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Office Depot Rallies on Strong Q1 Earnings

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Shares of Office Depot Inc. (ODP - Free Report) rallied 16% on the index yesterday following the better-than-expected first quarter 2014 results, upbeat guidance and increased synergies expectations from the merger with OfficeMax.

More importantly, this Zacks Rank #3 (Hold) stock is now on store rationalizing drive and will close 400 overlapping locations (150 stores in 2014) by 2016 to generate cost savings of $75 million annually. The savings will be accretive by 2015.

Office Depot’s adjusted earnings per share came in at 7 cents, rising over twofold from the Zacks Consensus Estimate and proforma earnings per share of 3 cents. Including one-time items, the company delivered loss per share of 21 cents, as against loss of 6 cents per share in the prior year quarter.

Office Depot’s total revenue of $4,354 million increased about 60% from the prior-year quarter and surpassed the Zacks Consensus Estimate of $4,288 million. However, on a proforma basis revenues slipped 3%.

Office Depot’s first quarter 2014 results are inclusive of OfficeMax’s operations. Since the merger was finalized in Nov 2013, the company has provided proforma figures (i.e. including both Office Depot and OfficeMax operations) for first quarter 2013 assuming completion of the merger in the beginning of 2013 to facilitate better year over year comparisons.

Gross profit for the quarter grew nearly 54% year over year to $1,015 million. On a proforma basis gross profit fell 5.7%. Adjusted operating income came in at $72 million, up 33.3% from the proforma figure of $54 million in the first quarter of 2013.

Segment Performance

In the quarter, North American Retail division’s revenues increased 58% to $1,811 million. On a proforma basis, revenues fell 5%. Comparable-store sales fell 3% due to fall in transaction counts, partly offset by higher average order values. The segment reported operating income of $37 million, up 76.2% year over year. On a proforma basis operating income grew 19.4%.

Total store count at the North America Retail division was 1,900 at the quarter-end (1,082 Office Depot outlets and 818 OfficeMax outlets). Moreover, during the quarter, the company closed 9 Office Depot stores, 5 Office Max stores and opened 2 Office Depot stores.

Revenues for North American Business Solutions rose nearly 88.7% to $1,540 million. On a proforma basis revenues fell 2%. The division posted an operating income of $40 million, up 53.8% from the year-ago quarter and 5.3% on proforma basis. The increase in operating income was driven by lower selling general & administrative expenses partly offset by lower gross margin rate.

The International division’s revenues grew 32.1% but declined 1% on proforma basis to $1,003 million. The overall sales in the European contract as well as the Direct Channel fell whereas it increased marginally in the Retail channel. The division reported an operating income of $20 million in the quarter, up over twofold year over year. On a proforma basis it increased 17.6%.

At the end of the quarter, total store count at the International division was 353 comprising 146 company-owned outlets, 92 OfficeMax locations (Mexico) and 115 outlets operated by franchisees and licensees.

Merger Update

Including the store rationalization cost savings, the company now expects to achieve synergies of $675 million by the end of 2016, over the earlier expectation of $600 million. The company expects to realize $180 million in 2014.

Office Depot continues to expect $400 million of integration expenses (excluding store rationalization expenses) with $300 million expected to be incurred in 2014.

OfficeMax and Office Depot completed the merger in Nov 2013. The company, under its new CEO Roland Smith, completed the reorganization of the company in Feb 2014.

Office Depot and OfficeMax merged to compete better with peers like Staples, Inc. and Inc. (AMZN - Free Report) .

Other Financial Details

Office Depot, which competes with United Stationers Inc. , ended the quarter with cash and cash equivalents of $870 million, long-term debt (net of current maturities) of $685 million and total shareholders’ equity of $1,962 million. It incurred capital expenditure of $39 million and generated negative cash flow of $74 million from operating activities during the quarter.

Outlook for 2014

Management foresees headwinds across product lines and distribution channels during 2014. As a result, the company projects total revenue to be lower than 2013 pro-forma combined sales.

However, adjusted operating income is expected to be at least $160 million, up from the earlier expectation of at least $140 million. In 2014, capital expenditure will be approximately $150 million, excluding an additional $50 million of integration costs.

For 2014-2016, capital expenditure is expected to be around $200-$250 million.

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