Q3 2020 ODP Corp Earnings Call

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Performance and following Anthonys comments, we will open up the line for questions.

But before we begin I need to inform you that certain comments made on this call include forward looking statements, which are subject to the safe Harbor provisions of the private Securities Litigation Reform Act of 1995.

These forward looking statements reflect the company's current expectations concerning future events and are subject to a number of risks and uncertainties that could cause actual results to differ materially.

A detailed discussion of these risks and uncertainties are contained in the company's filings with the U S Security and Exchange Commission.

During the call we will use some non-GAAP financial measures as we described business performance.

The SEC filings as well as the earnings press release presentation slides at a company today's comments and reconciliations of the non-GAAP financial measures to the most directly comparable GAAP financial measures are all available on our website at Investor Dot The ODP Corp, Dot com today's call and slide presentation.

Nation as being simulcast on our website and will be archived there for at least one year.

I will now turn the call over to Odp's CEO, Jerry Smith Jerry.

Including generated adjusted free cash flow of over $300 million against the backdrop of a very challenging environment highlights the strength agility of our ecosystem.

We are continuing to build upon this ecosystem and made solid progress on our BTB pivot to drive future growth.

We initiated or maximize BTB restructuring plan.

Which will reduce or retail lease liabilities.

Improve our cost structure and provide cash and resources to generate future growth are BTB platform.

We continued to leverage our supply chain capabilities and build key relationships to enhance our leadership position enter a lively serve our customers.

We are listening to our customers meeting their needs with our products and services are building upon or go to market engine to drive future growth.

Our supply chain assets give us the ability to consistently and cost effectively served customers at home in the office or through our retail facilities.

In many markets, we provide next day and even same day delivery.

As we know supply chain reliability and capacity has been a significant challenge for many in the market throughout the pandemic for the largest online retailers as well as the largest distribution companies.

We also have technology and communication products and bundles to support our customer needs, including home office, Workspaces and furniture and cleaning and break room.

We also provide a broad set of services, including copy and print as well as technology services, including security and device management and services on the edge through <unk>.

We continue to evaluate launching new categories, leveraging our capabilities and customer relationships.

Solid demand continues for PPE, a category, we launched last quarter and illustrates the agility of our underlying sourcing and supply chain capabilities.

Together with our low cost model or unique ecosystem is meeting our customers needs and a challenging environment and can be seen in our operating trends that drove a results as shown on slide six.

As we've discussed the COVID-19 outbreak has created a very challenging business environment.

While we are beginning to see early signs of recovery business operations that many of our customers remain impacted and is widely publicized schools, including higher education have either delayed opening our operating remotely or adopted a hybrid approach.

While this is created a headwind impacting revenue compared to last year and shifting the demand curve of our back to school selling season, we've been able to help offset these impacts by using the diverse nature of our distribution channels to address the changes and mix.

For example, we continued to drive a significant increase in demand from business customers and consumers through R. E Commerce channel, which was up significantly over the last year and now approaching over 1.2 billion in sales.

Or retail channel continues to be a convenient and resourceful means for businesses and consumers the source of the products and services they need.

Total omnichannel sales, including delivery Bocas and same day orders were up over 30% in fact focus sales nearly double from the last year.

This balance helped us to offset lower volume in our contract channel related the covid outbreak.

Our value proposition and broad product assortment continue to resonate with business customers as evident in a significant increase in demand in our work from anywhere category, including home office technology, and Workspaces R. B will work categories, which include cleaning and breakthrough PPE insanitation.

Also exhibited strong demand versus last year.

This progress has helped offset lower demand as some of our more traditional supply categories, which were negatively impacted by coping.

As evidenced adjacency category sales, which includes cleaning them break room.

Technology furniture copy and print and PPE compromise about 47% of total BST sales.

And we continue to see good market opportunities in those categories.

Fewer stores in service.

The remaining stores have performed better on a relative basis over last year.

Our operating performance was up significantly driven by our efforts to optimize the store operating model, managing our inventory and driving down corporate support costs.

This was achieved despite notable headwinds and shifts in back to school, which typically lands in Q3 and perhaps what we are most proud of is our continued support for schools and community outreach. We have held many major events across nation for our start proud School campaign program that raise millions of dollars in donations for time.

Well one schools.

I congratulate all of our associates, who have participated in support of our communities and our customers.

Expanding our ecosystems influence into a higher growth opportunities in the future at.

At the core of this ecosystem is are expensive supply chain, which way to continue to invest in this is complemented by our customers and vendor relationships and a strong I'm flexible go to market engine to satisfy our customers and derived growth.

We continue to drive cost efficiencies in our business, because we know that the low cost model wins we.

We have made great strides in this effort through several of our cost efficiency programs.

And we remain focused on driving additional costs out of this model.

Selling season as the impact from covered shifted some of this demand from the third quarter to the remainder of this year and perhaps into early next year.

Partially offsetting these impacts was our balanced channel approach and broad product assortment, both of which helped us address the evolving needs of our customers.

This approach gave us the ability to handle the demand changes and our channel mix driving increases in sales through our E commerce and retail channels and address the increasing need for work and learn from home products.

We drove improving revenue performance on a sequential basis with revenue up 18% over the second quarter and when comparing quarter over quarter revenue trends, our performance improved by 800 basis points.

Therefore, while the business environment is only beginning to recover our revenue performance is trending in the right direction.

GAAP operating income in the quarter was $102 million down slightly from $108 million last year.

Included in operating income was $26 million in merger and restructuring charges $17 million of which is associated with our maximize and b to b restructuring plan and $5 million associated with our business acceleration program or back.

We also recognize $10 million and asset impairments, mostly related to operating lease right of use assets.

Excluding these and other items, our adjusted operating income for the third quarter was $138 million exceeding the $137 million, we generated in last years pre covance third quarter. This.

This is a significant accomplishment considering the challenges posed by the pandemic.

Our focus on a low cost business model helped drive this result, driving SGN, a lower as a percentage of revenue to about 18% of revenue in the quarter.

Although not likely to be linear we believe we can drive SGN, a as a percentage of revenue to be consistently in the mid teens overtime.

Additionally, we drove supply chain efficiencies during the quarter, helping offset some of the increased third party costs, we have incurred during the shift to work from home that we've experienced during dependable.

Our large private fleet and multiple relationships with third party carriers has our supply chain well positioned to continue to reliably and cost effectively serve our customers.

Turning to the rest of the piano unallocated corporate expenses were $29 million in the quarter up slightly from the prior year.

Adjusted EBITDA was $186 million for the quarter compared to $191 million in last years third quarter.

This includes adjusted depreciation and amortization expense of $45 million and $51 million in the third quarter of 2020 and 2019, respectively.

Excluding the after tax impact from the items mentioned earlier adjusted net income for the third quarter was $97 million or $1.80 per diluted share up 18% over last year compared to adjusted net income of $84 million or $1.53 per diluted share in the prior year.

Despite the continuing challenging conditions, our team maintained they're focused on cash in the quarter delivering significant operating and free cash flow.

Operating cash flow in the quarter was $309 million, which included $4 million and integration costs and $17 million of restructuring costs.

Working capital efficiencies and prudent inventory management, along with a $44 million AMTI tax credit refund, which last year occurred in Q4 helped to drive this result.

Capital expenditures in the quarter were $14 million compared to $32 million in the prior year period, reflecting lower investment in our retail operations, while continuing investments in our B to B platform distribution network and E commerce capabilities.

Adjusting for cash charges of $17 million associated with the company's restructuring plans adjusted free cash flow in the quarter was $312 million up nearly 50% over last year a.

A testament to the team our cost focus as well as meeting our customers needs in all channels.

Let's now turn to slide 11, which highlights the performance of our BSD Division.

As a reminder, DSD is the largest component of our BD integrated distribution platform, serving customers from the fortune 500 to small and medium size companies.

BSD consist primarily of serving customers through both our contract and E commerce channels.

As we know the outbreak of COVID-19 cause significant business disruption for our b to b customers and schools.

While we are beginning to see signs of a recovery. This has not been a business as usual situation and the effect of the pandemic has most notably impacted topline results in our BSD Division.

However, our balance channels to market have helped offset the mix shift we have experienced in our contract channel shifting business customer demand and to other channels, including ecommerce and retail.

This balanced approach has helped us make progress despite the challenging conditions.

Reported sales in the quarter for BSD were at $1.2 billion.

While this result, as 11% lower than last year revenue trends improved sequentially highlighted by a 1200 basis point quarter over quarter improvement.

Our channel mix and product breadth helped offset some of the negative impacts and drove the improved sequential performance.

Sales increased over 20% in our E Commerce channel and demand increase for products supporting work and learn from home and essential products with technology sales up over 30% and cleaning and breakroom sales, including TERP up nearly 20% versus last year.

Our total adjacent categories grew relative to last year and comprise approximately 47% of total revenue in our BSD Division.

This balance helped to partially offset the impacts related to the cobot pandemic negatively impacting core supply categories.

Sales trends improved throughout the third quarter as business activity increased and many individuals began to adjust their needs for the work from home environment.

We are continuing to monitor the pace of business in school Reopenings as this will impact the speed of our topline recovery.

Operating income was $45 million in the third quarter compared to $71 million in the prior year period. The decrease in operating income versus last year was related to the coated impact to sales and product mix, partially offset by SGN, a cost improvements related to our cost efficiency programs.

Turning to slide 12 reported sales in the quarter for our retail division showed significant sequential improvement down only 3% to $1.15 billion.

This was achieved despite 73 fewer stores compared to a year ago and a slower back to school selling season due to covance.

Offsetting lower store traffic was higher average order volume and sales per shopper, helping drive an increase in year over year sales for stores in operation during the quarter.

We saw increased demand for work and learn from home products supporting business customers and consumers as well as essential cleaning products, including pp to address customers needs posed by the pandemic.

Categories, such as furniture technology, and peripherals and cleaning products saw strong double digit increases in demand.

The combination of our curbside pickup option and BOPUS offerings remain popular with BOPUS demand up over 80% as customers chose the convenience of this option.

Ship from store and same day deliveries were also up highlighting the flexibility of our delivery capabilities.

Moving the mix while product revenue held its own and was flat with last year service revenue was down 22% negatively impacted by the COVID-19 pandemic.

We once again delivered strong operating performance.

Operating income was $119 million in the third quarter up over 40% compared to the same period last year or as a percentage of sales a 320 basis point improvement in margin.

This improved performance was largely related to lower SDMA from cost efficiency initiatives and an improvement in distribution and inventory management costs as well as lower operating lease costs.

Looking at Slide 13, we highlight the performance of the comp become division.

The conditions related to the coated pandemic continue to weigh on comp the comps performance in the quarter.

Sales were $197 million down 22% versus the prior year period.

While annuity services revenues remained relatively stable the decrease was largely due to lower product sales and customer imposed project delays as the cobot pandemic impacted our customers operations.

We expect some recovery and project work for the balance of the year.

The comp become division reported operating income of $3 million in the third quarter of 2020 flat with the prior year period that cost efficiency measures and other cost reduction efforts helped to drive the year over year margin improvement despite lower revenue.

Coffee come support for its customers during the pandemic has been stellar and their core competencies and support platform has been well positioned for the future. We are focused on accelerating our business growth and bringing our vision regarding the future of work to life at an accelerated pace.

As you heard Gerry mentioned and as part of the normal course of business. We continue to explore options for partnerships teaming and joint investments all options that will help us accelerate our business and unlock value.

Now turning to the balance sheet and cash flow highlights as shown on slide 14.

We ended the quarter with total liquidity of over $1.7 billion, consisting of $743 million in cash and cash equivalents and $1 billion of availability under our ABL after.

After paying down $300 million of the ABL during the period total.

Total debt at the end of the quarter was approximately $375 million of which $100 million remains outstanding under the ABL facility, which does not mature until 2025.

We ended the quarter with a pristine balance sheet and it remains a source of strength, which provides us flexibility as we execute our strategy and pursue growth.

I already covered cash flow in my earlier remarks, however, I would point out that despite the challenging conditions, we prudently manage cash in the quarter through strong working capital improvements, including solid inventory management, resulting in adjusted free cash flow generation of $312 million versus $209 million in the prior year period.

Aligned with one of my top priorities as CFO, our capital allocation will remain focused on investing in our b to b platform to drive profitable growth, including expanding our supply chain network and distribution capabilities. We.

We believe that investing in and leveraging our BTB ecosystem, we will continue to position us to drive long term shareholder value also.

Also as we announced this morning, our board approved the resumption of our existing share buyback program with the goal of enhancing shareholder returns, we have approximately $130 million left on the existing $200 million authorization, which will resume in the fourth quarter and run through the end of 2021.

Our decision to resume our share buyback program as well as paying down borrowings under our ABL reflect the strength of our business and financial position and highlights our commitment to maximizing returns for our shareholders I look forward to sharing more about our overall capital allocation strategy at our Investor day scheduled for Q1.

Finally, I too would like to thank all of our associates, who continue to make a difference and live up to our five C. culture. We once again delivered strong performance against the backdrop of a challenging market the strength of our assets strong free cash flow growth and ability to generate substantially higher EBITDA growth in the future creates a very compelling opportunity.

To drive significant value at ODP.

Expanding our multiple and delivering sustainable long term growth.

With that operator, we will now open the line for questions.

At this time, if you would like to ask a question Press Star then the number one on your telephone keypad again that is star line. Our first question will come from the line of Chris Mcginnis. Please state your company name them and proceed with your question.

Good morning, Chris Mcginnis from Sidoti and company. Thanks for taking my question.

Can you maybe just start around the commentary around the SDMA.

Great job in terms of.

Drilling the cost there.

You talked about a mid teen target going forward.

Just talk about how you see that playing out given the recovery on which you need to kind of.

Backing US you made the economy.

Boston strengthen.

And then maybe just also on that on the on the consolidated operating margin a really strong number.

You'll have favorable those going forward. Thanks.

Hey, good morning, Chris and thank you I'll take the first part, though Anthony Wells, we'll go over to Anthony for some comments as well so really pleased with the progress from an overall US unique perspective. This is a long term program. We put in place when I came in and were continue the great work by our leadership across my entire staff, but we really embarked on a zero base.

Budgeting type of program a couple of years ago, which is really bap multiple work streams to drive cost out of the business and our teams have it's really been inoculate into the culture of our company I'd like to say the low cost model wins, I'd say that constantly and we're going to continue to drive that through a number of actions where whether its opposite optimization in our supply chain continue the great work by Kevin.

This team in retail we across the board there has been significant savings are shifting our go to market models from areas that I think is very sustainable tickets up than where we're going to continue to drive aggressively because the.

Well position to as we ship to be to be.

Well Anthony add some color as well hey, good morning, Chris So to Jerry points with the actions, we've taken with that and other initiatives we've created struck.

Structural changes in our operating cost model driving that low cost model, including operating changes at the labor model within retail. So we're seeing some of those benefits driving the quarter and the cash flow some of the variable cost and actually enable come back in 21 at the business rebound, but for the most part the costs. We've taken out are permanent in nature.

If you look at it from the statement around mid teens I think based on our channel shift that continued focus on the low cost model as well as other initiatives. We can accomplish that mid teens target over time, as we navigate into 2021 and beyond.

Great. Thanks for that and then.

Moving to the retail.

Segment strong.

Strong operations there both on the top and and obviously on the bottom line and it's just it is.

That's improved of late.

How does that play into your thoughts around the maximized strategy can you talk a little bit about how earle earlier or late you are into that maximized strategy union implementing it around that and any changes around retail given the strength.

Yes, again, we will double team this one as well Chris at a high level all our channels are important from a.

Ecosystems important as we said in our script, all our routes to market or important, especially you've seen some of that shift.

Depending on the normalcy about how our business operates in 21 and 22.

Good thing is our online business is doing well, we have been able to capture some of that shift, but very very importantly, maximize b to b is a very important part of our strategy. We have to reduce our lease liability. We added 19 about 1.4 billion were going to close 2020, but 1.12 billion and we're going to get below the ability to lower mark and drive that down.

Specifically, we'll talk about that more at Investor day, where we have a very aggressive target to reduce our lease liability very very importantly drive and really drive and generate tremendous amount of free cash flow over the next couple of years.

Just to give us flexibility.

We're going to Kevin and his leadership team have done a tremendous job, we're going to give them the flexibility to drive profitable stores overall overarching that is flexibility cash reduce lease liability because we think we need to be valued as a b to B company, yes, yes.

I think the.

You covered it well Jerry I would just say within retail we continue to see strong performance across core categories work from home learn from home NPP. So that continued to trend that we saw in Q2, and we expect that trend to continue.

Great. Thanks for taking the questions. We'll go back in queue and good luck in before.

Thanks, Chris.

Your next question will come from the line of Michael Lasser. Please state Your company name and then proceed with your question.

Good morning.

Good morning, Michael Thank you Greg Foran, Gary. Thank you very much for taking my question. Gary are you operating under the assumption that any of the strong demand you're seeing in the technology or PPD speed is due to be pulling forward sales from future periods.

No not at all I think what we've seen it I think our online sales indicate that that people are viewing is not just an office supply company. We're really broaden the whole focus condition has been to be a BBB platform and I'm very pleased with furniture sales I'm very pleased with technology.

I'm very pleased with DP cells, and cleaning and Breakroom and so people are coming to us through our retail channel, they're coming through our traditional pay TV channel and are aligned channel as well, but yes, we're very optimistic that we'll continue to have a multichannel approach and we'll be able to shift and again spend division since day, one to have broader and broader products and services.

And more to come at Investor Day, really really excited investor day to sort of.

Show that next step of the evolution as well and Mike I'll only thing I would add is also overcoming a weaker than expected seasonal back to school. So some of the.

Performance is overcoming that week or back to school to balance out channel NPD data says, there's about 47% of the schools are actually physically in person right now across the country. So as that other 53% comes online whether it's in Q4, whether it's in Q1, we have specifically kept ourselves in position from an inventory per store.

Active and execution perspective to fulfill that whether it's through our BSD channel, whether it's through our online channel through our retail channel. So we feel like we're ready to capture that demand and depending on what happens in the future. It will build that we have the multichannel approach to build the services.

And presumably.

We're well past the back to school season, now that we're into November liquidity now have you seen.

Hi, good we don't we don't think that indicate we actually think that there will be demand as people shift into a bet again half. The people are students are still virtual.

Eventually.

I can't predict when the pandemic will end, but hopefully we'll make progress as the country on that but the reality is as people start shifting to a physical or hybrid environment. We still think there's a lot of demand opportunity. We just think it's a longer dated I think its important okay theres still.

Excellent Q4 and Q1.

Okay and.

And my last question is on the sustainability of.

The interaction between your edge DNA Capex.

And your sales so your estimate.

Is down about 15% year over year in the most recent quarter. Your capex is running less than 1% of sales. How long do you think you can mean those maintain those type of run rate, we the outage, having some impact detrimental impact on your and your sales performance.

But I think we covered the M&A piece and the fact that we've been able to take cost out both on a structural level.

Pork costs as well as looking at the retail model and I think there's opportunities continue to be there as we continue to execute maximize b to b on the Capex. You know we continue to invest in RFP to be platform and we look forward to sharing more about details at our Investor day, but that's a core component of our growth in the future. So I wouldn't look at the.

Capex trends in the near term and extrapolate that in the future.

Thank you very much and good luck.

Thank you Michael.

Your next question will come from the line of Chris Horvers. Please state your company name them and proceed with your question.

Thanks, Good morning, guys. So maybe you know obviously you talked about some some.

Positive cadence commentaries around the business can you give us a little sense of how the different divisions trended, how you're thinking about what the exit rate here into the fourth quarter, just as we try to calibrate the models.

Yes, I think thats hard to and that's one of the reasons why we're not giving guidance is still unknown in the in the quarter I think the trends that you saw coming out of Q2, and what we've been able to accomplish in Q3 should be similar trends as we execute the balance of this year.

We are looking forward to back to back to work at normal that will help our contract channel, but if you saw the diverse nature of our business model and the multi channel approach I think you're going to see continued execution for the balance of this year.

So so when you say I guess continued trends you're sort of expecting does that mean sort of BSD down, but not not as bad and retail is continuing to grow.

That's correct. So we're looking at sequential improvement through the remainder of this year similar to what you saw Q2 Q2 to Q3 Q3 potentially to Q4, but again a lot of variables in the last few weeks of the quarter that we're looking for.

All right. So it's the sequential not per se year over year. Okay, yes, Okay, I just want make sure and then.

Just a bigger picture question right. So in the Colgate World. It's it's helped certain parts of your business you know the TPP PB Adjacencies home office work learn from home and so forth. But then you have the in this big contract business six.

660% of operating profits as BSD and and that's hurt as we all know or from our basements or a lot of us. So I guess I wanted to get your thoughts on on a net basis do you think cove it actually help.

Helps you.

I on an overall perspective or do you think actually Kobe. It is more of a a net headwind because as we think about 21 of Z go back to whatever as normal youre going to have to get back some of the things like in our home office versus work from work. So just trying to think about how you think about you know.

Whether a covert is a net benefit or b and B, how we purchase project forward from here.

I'll, let answer you go through the details, but at a high level, obviously coal is not good for.

For us from a structural perspective, I will say that it's made us better as a company because we accelerated our or Jason see penetration were up to 47% adjacent season, that's always been an area that I really wanted to push on because I think again, we're going to be a b to b platform not just an office supply company and so and I think our our focus we've had over the last three or four.

For years on yeah.

Cash and low cost model has been accelerated as well. So we're coming out of this stronger were a great liquidity position from a balance sheet perspective, we're selling a lot more diverse set of products I think an investor day, you're going to see us talk more about what that next evolution is be honest with you we've accelerated that through the pandemic, we haven't talked about it publicly but.

We're really excited for Investor day to walk through so that next evolution, which is an extension of exactly where we want to go through a strategy as a company. So its been painful, but I think our team great leadership across in support of our associates and we are focused on making sure we take care of our customers, but I think we're we've learned a ton and were.

Much broader.

The ecosystem that we have that's been and again I want to mention the supply chain our supply chain teams under incredible job, it's a huge asset for us and so many people under look that asset of the company I think you're going to see a lot more of that in the future, especially at Investor day of how we're going to leverage that going forward and Theyll, let you jump in as well, yes, that's correct I think Jerry covered most of the.

Topic around the power the ecosystem, obviously mix shift has occurred during this period, we're seeing strength in retail strength in E commerce as more of the work from home to took hold in Q2 and Q3 and continues to be the case now, but as we look into the future stayed in that business begin to reopen it becomes back to hopefully normal.

In the near term, we're expecting to improve our business activity as that ramps up and improve performance in the contract channel specifically.

Okay. One quick last one similar question on I guess from a margin perspective in a shift out of contract and into retail is data overall net sort of margin rate in benefit. So we have whether it's the merch margin and leverage on a higher fixed cost you know retail rent model.

Or does the mix of tech and some of the other covance categories offset so how is cove it impacted sort of the profitability from a margin perspective yeah.

Yeah. So I think you hit at retail has that fixed cost nature. So as more volume goes through there that they leverage effect and retail also has lower distribution costs, because your drop shipping versus having distributed at work from home, which is occurring in the BSD channel through E. Commerce. So there is a definite definite benefit from having that fixed costs.

Model in retail as volume comes back that we saw in the quarter and we saw a year to date.

Understood. Thanks, very much best of luck. Thanks.

Thanks, Thank you so much.

Our final question will come from the line of William 'cause Laurie. Please state your company name and proceed with your question.

Hi, This is work before your front from elevation.

Nice execution in the in the quarter, it's good to see.

I guess my question is around on retail as you execute on the cost savings target that you laid out and you are closing stores.

<unk> are you targeting kind of the the lease profitable stores first the close is there any sort of methodology there as you execute on that.

Yeah, Yeah, obviously, there's a lot of factors that take into consideration, but yes.

Looking at profitability at four to four wall profitability of each of the stores that their lease terms come up for renewal and how how they performed historically and how we expect them to perform going forward. So it's obviously the lease profitable stores, our highest on the list in terms of taking action.

But it's a it's an evolving model because they are demand shifts that are coming to consideration, but our model is a well well tested.

A lot of history, there so feel really confident about how thats being executed not only for the quarter about the go forward as well.

Got it thank you.

I'll now turn the conference back over for any concluding remarks.

I just wanted to thank you all everyone for joining the call today, we look forward to discussing our results next year and in the Q4 and when we look forward to our Investor day, and we're really excited by our next steps we're going to talk about too is our investor base as well as the as the community and our associates as well, but we'll see we'll see you in Investor day, hopefully in the late January early February or early.

Early 2021 have a great day and thank you again for joining us.

Thank you for your participation. This concludes today's call you may now disconnect.

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