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Office Depot (ODP) Q1 Earnings Top, Fall Y/Y, View Revised

Zacks Equity Research

Office Depot, Inc. ODP delivered fourth straight quarter of positive earnings surprise, when it reported first-quarter 2019 results. Further, total sales marginally came ahead of the Zacks Consensus Estimate after missing the same in the preceding quarter. However, both the top and bottom line fell year over year.

Management had earlier warned that lower-than-expected operating performance at the CompuCom division would have a direct bearing on total sales and operating income. We note that shares of this Zacks Rank #4 (Sell) company have plunged roughly 30.5% in the past three months against the industry’s growth of 5.7%.

Nevertheless, the company has undertaken initiatives such as strategic review of business operating model, growth prospects and cost structure to bring itself back on track. It is also concentrating on e-commerce platforms. Management is also making incremental investments to catapult it into a product and service-driven enterprise.

Office Depot initiated Business Acceleration Program that involves reducing costs, improving operational efficiencies, enhancing service delivery, effective use of technology and automation and identifying strategic investment opportunities. Moreover, in order to control discretionary spending, the company adopted zero-based budgeting approach. As a result, management anticipates cost savings of at least $40 million in the second half of 2019 and to attain at least $100 million in annual run-rate costs savings thereafter.



Quarterly Results

This office supplies retailer delivered adjusted earnings per share from continuing operations of 7 cents that beat the Zacks Consensus Estimate by a penny but fell 13% from the prior-year quarter.

The company generated total sales of $2,769 million that marginally beat the consensus mark of $2,763 million but declined 2% year over year owing to lower sales in CompuCom and Retail divisions. We note that while product sales fell 3% to $2,361 million, service revenues remained almost flat at $408 million.

Adjusted operating income came in at $67 million, down 28% year over year, while adjusted operating margin shriveled 90 bps to 2.4%. Adjusted EBITDA of $118 million fell 16% year over year, while adjusted EBITDA margin contracted 70 bps to 4.3%.

Segment Performance

Business Solutions Division sales inched up 1% to $1,344 million on the back of buyouts. Excluding acquisitions, sales were down 2%. Organic sales performance was buoyed by sustained growth in adjacency categories and services. These were more than offset by fall in traditional office product categories. Product sales grew 1%, while service revenue surged 13% during the reported quarter. Operating income came in at $46 million, down from $55 million reported in the year-ago period. Management informed that increase in paper and paper related costs, lower e-commerce sales and other investments were a drag on operating income.

In the reported quarter, the Retail Division’s sales fell 6% to $1,175 million owing to planned closure of stores. Product sales fell 8%, while service revenue advanced 16%. Comparable-store sales dropped 4% owing to fall in store traffic, partly offset by rise in conversion rates and surge of 16% in buy on-line, pick up in store sales.

Segment operating income came in at $67 million, down from $72 million in the prior-year quarter. The year-over-year decline can be attributed to deleverage related to closure of outlets, lower sales, and investments in additional service delivery capabilities. Operating margin shrunk 10 bps to 5.7%.

Total store count at the division was 1,359 at the quarter end. During the reported quarter, the company shuttered two outlets.

CompuCom Division generated sales of $247 million in the quarter, down 4% year over year on account of weaker-than-anticipated revenues from existing customer projects. The segment reported operating loss of $15 million compared with operating income of $5 million in the year-ago period. This can be attributed to lower sales and less-than-proportionate fall in related expenses.

Other Financial Details

Office Depot ended the reported quarter with cash and cash equivalents of $604 million, long-term debt (net of current maturities) of $632 million, and shareholders’ equity of $2,106 million. The company also repaid approximately $19 million scheduled debt repayment on the 2022 term loan during the quarter. The company bought back roughly 4 million shares at a total cost of $11 million.

During the quarter, the company generated cash flow of $60 million from operating activities and incurred capital expenditures of $46 million, consequently resulting in free cash flow of $14 million. Management now anticipates generating free cash flow in the range of $300-$325 million in 2019.

Guidance

Taking into account the quarterly results and expected benefits from Business Acceleration Program, management revised its 2019 view. Office Depot now projects sales in the band of $10.8-$10.9 billion, adjusted EBITDA in the range of $525-$550 million and adjusted operating income between $325 and $350 million. The company had earlier guided sales of $11.1 billion, adjusted EBITDA of $575 million and adjusted operating income of $375 million.

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