After reporting an in-line earnings in the first quarter of 2018, Office Depot, Inc. (ODP - Free Report) delivered a positive earnings surprise of 25% during the second quarter. Meanwhile, the top line came ahead of the Zacks Consensus Estimate for the fourth straight quarter. However, in spite of higher sales, earnings declined year over year. This may be attributed to rise in cost of goods sold and occupancy costs as well as increased SG&A and interest expenses.
Nevertheless, analysts believe that decent results and strategic initiatives, including strengthening of core businesses and expansion of service and subscription offerings, might have prompted management to maintain 2018 view.
We believe improvement in Business Solutions and CompuCom divisions is likely to benefit the company going forward. The company has undertaken a strategic review of business operating model, growth prospects and cost structure and is concentrating on e-commerce platforms. Management is also making incremental investments to catapult it into a product and services-driven enterprise. Service revenue now represents approximately 16% of total sales.
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.
We note that shares of this Zacks Rank #3 (Hold) company have surged roughly 17% compared with the industry’s growth of 8% in the past three months.
This office supplies retailer delivered adjusted earnings per share from continuing operations of 5 cents that beat the Zacks Consensus Estimate by a penny but declined roughly 17% from the prior-year quarter.
The company generated sales of $2,628 million that fared better than the consensus mark of $2,605 million and increased 11% year over year. We note that while product sales inched up 1% to $2,196 million, service revenue more than doubled to $432 million.
Gross profit increased 9% year over year to $596 million, however, gross margin contracted 40 basis points (bps) to 22.7%. Adjusted operating income came in at $63 million flat year over year, while adjusted operating margin shriveled 30 bps to 2.4%.
Business Solutions Division sales increased 4% to $1,298 million on account of growth endeavors taken in adjacency categories, online sales and buyouts. Product sales grew 3%, while services revenue rose 15% during the quarter. Operating income came in at $67 million, up from $64 million reported in the year-ago period on account higher sales and cost containment efforts. Operating margin increased 10 bps to 5.2%.
In the reported quarter, the Retail Division’s sales fell 5% to $1,053 million on account of planned closure of stores and adoption of the new revenue recognition standard that lowered revenue by approximately $10 million. Product sales fell 7%, while services revenue surged 12%. Comparable-store sales (comps) drop 2% due to lower transactions and fall in average order values. However, the metric improved 200 bps sequentially.
Segment operating income came in at $22 million, up from $20 million in the prior-year quarter. The year-over-year increase can be attributed to cost cutting endeavors. Operating margin expanded 30 bps to 2.1%.
Total store count at the division was 1,374 at the quarter end. During the quarter, the company shut down 2 outlets.
CompuCom Division posted sales of $277 million in the quarter, while operating income came in at $6 million or 2.2% of sales.
Other Financial Details
Office Depot ended the quarter with cash and cash equivalents of $747 million, long-term debt (net of current maturities) of $903 million, non-recourse debt of $765 million, and shareholders’ equity of $2,156 million. The company repaid $19 million of outstanding term loan in relation to the repayment schedule. The company bought back approximately 3 million shares at a total cost of $8 million in the quarter.
During the quarter, the company generated cash flow of $44 million from operating activities and incurred capital expenditures of $37 million, consequently resulting in free cash flow of $7 million. Management expects to generate free cash flow of $350 million in 2018.
Office Depot reiterated full year sales view of $10.8 billion and adjusted operating income projection of $360 million for 2018.
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