Office Depot (ODP) Misses Q2 EPS by 3c; Announces Cost Savings Program; Initiates Dividend, Hikes Stock Buyback

Office Depot (NASDAQ: ODP) reported Q2 EPS of $0.03, $0.03 worse than the analyst estimate of $0.06. Revenue for the quarter came in at $3.2 billion versus the consensus estimate of $3.2 billion.

North American Retail Division

Retail Division sales were $1.2 billion in the second quarter of 2016 compared to $1.3 billion in the prior year period. Second quarter sales declined 7%, primarily due to the impact of planned store closures in the twelve months through June 25, 2016. Same-store sales in the quarter declined 1% primarily due to lower transaction counts, partially offset by higher average order value. Same-store sales benefited from the positive impact of transferred sales from closed stores.

Update on Comprehensive Business Review and Strategy

In conjunction with the announcement of the Staples merger termination on May 16, 2016, Office Depot announced that it had engaged Bain & Company to assist with finalizing a comprehensive strategic review of its business. This review included a detailed analysis of the company’s current operating model, growth opportunities and cost structure to support the company’s overall Framework for Growth. The result is a three-year strategic plan to grow profitability and provide shareholder value that contains four key elements: accelerating opportunities in the contract channel, optimizing and reinventing the North American Retail model, implementing multi-year cost reductions across the company and returning capital to shareholders. This review is substantially complete and a number of initiatives are underway across the business.

Identifies Initiatives for Future Growth

Office Depot has identified a number of opportunities to grow sales in the contract channel by improving penetration into adjacent categories and increasing share of wallet with existing customers. One attractive opportunity is in the facilities space where the company can leverage its relationships with current customers by offering an expanded assortment of products. The market for these products remains large and fragmented, with attractive growth potential for Office Depot. The company intends to aggressively compete in this space by adding additional core products, leveraging its supply chain capabilities and increasing selling efforts to drive penetration.

Expanding U.S. Retail Optimization and Store of the Future Plan

During the second quarter of 2016, Office Depot completed the first phase of the U.S. Retail Store Optimization that was launched in 2014. This plan resulted in the closure of 400 stores, with sales transfer rates in excess of the company’s 30% stated target, leading to over $100 million in ongoing benefits. Based on the success of this initiative, Office Depot is expanding this plan to include approximately 300 additional store closures over the next three years.

The company intends to build on the early success of its store of the future format by expanding the pilot program to a total of 24 stores by the end of 2016 with 100 stores targeted for 2017. This format features a smaller 15,000 sq. ft. footprint and is designed to provide customers with an enhanced shopping experience including a curated assortment of products and expanded services. Office Depot expects that many of these elements will be incorporated across the retail portfolio in the coming years which will create a more consistent and efficient retail operating model with enhanced sales per square foot.

Launching Additional Cost Savings Program

As part of the comprehensive business review process, several opportunities were identified to increase efficiencies and optimize the organization. Accordingly, the company is launching a number of initiatives across key business areas to capture these savings including the implementation of a more effective customer coverage model, a reduction in indirect procurement costs, lower overall general and administrative costs as well as realizing the benefits from the expanded U.S. retail store optimization program. In total, these initiatives are expected to deliver over $250 million in annual benefits by the end of 2018.

These savings are in addition to the expected merger synergy benefits of more than $750 million from the OfficeMax integration and will bring the total of annual savings benefits realized since 2014 to more than $1 billion by the end of 2018.

Optimizing Capital Structure

In conjunction with the comprehensive business review, Office Depot also completed an analysis of its capital structure during the second quarter. The company recently announced the extension of its $1.2 billion asset-based credit facility for an additional five years to provide for long term liquidity and had approximately $2.2 billion in total liquidity at the end of the second quarter of 2016. Based on this liquidity position, Office Depot announced today that it is calling its outstanding 9.75% senior secured notes due 2019 for redemption on September 15, 2016. The notes are currently callable at a price equal to 104.875% of the principal amount for a total consideration of approximately $262 million. The company will realize annual cash interest savings of approximately $24 million as a result of this debt retirement.

Initiating a Quarterly Dividend

In recognition of the company’s strong liquidity position and confidence in the ability to generate future cash flow, the Office Depot Board of Directors has approved the initiation of a quarterly cash dividend. The company has declared an initial dividend of $0.025 per share ($0.10 per share on an annualized basis) on the common stock of the company payable on September 15, 2016, to shareholders of record at the close of business August 25, 2016.

Increasing Share Repurchase Authorization

On May 31, 2016, the company announced that its Board of Directors had authorized a stock repurchase program of up to $100 million of its outstanding common stock. As of July 29, 2016, the company has repurchased approximately 16 million shares for an aggregate cost of $55 million. Office Depot remains committed to enhancing shareholder return and the Board has approved an increase in the stock repurchase authorization from the previously authorized $100 million to a total of $250 million.

Outlook

Office Depot continues to expect total company sales in 2016 to be lower than 2015, primarily due to the impact of store closures, the business disruption from the protracted regulatory process related to the Staples’ acquisition attempt and continued challenging market conditions. The company expects this disruption to continue throughout the year but at a decelerated rate as the company focuses on winning new business.

As a result of the adverse impact on the company’s sales resulting from the prolonged Staples’ acquisition attempt, Office Depot now expects to generate between $450 million and $470 million in adjusted operating income in fiscal 2016.

Office Depot closed 42 stores in the second quarter of 2016 as part of its previously announced U.S. retail store optimization plan. The company expects to close approximately 25 additional stores in 2016 as part of the second phase of this plan.

Total capital expenditures in 2016 are now expected to be approximately $175 million, a reduction of $75 million from the previous target. This estimate includes approximately $50 million in capital spend related to the merger integration. Depreciation and amortization is expected to be approximately $215 million in 2016.

Office Depot continues to expect total annual run-rate merger synergy benefits of more than $750 million from the OfficeMax integration and expects the integration to be substantially complete by the end of 2017. The company expects to incur approximately $70 million of merger integration expenses in 2016 and the remaining $30 million in 2017.

Office Depot anticipates a non-GAAP effective tax rate of approximately 45% in fiscal 2016, dependent on the mix and timing of income across jurisdictions, and an estimated cash tax rate of between 10% and 15% as the company utilizes available tax operating loss carry forwards and credits.

The company expects free cash flow to be in excess of $200 million in 2016 and more than $300 million in 2017 as one-time merger and integration spending abates.

For earnings history and earnings-related data on Office Depot (ODP) click here.

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