Office Depot, Inc. ODP delivered third straight quarter of positive earnings surprise, when it reported fourth-quarter 2018 results. However, sales fell short of the Zacks Consensus Estimate after surpassing the same in the preceding two quarters. Nonetheless, both top and bottom-line increased year over year.
Following the results, shares of this Zacks Rank #2 (Buy) company have risen roughly 9.5% during the trading session on Feb 27. We note that the stock has gained roughly 10% compared with the S&P 500 index that advanced about 2% in the past three months.
The company has undertaken initiatives such as strategic review of business operating model, growth prospects and cost structure that have helped it get back on track. Experts believe that improvement in Business Solutions and CompuCom divisions is likely to benefit the company going forward. It is also concentrating on e-commerce platforms. Management is also making incremental investments to catapult it into a product and service-driven enterprise. Service revenue now represents approximately 16% of total sales.
Quarterly Results
This office supplies retailer delivered adjusted earnings per share from continuing operations of 9 cents that beat the Zacks Consensus Estimate by a penny and advanced 12.5% from the prior-year quarter.
The company generated sales of $2,670 million that missed the consensus mark of $2,684 million but increased 3% year over year. We note that while product sales fell 1% to $2,250 million, service revenue surged 34% to $420 million.
Adjusted operating income came in at $84 million, down 9% year over year, while adjusted operating margin shriveled 50 basis points (bps) to 3.1%. Adjusted EBITDA of $138 million remained flat year over year, while adjusted EBITDA margin contracted 10 bps to 5.2%.
Segment Performance
Business Solutions Division sales increased 3% to $1,293 million on account of buyouts. Organic sales performance was buoyed by sustained growth in adjacency categories and services. Product sales grew 2%, while service revenue surged 20% during the reported quarter. Operating income came in at $54 million, down from $68 million reported in the year-ago period on account of cost impacts and investments made.
In the reported quarter, the Retail Division’s sales fell 6% to $1,090 million owing to planned closure of stores and adoption of the new revenue recognition standard that lowered revenue by approximately $10 million. Product sales fell 8%, while service revenue advanced 18%. Comparable-store sales (comps) dropped 5%. Segment operating income came in at $28 million, down from $40 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 80 bps to 2.6%.
Total store count at the division was 1,361 at the quarter end. During the reported quarter, the company opened one new outlet, replaced one and shuttered 13 outlets.
CompuCom Division posted sales of $283 million in the quarter, while operating income came in at $5 million or 1.8% of sales.
Other Financial Details
Office Depot ended the reported quarter with cash and cash equivalents of $658 million, long-term debt (net of current maturities) of $690 million, non-recourse debt of $754 million, and shareholders’ equity of $2,126 million.
During the final quarter, the company lowered the rate on its Term Loan Credit Agreement due 2022 by 175 basis points. Management expects that this will lower future annual net interest expense by an estimated $21 million. The company also repaid approximately $200 million of the term loan’s outstanding balance. Management expects net interest expense to be $75 million in 2019.
The company bought back approximately 6 million shares at a total cost of $17 million in the quarter. The company’s board of directors also approved a new $100 million share repurchase program, which is effective from Jan 1, 2019.
During the quarter, the company generated cash flow of $61 million from operating activities and incurred capital expenditures of $66 million, consequently resulting in negative free cash flow of $5 million. Management expects to incur capital expenditures of up to $175 million and generate free cash flow of $350 million in 2019.
Guidance
For 2019, management continues to forecast sales of $11.1 billion, adjusted EBITDA of $575 million and adjusted operating income of $375 million.
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