Office Depot, Inc. (ODP - Free Report) delivered second straight quarter of positive earnings and sales surprises, when it reported third-quarter 2018 results. However, in spite of higher sales, earnings declined year over year. This can be attributed to rise in cost of goods sold, occupancy costs, and increased SG&A and interest expenses. Moreover, the prior-year period was also favorably impacted by the tax benefit.
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 raise 2018 sales view.
Experts believe that improvement in Business Solutions and CompuCom divisions is likely to benefit the company going forward. It has undertaken a strategic review of business operating model, growth prospects and cost structure. The company is also 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 15% of total sales.
Following the results, shares of this Zacks Rank #3 (Hold) company have surged roughly 24% during the trading session on Nov 7. We note that the stock has gained 13% compared with the industry’s growth of 10% in the past three months.
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.
This office supplies retailer delivered adjusted earnings per share from continuing operations of 13 cents that beat the Zacks Consensus Estimate by a penny but declined roughly 7% from the prior-year quarter.
The company generated sales of $2,887 million that fared better than the consensus mark of $2,858 million and increased 10% year over year. We note that while product sales inched up 1% to $2,453 million, service revenue more than doubled to $434 million.
Adjusted operating income came in at $120 million, down 6% year over year, while adjusted operating margin shriveled 70 basis points (bps) to 4.2%. Adjusted EBITDA of $172 million increased 3%, while adjusted EBITDA margin contracted 40 bps to 6%.
Business Solutions Division sales increased 6% to $1,364 million on account of growth endeavors taken in adjacency categories, online sales and buyouts. Product sales grew 5%, while services revenue surged 28% during the quarter. Operating income came in at $67 million, down from $71 million reported in the year-ago period on account increased SG&A expenses partly offset by higher gross margin. Operating margin decreased 60 bps to 4.9%.
In the reported quarter, the Retail Division’s sales fell 6% to $1,254 million on account of planned closure of stores and adoption of the new revenue recognition standard that lowered revenue by approximately $8 million. Product sales fell 7%, while services revenue advanced 11%. Comparable-store sales (comps) drop 5% due to lower transactions. Segment operating income came in at $70 million, down from $82 million in the prior-year quarter. The year-over-year decline can be attributed to deleverage related to closure of outlets, fall in volume sales, and investments in additional service delivery capabilities. Operating margin shrunk 60 bps to 5.6%.
Total store count at the division was 1,372 at the quarter end. During the reported quarter, the company shut down two outlets.
CompuCom Division posted sales of $268 million in the quarter, while operating income came in at $1 million or 0.4% of sales.
Other Financial Details
Office Depot ended the reported quarter with cash and cash equivalents of $925 million, long-term debt (net of current maturities) of $887 million, non-recourse debt of $759 million, and shareholders’ equity of $2,197 million. The company repaid $18 million of outstanding term loan in relation to the repayment schedule. The company bought back approximately 5 million shares at a total cost of $14 million in the quarter.
During the quarter, the company generated cash flow of $304 million from operating activities and incurred capital expenditures of $47 million, consequently resulting in free cash flow of $257 million. Management expects to generate free cash flow of $450 million and $350 million in 2018 and 2019, respectively.
Office Depot now expects full year sales to be $11 billion, up from $10.8 billion guided earlier. Management continues to project adjusted operating income of $360 million for 2018. The company now envisions adjusted EBITDA to be $560 million.
For fiscal 2019, management forecasts sales of $11.1 billion, adjusted operating income of $375 million and adjusted EBITDA of $575 million.
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