Office Depot, Inc. (ODP Quick QuoteODP - Free Report) reported better-than-expected earnings after missing the same in the trailing four quarters. This came on the back of strategic measures the office supplies retailer has undertaken to bring itself back on the growth trajectory. Following the results, the company's shares gained more than 15% on Nov 2.

Overall Quarterly Performance

Office Depot posted adjusted earnings per share of 16 cents that came a penny ahead of the Zacks Consensus Estimate but declined roughly 6% from 17 cents in the prior-year quarter. Including one-time items, the company delivered earnings of 61 cents per share from continuing operations in comparison to 8 cents in the prior-year period.

However, the company’s top line continues to struggle, missing the Zacks Consensus Estimate for the ninth consecutive quarter. The company’s revenues of $2,836 million lagged the Zacks Consensus Estimate of $3,492 million and declined 7% year over year. Excluding the impact of the U.S. retail store closures and foreign currency translation, sales dropped 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 8% year over year to $726 million, whereas gross margin contracted 20 basis points (bps) to 25.6%. Adjusted operating income came in at $158 million, slipping 2% from the year-ago period, while adjusted operating margin expanded 30 bps to 5.6%.

Segment Performance

In the reported quarter, the North American Retail division’s revenues fell 8% to $1,482 million due to the planned closure of stores. Comparable-store sales dipped 2% year over year on account of lower transaction counts.

The segment reported operating income of $105 million, down from $120 million in the prior-year quarter. The decline is attributable to favorable legal settlements registered in the year-ago period, a lower gross margin rate, decline in sales partly mitigated by a fall in occupancy costs and SG&A expenses. Segment operating margin contracted 40 bps to 7.1%.

Total store count at the North American Retail division was 1,506 at quarter end. During the quarter, the company shut down seven outlets..

Revenues for North American Business Solutions declined 6% to $1,348 million owing to lower sales in both the contract and direct channels.

The division posted operating income of $81 million, which surged 23% year over year, while operating margin expanded 140 bps to 6% 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 $801 million, long-term debt (net of current maturities) of $360 million, non-recourse debt of $803 million and shareholders’ equity of $1,849 million.

Management anticipates generating free cash flow over $375 million in 2016 and in excess of $300 million in 2017. The company incurred capital expenditures of $26 million during the quarter, comprising $8 million related to merger integration. Management expects capital expenditures of approximately $120 million in 2016, including $30 million related to merger integration.

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

During the quarter, the company bought back 16 million shares aggregating $55 million. As of Sep 24, the company has bought back about 23 million shares for an aggregate amount of $81 million and had $169 million remaining at its disposal under the current share repurchase authorization of $250 million.

Discontinuation on International Business

The company in September announced its decision to sell its European operation to The Aurelius Group. The financial terms of the deal, which is expected to be concluded by the end of 2016, have been kept under wraps. The news came almost four months after the attempt to merge with Staples, Inc. fell through.

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

Further, the retailer said that they are in the process of shutting down all international businesses in Australia, New Zealand, South Korea, and mainland China. The company garners nearly $600 million of combined revenues and an operating loss from its international business.

Outlook

Management expects total sales to be lower in fourth-quarter 2016 in comparison with the prior-year period, on account of store closures, business disruption owing to merger related issues and tough market conditions. However, management anticipates the rate of decline to decelerate sequentially on the heels of higher customer retention and improvement in the contract channel sales pipeline, coupled with the implementation of new customer wins.

Office Depot reiterated adjusted operating income projection of $450–$470 million in 2016 compared with adjusted operating income of $438 million in 2015.

During the third quarter, the company shuttered seven stores with respect to its U.S. retail store optimization plan. In the final quarter, the company plans to close about 65 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 next year, and expects to incur merger integration expenses of about $70 million in 2016 and the remaining $30 million in 2017.

Additionally, the company now projects total sales to be lower in 2017 in comparison with 2016. Adjusted operating income is anticipated to be nearly $500 million whereas capital expenditures are expected to be roughly $200 million.

Strategic Measures

After the termination of the merger with Staples, Office Depot has undertaken a strategic review of its business operating model, growth prospects and cost structure. The company, by increasing its 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 its 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 year time frame. 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 three stores in July and plans to test this format at 24 stores by the end of this year, with 100 stores targeted for next year.

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, and also gaining 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. This, together 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 has a Zacks Rank #4 (Sell). A better-ranked stock in the retail sector is Dick's Sporting Goods Inc. (DKS Quick QuoteDKS - Free Report) , sporting a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1  Rank stocks here.

Dick's Sporting Goods has a long-term earnings growth rate of 12.3%.

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