After three straight quarters of earnings beat Office Depot, Inc. (ODP - Free Report) succumbed to a negative earnings surprise of 33.3% in second-quarter 2017, as the top line continues to struggle. This office supplies retailer posted adjusted earnings per share from continuing operations of 6 cents that missed the Zacks Consensus Estimate of 9 cents but came in line with the prior-year quarter.
Including one-time items, the company delivered earnings of 4 cents a share from continuing operations in comparison with 41 cents in the prior-year period.
The company generated sales of $2,363 million that also lagged the Zacks Consensus Estimate of $2,460 million and declined 9% year over year. This was the 12th consecutive quarter that the company had missed the consensus mark. We note that shares are down roughly 14% during pre-market trading hours.
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 - 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. These initiatives have provided cushion to the stock that has increased 17.7% in the past three months compared with industry’s decline of 10.1%.
Gross profit fell 11.1% year over year to $545 million, whereas gross margin contracted 60 basis points (bps) to 23.1%. Adjusted operating income came in at $68 million, down 12.8% from the year-ago period, while adjusted operating margin decreased 10 bps to 2.9%.
In the reported quarter, the Retail Division’s sales fell 11% to $1,111 million on account of planned closure of stores and a 6% drop in comparable-store sales (comps). Comps declined due to fall in foot traffic and average order purchase value. The segment reported operating income of $20 million, down 33.3% from the prior-year quarter, whereas operating margin shriveled 60 basis points to 1.8% due to lower sales and gross margin rate, partly offset by fall in SG&A expenses. Total store count at the division was 1,408 at the quarter end. During the quarter, the company shut down 31 outlets.
Sales for Business Solutions Division tumbled 6.2% (or down 6% in constant currency) to $1,248 million on account of customer attrition in the contract channel, stiff competition and lower catalog sales. The segment posted operating income of $64 million, marginally up from $63 million reported in the year-ago period. Operating margin expanded 30 bps to 5.1% on account of effective cost management, including 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 $347 million, non-recourse debt of $787 million, and shareholders’ equity of $1,975 million.
Management continues to expect free cash flow from continuing operations of over $300 million in 2017. The company incurred capital expenditures of $25 million during the quarter under review. Management expects capital expenditures of approximately $150 million in 2017, which comprises of investments to fund critical priorities as well as the Store of the Future test formats.
During the quarter, the company bought back 2 million shares for an aggregate amount of $7 million. Since May 2016, the company has bought back approximately 41 million shares at a total cost of $149 million with $101 million remaining at its disposal under the current share repurchase authorization of $250 million.
Discontinuation of International Business
During the quarter under review, the company concluded the sale of its operations in South Korea. Recently, it reached an agreement to offload its mainland China business, which was finalized on Jul 28, 2017. Office Depot has entered into a deal to divest operations in Australia and New Zealand to Platinum Equity. The terms of the transaction are kept under wraps. However, the company has retained sourcing and trading operations in Asia. Results from the Asia operations are reported as “Other” segment.
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 decelerate in the second half of 2017 taking into consideration higher customer retention and strategic endeavors, along with the implementation of new customer wins. Office Depot expects adjusted operating income of about $500 million in 2017.
After termination of the merger with Staples, Inc. (SPLS - Free Report) , 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.
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.
Office Depot currently carries a Zacks Rank #3 (Hold). A better-ranked stock in the space is Build-A-Bear Workshop, Inc. (BBW - Free Report) with a Zacks Rank #2 (Buy) and a long-term earnings growth rate of 22.5%. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
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