for North American Business Solutions slipped 0.4% to $1,355 million owing to lower sales in the contract channel primarily due to increase in customer attrition and lesser customer additions. However, the company registered increase in sales in the direct channel driven by robust sales during holiday season.

The division posted operating income of $75 million, surging 92.3% year over year, while operating margin expanded 260 bps to 5.5% on account of higher gross margin rate and lower SG&A expenses.

Other Financial Details

Office Depot ended the quarter with cash and cash equivalents of $763 million, long-term debt (net of current maturities) of $358 million, non-recourse debt of $798 million and shareholders’ equity of $1,852 million.

Management generated free cash flow from continuing operations of $380 million in 2016 and anticipates it to be over $300 million in 2017. The company incurred capital expenditures of $111 million during 2016, in comparison with $144 million in 2015. Management expects capital expenditures of approximately $200 million in 2017 which comprises of investments to fund critical priorities as well as the Store of the Future test format.

Additionally, on Dec 15, 2016, the company has announced quarterly cash dividend of 2.5 cents a share (10 cents a share on an annualized basis).

During the quarter, the company bought back 14 million shares aggregating $51 million. As of Dec 31, it has bought back about 37 million shares for an aggregate amount of $132 million and had $118 million remaining at its disposal under the current share repurchase authorization of $250 million.

Discontinuation of International Business

In September, the company announced its decision to sell European operation to The Aurelius Group. The company successfully completed the deal on Dec 31, 2016. The financial terms of the deal were kept under wraps.

Office Depot has been taking strategic initiatives to return on growth track and focus on core North American market. The sale of the company’s European operations is being looked upon as a part of these efforts.

Further, the retailer stated that it is in the process of shutting down all international businesses in Australia, New Zealand, South Korea, and mainland China. The company expects the divestiture to be completed by 2017. Sales from these operations are reported as discontinued operations. However, the company plans to retain sourcing and trading operations in Asia. Results from the Asia operations are reported as “Other” segment outside of the North American segments. In 2016, the sourcing and trading business garnered $18 million in sales and $1 million in operating income.

Outlook

Management expects total sales to be lower in 2017 in comparison with 2016, owing to the store closures, tough market conditions and losses of contract customers in the previous year. However, management anticipates the rate of decline to decrease throughout 2017 taking into consideration higher customer retention and improvement in the contract channel sales pipeline, along with the implementation of new customer wins.

Office Depot expects adjusted operating income of $500 million in 2017 compared with adjusted operating income of $471 million in 2016.

During the fourth quarter, the company shuttered 65 stores with respect to its U.S. retail store optimization plan. In 2017, it plans to close about 75 outlets. Office Depot reiterated annual run-rate merger synergy benefits in excess of $750 million from the OfficeMax integration, which is likely to be concluded by the end of this year, and anticipates incurring merger integration expenses of about $45 million in 2017. The company has already achieved more than $700 million merger synergy benefits.

Strategic Measures

After termination of the merger with Staples, Office Depot has undertaken a strategic review of business operating model, growth prospects and cost structure. The company, by increasing penetration into adjacent categories and enhancing share of wallet with existing customers, intends to boost sales in the contract channel. Further, the company can leverage existing customer base by offering an expanded assortment of products.

As part of its U.S. retail store optimization program launched in 2014, the company had shuttered 400 stores in the first phase, and plans to close 300 more stores over the next three years. Furthermore, it is focusing on smaller format stores of 15,000 square feet to better serve customers. As part of the pilot program the company converted 25 stores in 2016 and plans to convert 75 stores to this format in 2017.

Coming to the cost containment effort, Office Depot is employing a more efficient customer coverage model, focusing on lowering indirect procurement costs as well as general and administrative expenditures. Further, the company will also gain from its U.S. retail store optimization plan. Management expects these endeavors to result in annual benefits of over $250 million by the end of 2018, with nearly half of those benefits are expected to be realized in 2017. This, along with synergy benefits in excess of $750 million, will amount to total annual savings of $1 billion by the end of 2018.

Zacks Rank

Office Depot currently carries a Zacks Rank #4 (Sell). A better-ranked stock in the retail sector is MarineMax, Inc. (HZO Quick QuoteHZO - Free Report) , carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

MarineMax has surpassed the Zacks Consensus Estimate in the three of the four trailing quarters, with an average earnings beat of 131.2%.

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