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Here's Why Office Depot (ODP) Fell Despite Q4 Earnings Beat

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After reporting in-line earnings in the third quarter of 2017, Office Depot, Inc. (ODP - Free Report) delivered positive earnings surprise of 14.3% in the fourth quarter. Meanwhile, the top line came ahead of the Zacks Consensus Estimate for the second straight quarter. But despite reporting better-than-expected results, shares of this Zacks Rank #3 (Hold) company plunged 16% following the results.

It seems that investors’ apprehension about the stock stems from dwindling top and bottom-line performance. Further, management’s soft earnings projection and bleak adjusted operating income view for 2018 alarmed investors. Management hinted that incremental growth investments to catapult it into a services-driven company and reduced sales volume are the primary reasons behind lower adjusted operating income.

Nevertheless, the company anticipates that sales from the new growth endeavors may help mitigate the impact of lower store volume, prior year store closures and adoption of new revenue recognition standards, to an extent. The company also informed that it has completed the integration with OfficeMax and decided to tread slowly on store closure path. The company plans to close 20 net stores in 2018.

The company is trying all means to give itself a complete makeover. This seems evident as 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. Further, stiff competition from online retailers such as Amazon (AMZN - Free Report) and lower traffic count in retail stores have been playing spoilsport.

The reflection of the same is quite visible from the stock’s performance in the bourses. So far in the year, shares of the company have nosedived 31.9%, wider than the industry’s decline of 5.4%.

Quarterly Results

This office supplies retailer delivered adjusted earnings per share from continuing operations of 8 cents that beat the Zacks Consensus Estimate by a penny but declined 27% from the prior-year quarter, as the top line continues to struggle. The company generated sales of $2,581 million that fared better than the consensus mark of $2,541 million but fell 5% year over year.

For quite some time now, Office Depot has been grappling with dwindling top-line performance. Nevertheless, the company is closing underperforming stores, reducing exposure to higher dollar-value inventory items, shuttering non-critical distribution facilities, concentrating on e-commerce platforms as well as focusing on offering innovative products and services.

Gross profit fell 7% year over year to $607 million, while gross margin contracted 50 basis points (bps) to 23.5%. Adjusted operating income came in at $95 million, down from $96 million (excluding $15 million from the additional 53rd week) reported in the year-ago period, while adjusted operating margin remained flat 3.7%.

Office Depot, Inc. Price, Consensus and EPS Surprise

 

Office Depot, Inc. Price, Consensus and EPS Surprise | Office Depot, Inc. Quote

Segment Performance

In the reported quarter, the Retail Division’s sales fell 15% to $1,164 million on account of 4% drop in comparable-store sales (comps). Comps declined due to lower transactions and fall in average order values. The segment reported operating income of $40 million, down 17% from the prior-year quarter, while operating margin decreased 40 bps to 3.4% due to lower sales and gross margin rate, partly offset by fall in SG&A expenses. Total store count at the division was 1,378 at the quarter end. During the quarter, the company shut down 26 outlets.

Sales for Business Solutions Division tumbled 7% to $1,257 million on account of fall in average sales volume in the contract channel, holiday calendar shift and the impact of sales from omni-channel programs that are recorded in the Retail Division. The segment posted operating income of $68 million, down from $71 million reported in the year-ago period. Operating margin decreased 10 bps to 5.4%. The fall in the operating income was due to lower sales and gross margin rate, partly negated by effective cost management, including lower SG&A expenses.

CompuCom Division posted sales of $156 million in the final quarter, while operating income came in at $8 million or 4.8% of sales.

Other Financial Details

Office Depot ended the quarter with cash and cash equivalents of $622 million, long-term debt (net of current maturities) of $936 million, non-recourse debt of $776 million, and shareholders’ equity of $2,120 million. During the quarter, the company bought back 6 million shares for an aggregate amount of $22 million.

During the full year, the company generated cash flow of $467 million from operating activities and incurred capital expenditures of $141 million, consequently resulting in free cash flow of $326 million. Management expects to generate free cash flow of $325 million in 2018. The company anticipates capital expenditures of approximately $175 million.

Discontinuation of International Business

Office Depot concluded the sale of its mainland business in Australia on Feb 5, 2018. The sale of the remaining discontinued operation in New Zealand remains subject to regulatory approvals. However, the company has retained sourcing and trading operations in Asia. Results from the Asia operations are reported as “Other” segment.

Guidance

Office Depot now envisions sales to be $10.6 billion during 2018. Further, it expects earnings to come in at 30 cents a share for the full year, which is sharply down from 45 cents and 46 cents reported in 2017 and 2016, respectively. The forecasted number is also well below analysts’ expectations. The current Zacks Consensus Estimate for the full year is pegged at 56 cents, which could witness downward revision in the coming days.

Office Depot now projects adjusted operating income of $350 million for 2018, down from $446 million and $456 million posted in 2017 and 2016, respectively.

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