After reporting a positive earnings surprise of 14.3% in the final quarter of 2017, Office Depot, Inc. (ODP - Free Report) delivered in-line earnings in the first quarter of 2018. Meanwhile, the top line came ahead of the Zacks Consensus Estimate for the third straight quarter.

Favorable results and strategic initiatives, including strengthening of core businesses and expansion of service and subscription offerings, prompted management to provide an encouraging outlook for 2018. This led the stock to rise as much as 9% during pre-market trading hours.

Moreover, improvement in Business Solutions and CompuCom divisions is also likely to benefit the company going forward. The company has undertaken a strategic review of business operating model, growth prospects and cost structure and 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 14% of the 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.

The reflection of the same is quite visible from this Zacks Rank #3 (Hold) stock’s performance in the bourses. In the past three months, shares of the company have nosedived 20.4%, wider than the industry’s decline of 1.1%.

Office Depot, Inc. Price, Consensus and EPS Surprise

 Quarterly Results

This office supplies retailer delivered adjusted earnings per share from continuing operations of 8 cents that came in line with the Zacks Consensus Estimate but declined 50% from the prior-year quarter, in spite of higher sales. Analysts pointed that lower margins and higher interest expense might have hurt the bottom line.

The company generated sales of $2,830 million that fared better than the consensus mark of $2,812 million and increased 6% year over year. We note that while Product sales declined 2% to $2,423 million, Service revenue surged 88% to $407 million.

Gross profit fell 1% year over year to $667 million, while gross margin contracted 160 basis points (bps) to 23.6%. Adjusted operating income came in at $93 million, down from $148 million reported in the year-ago period, while adjusted operating margin shriveled 220 bps 3.3%.

Segment Performance

Business Solutions Division sales rose for the first time since 2012. Sales increased 1% to $1,328 million on account of growth endeavors taken in adjacency categories, online sales and buyouts. Operating income came in at $55 million, down from $58 million reported in the year-ago period. Operating margin shrunk 30 bps to 4.1%. The fall in the operating income was due to conversion costs and additional marketing investments.

In the reported quarter, the Retail Division’s sales fell 8% to $1,244 million on account of planned closure of stores and adoption of the new revenue recognition standard that lower revenue by approximately $30 million. Comparable-store sales (comps) drop 4% due to lower transactions and fall in average order values. Segment operating income came in at $72 million, down from $112 million in the prior-year quarter. The year-over-year decrease can be attributed to fall in sales and increased marketing and advertising investments. Operating margin decreased 240 bps to 5.8%.

Total store count at the division was 1,376 at the quarter end. During the quarter, the company shut down two outlets.

CompuCom Division posted sales of $257 million in the quarter, while operating income came in at $5 million or 2% of sales.

Other Financial Details

Office Depot ended the quarter with cash and cash equivalents of $737 million, long-term debt (net of current maturities) of $918 million, non-recourse debt of $770 million, and shareholders’ equity of $2,157 million.

During the quarter, the company generated cash flow of $207 million from operating activities and incurred capital expenditures of $37 million, consequently resulting in free cash flow of $170 million. Management now expects to generate free cash flow of $350 million in 2018, up from prior projection of $325 million.

Discontinuation of International Business

Office Depot concluded the sale of its mainland business in Australia on Feb 5 and closed the sale of its business in New Zealand on May 4, 2018. However, the company has retained sourcing and trading operations in Asia. Results from the Asia operations are reported as “Other” segment.

Guidance

Office Depot raised its full year sales view to $10.8 billion from $10.6 billion. Management now projects adjusted operating income of $360 million for 2018. The company had earlier guided adjusted operating income of $350 million for the full year.

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