Q2 2023 The ODP Corporation Earnings Call

August 9, 2023

Good morning, and welcome to the ODP Corporation second quarter 2023 earnings Conference call.

All lines will be on a listen only mode for today's call after which instructions will be given in order to ask a question.

At the request of the ODP Corporation today's call is being recorded.

I would like to introduce Tim Perrott, Vice President Investor Relations and Treasurer.

You may now begin.

Good morning, and thank you for joining us for the ODP corporations second quarter 2023 earnings Conference call.

This is Tim Perrott, and I'm here with Gerry Smith, our CEO and Anthony Scaglione, our executive Vice President and CFO .

During today's call Gerry will provide an update on the business focusing much of his commentary on our accomplishments for the second quarter of 2023, including our operational performance and the progress we are making on all of our initiatives to drive shareholder value.

After Jerry's commentary Anthony will then review the details of the company's second quarter results, including highlights of our divisional performance. Following Anthonys comments, we will open up the line for your questions.

Before we begin I'd like 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 Securities and Exchange Commission.

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

SEC filings as well as the earnings press release presentation slides that accompany today's comments and reconciliations of 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 is being simulcast on our website and will be archived there for at least one year I will now turn the call over to Gerry Smith Gerry.

Thank you, Tim and good morning, everyone.

Really appreciate you joining our call today and we're excited to be here with you. This morning discuss our second quarter 2023 results.

As you can see in the release that we issued this morning, we continue to drive solid operating results and an increasingly mixed demand environment as we continue to leverage our new four business unit structure and execute upon our capital allocation plan.

As highlighted on slide four of our presentation.

We remain committed to operational excellence and our low cost model approach to anchor tenants of our disciplined strategy.

For our team operational excellence is not just a catchphrase, it's a cultural mindset that is ingrained into the fabric and how we run our business and how we create shareholder value.

Using this approach along with the strength and flexibility of our four business unit model.

We again delivered strong operating results against an increasingly challenging macroeconomic backdrop and somewhat sluggish consumer activity.

We delivered these results and continue our capital allocation program, making progress towards our long term goal of returning $1 billion of shareholder capital.

We also maintain a strong liquidity position and balance sheet.

And I'd like to thank our entire team for remaining focused on delivering these solid results, which is a true testament to our team's unwavering commitment to operational excellence and dedication to driving shareholder value.

Therefore, before I cover the highlights of our Q2 results.

Wanted to reemphasize, our realigned <unk> business unit model and our strategy to unlock its potential.

This is shown on slide five.

It's only been about nine months since we launched our realigned four business unit structure, and we're really excited and encouraged about the more dynamic and capable company. It has helped us create.

Our new structure allows us to more fully utilize our assets.

Greater transparency into the value of each of our businesses and positions us to pursue new avenues for growth.

This structure is truly create a new ODP and our <unk> business has placed us on a path to unlock our potential and create even more value for our shareholders over time.

One early Shining example of how the structure is helping us unlock our growth potential can be found at there.

Various our supply chain and logistics business that we have developed over the past three decades that was previously embedded as a primary support cost function for our business. We have separated there as its own operating segment to pursue future growth by leveraging its world class capabilities to bring its strong value proposition.

To continue to serve its internal customers ODP business solutions at office depot.

Well as serving its existing and new external third party customers.

Very strong and competitive value proposition includes a nationwide coverage capabilities next day delivery capability to about 98, 5% and the ZIP codes in the U S, including desktop delivery and.

We can provide services such as just in time logistics as well as leverage its proprietary analytic tools to provide greater insight to drive efficiencies for both internal and external customers.

The investments we've made over many years has enabled us to create a network that we feel few supply chain operators possess today currently various utilizing existing capacity and capabilities to deliver a variety of services to third parties, including leveraging 9 million square feet of distribution Center space.

Over a network at 55 distribution centers.

Through a large private fleet, enabling us to deliver tailored solutions and full end to end supply chain services.

In its first year of operating as its own segment.

Various also executing along a modernization roadmap developing proprietary capabilities leveraging technologies are often gartner magic quadrant leaders to improve capabilities and warehouse management transportation and inventory routing and visibility and planning tools.

From a cost center to a profit center with significant runway to generate long term profitable growth.

There is off to a great start a wellness weight of delivering meaningful incremental enterprise EBITDA.

Also off to a great start under our new structure is ODP business solutions.

ODP business solutions is a large and growing BTB distribution business with over 4 billion in annual revenue servicing enterprise level companies as well as medium and small businesses.

It serves over half the fortune 100, and provides customers with a highly curated procurement solution delivering core business products, all with growing categories and adjacency products, such as Jan San cleaning and break room Tech workspaces in furniture, and copy and print products and services.

As I stated on our last call, our Jan San and cleaning and break room businesses alone generates about $700 million on an annual basis, making us one of the larger distributors that Jan San and break room related products in the U S.

With a clear objective to grow net new customers and broaden its value proposition through expanding instead of product and service offerings ODP business solutions is focused on growing this business.

Dan its margin profile objectives over the long term.

Next up is office depot, a brand name remarkably familiar to consumers and the only true omni channel consumer business.

Profitable retail footprint and award winning E. Commerce platform Office depot continues to be a key cash generation engine for ODP.

And with our focus on driving risk adjusted positive contribution margin.

Generates strong consistent EBITDA and cash flow, while also improving the customer experience, including through our industry, leading 20 minute pickup guarantee.

Band assortment offering, resulting in one of the highest NPS scores in the industry.

And finally, various various as an early stage transformative BBB procurement platform business that just launched late last year.

Various as a category creator and focus on transforming the complete procurement ecosystem for buying organizations and the suppliers who serve them aligned for a more modern frictionless consumer like experience for BTB buyers and suppliers.

The market opportunity for <unk> is very large with over four trillion dollars in gross indirect transaction volume within our target market.

While we are still in the early stages and as with all new startups refining. This approach <unk> continues to make progress enhancing capabilities and adding customers to its platform.

Our new operating structure is creating opportunities for our business as we execute upon what is termed as odp's three horizons strategy.

This strategy puts into perspective, how we will drive our business units in order to lock the underlying fundamentals pursue long term sustainable growth and maximize shareholder value.

Briefly highlighting our approach our first horizon focus on continuing to drive office Depot's performance.

Customer service and net promoter scores and most importantly, our relentless focus on maximizing EBITDA and cash conversion.

Office Depot is a cash generation engine and this horizon continues that focus getting the most out of this engine.

Next our second Horizon is focus on continue to drive ODP business solutions delivering growth margin expansion and cash flow.

As you can see in our release. This morning, we're moving well along the margin expansion path. We set we believe that as we execute our plan the market will begin to recognize the value of what we believe is a higher multiple business and this should be reflected in odp's overall value.

Our third horizon is building value in pursuing higher long term growth opportunities through <unk>.

Both of these businesses represent significant long term growth and multiple expansion opportunities for ODP.

<unk> as a world class logistics and supply chain business with growing services to third party customers and various as a high growth transformative digital procurement platform business and a very large target market. So overall, our three horizons strategy will help us continue to drive our near term cash flow engines.

While allowing us to continue to pursue both midterm and long term growth and higher multiple businesses, which we believe will create significant value for our shareholders.

This is all anchored by our operational excellence and our focus on our low cost business model, while prudently managing our balance sheet and deploying capital to the benefit our shareholders and of course, continuing to live our five C culture.

Now turning to the highlights of our key accomplishments for the second quarter as shown on slide six through 11.

First on a consolidated basis, we drove strong overall operating performance in the second quarter, despite a more challenging macroeconomic environment.

Overall revenue was down due to fewer stores and service and sluggish consumer demand. Our disciplined approach helped drive adjusted operating income and EBITDA results that were consistent with last year.

Combining our solid performance with our share repurchase activity, we drove a 25% increase in adjusted earnings per share versus last year, a meaningful accomplishment.

Our cash flow results were also impressive as we significantly reduced cash flow usage relative to last year, even as we built inventory for the upcoming back to school season.

Our continued commitment to operational excellence and our low cost model approach combined with our balanced go to market strategies helped drive the strong results against the ongoing challenging macroeconomic backdrop hampered by high inflation and slowing consumer activity.

I can't say enough about our team's continued focus and discipline and achieving these strong results in the quarter. Thank you team.

Anthony will provide more of the details on the drivers in his prepared remarks later on the call.

Next we continue to execute upon our $1 billion share repurchase authorization that our board of directors put in place in November of last year, we believe that buying back our stock at these levels one of the best investments, we can make to create additional shareholder value.

During the quarter, we repurchased approximately 725000 shares for about $31 million and since the beginning of the authorization, we have repurchased approximately $8 3 million shares in total for approximately $385 million.

Putting this activity into context since November of last year, we bought back over 20% of the market value of the company.

Moving forward, we will continue to be disciplined monitoring market economic conditions and continue to prioritize capital allocation, while prudently managing our four business unit model.

Now moving onto our business unit performance in the quarter, starting with ODP business solutions.

ODP business solutions are large and growing PDP distribution business delivered strong operating performance in the quarter generating nearly a 30% increase in adjusted operating income on a consistent revenue results year over year.

This is impressive given some of the macroeconomic headwinds that some of our customers are facing that are resulting in corporate layoffs and reductions in force.

EBITDA margins increased significantly and are rapidly approaching pre pandemic levels and our long term goals.

Adjacency penetration remained at 44% of the total division revenue and overall revenue retention rates remained near historic highs.

We're continuing to win net new business with key new customer wins that we expect to be on boarded later in the year and our pipeline of new business has never been higher.

Our team's performance was impressive given some of our corporate customers are enacting reductions in force and other activities give a broader macroeconomic conditions that impacts our core business.

This is another reason why our assortment strategy and reorganized routes to market are so key to our long term success.

As we head into the second half of the year and beyond our foundation remains strong to continue to drive profitable growth, while we expect to continue facing some of the macroeconomic headwinds.

Continuing to raise the bar evaluating new ways to serve customers and pursue growth as a strategic initiative over the last few quarters Dacent trail. The team have been analyzing the marketplace and taking time to listen to customers and gather feedback as well as reevaluating the market segment landscape and new approaches to meet customers need.

Based on this work we've improved upon how we segment our customer base.

We've enhanced our go to market strategy.

Aligning with this approach we have redeployed our sales resources to better address our customer specific requirements.

Riding tailored solutions and continue to deliver a superior customer experience.

Cited about what this realignment means for our go to market strategy and our ability to further enhance customer experience and drive future growth.

Next up is office depot, our Omnichannel consumer business, which includes a profitable retail footprint and award winning E Commerce platform.

A strong value proposition to education home office and small business customers.

The division continues to provide a positive shopping experience for its customers leading to continued strong net promoter scores above 70% among the best in the industry.

Office depot had a more challenging quarter and experienced weaker topline performance largely driven by fewer stores in service compared to last year related to planned store closures as well as from lower in store and online traffic demand.

Categories previously and strong demand last year, primarily home office furniture, and technology, specifically lower demand in the quarter.

Additionally, as I mentioned in our previous calls and as we've seen in the press nearly every day the weaker economic environment is having a negative flow through effect of market wide are consumer related activity, resulting in lower demand across many industry segments.

We believe the lack of seamless and the overall weaker macro environment contributed to lower demand in our consumer business in the quarter as traffic trends in same store comps were lower than anticipated.

The good news, we are seeing improving trends over the past few weeks to start the quarter.

Operationally, while our team continues to drive a low cost model revenue headwinds had a flow through effect, resulting in lower margins during the quarter.

That said, we are well positioned to address these challenges in the second half with a strong operating model as we head into the higher demand back to school season upcoming in the third quarter. Additionally, we are selectively adding new category assortments, including our dorm room offering targeted at college students as well as celebrations and party assortment categories.

Although early the customer feedback has been positive.

We're also realigning our digital marketing efforts designed to drive greater traffic and conversion, including adding a highly experienced member to lead our e-commerce efforts.

And all what was a challenging quarter for our consumer business. We are cautiously optimistic about the second half of the year and we're managing prudently and believe we are well positioned to improve our performance.

Next up is there.

There is a world class supply chain services and sourcing provider with core competencies in distribution fulfillment transportation global sourcing and purchasing which also includes our global sourcing operations in Asia.

There may continued significant progress in the quarter, adding new external customer logos to a slate of business and continued to drive EBITDA from third party customers. In fact third party EBITDA in the quarter doubled relative to last year and we remain slightly ahead of plan to double EBITDA from external customers. This year.

Their profit from backhaul is up over 40% versus last year, and nearly 30% year to date.

Also vendor additions to its vendor consolidation program, providing supply chain service to its vendor partners is already greater than all of 2022.

It is becoming clear that various compelling value preposition is beginning to resonate with customers.

Their contingent prove upon its service level metrics, while driving efficiencies throughout its network utilizing route management tool to optimize the network driving more capacity to our own private fleet and balancing capacity among our three PL carrier partners.

Also continue to make progress on our tech stack deployment and capabilities, improving our position to serve external third party customers and a proven internal operations.

Now turning to virus barest is still in the early innings of its platform launch the company is continuing to track and onboard new customers gather customer feedback and work to ramp new customers on its recently launched platform.

<unk> is making good progress the team has taken the time to prove the onboarding process and other capabilities of the platform for the benefit of its customers.

Customer feedback adoption has been positive with many testimonials on the value proposition that the platform delivers we need to manage through some additional technical capabilities to truly enable us to scale.

We have redirected and re prioritize resources to address this and while I'm not satisfied with where things stand financially I could not be more excited about the growth potential of this platform and its value proposition in the market.

He will provide further information on our financial expectations for the balance of the year.

As I wrap up my comments I want to say just how proud I am of our entire team for all of these accomplishments in the first half of the year when I look at our performance in Q2.

A lens of navigating the economic challenges it points the balanced nature of resilience of our business model as well as the cultural excellence that we have created the ODP.

And through our operational excellence approach and disciplined capital allocation focus we delivered strong performance in the quarter driving EBITDA strong free cash flow and a significant increase in earnings per share.

Looking forward, we expect to continue facing ongoing macroeconomic headwinds we remain cautiously optimistic for all of our routes to market as we move into the second half of 2023.

We will remain acutely focused on our formula of success driving our operational excellence approach building, our winning five C culture, and staying committed to our capital allocation focus.

<unk> shareholder value.

With that I'll turn it over to Anthony for his remarks regarding the specifics of our financial results.

Thank you Jerry and good morning to everyone joining the call today, it's great to be here today to provide more details on our financial results for the second quarter.

Before I begin I'd like to thank our entire team for remaining focused and delivering solid performance. The operational foundation of our business remains strong, but as you heard from Gerry and as we've mentioned over our last few earnings calls the macroeconomic environment remains challenging and not just for us, but for most businesses and nearly all industry.

Yeah.

Record high inflation, which is outpacing wage increases and higher interest rates have led to an overall slowing of demand there.

This environment has been negatively impacting not only the level of consumer activity, but also business activity as evidenced by some of the larger and well publicized corporate layoffs and reductions in force.

I would also point out that while the input cost to our business or our cost of goods sold which include product shipping and other costs continue to be higher on an absolute basis, we have seen some cost acceleration as evidenced by container costs, returning back to historical norms, lower fuel costs and fewer supply chain disruptions compared to last year.

Here.

Despite these challenges I'm so proud of our team for remaining focused on the factors that we can control and continuing to drive our low cost model with an eye toward continued cash generation capital returns and earnings per share growth.

In the quarter, we again delivered strong operating income and EBITDA results and significantly improved cash flow versus the prior year.

And when combining our solid operational performance with our capital allocation priorities, we drove a 25% increase in adjusted earnings per share.

This powerful combination of driving solid operating results, while buying back shares is a formula that we expect to continue to enhance value for our shareholders into the future and as the algorithm I outlined at Investor Day.

We continue to prioritize our capital returned resulting in buying back approximately $31 million of stock in the quarter.

And adding to this our previous activity, we've repurchased approximately $390 million of our stock since putting the new plan in place back in November of last year.

This equates to over 20% of our market value in the last nine months.

Overall, our disciplined capital allocation and solid operational performance in the quarter continues to underscore our team's unwavering commitment to operational excellence and continues to be a testament of our winning by sea culture.

We're also encouraged by our four business unit structure and what this means for the future of our business, allowing us to more fully utilize our assets and positioning us to pursue greater opportunities for long term growth.

We continue to make good progress in our business.

ODP business solutions expanded its margin profile in the quarter moving closer to its long term goals.

And there continues to add new logos and is well on its way to more than doubling its third party EBITDA this year.

Despite top line softness office depot continues to leverage its omnichannel capabilities to meet customer needs and drive strong cash generation.

And despite a slower start there is continues to have a strong value proposition and we are working to enhance the platform capabilities along with Onboarding new customers.

Our realigned structure with these four business units pursuing growth independently and working in concert will help us to continue to drive shareholder value overtime.

Now turning to the highlights of our financial results as shown on slide 12.

Consistent with previous quarters, we have provided our results on both a GAAP and adjusted basis.

We generated total revenue of $1 $9 billion in the second quarter down 6% versus Q2 of last year as weaker macro conditions slowed consumer activity, creating topline headwinds at office depot.

Lower sales at office depot, where do the 68 fewer stores in service compared to last year, as well as lower retail and online consumer traffic and transactions.

This was partially offset by stable sales and ODP business solutions as return to office trends helped to offset some of the macro headwinds and higher than anticipated corporate reductions enforced that have recently made headlines.

GAAP operating income in the quarter were $46 million up 60% from Q2 of last year. Also included in operating income was a net $4 million of charges associated with noncash asset impairments primarily related to the right of use assets associated with our store locations.

Adjusted operating income for Q2 was $53 million flat with last year and included unallocated corporate expenses of $19 million.

Adjusted EBITDA was $86 million for the quarter compared to $91 million in the same period last year. This includes depreciation and amortization expense of $29 million and $34 million in the second quarters of 2023 and 2022, respectively.

Excluding the after tax impact from the items mentioned earlier adjusted net income for the second quarter was $39 million or <unk> 99 per diluted share representing a 25% increase in adjusted EPS driven by consistent net income and strong execution under our share repurchase program.

Turning to cash generation in the quarter, we significantly improved cash flow compared to last year operating cash used in the quarter with $8 million, an improvement of over $106 million versus cash use of $114 million last year.

Capital expenditures in the quarter were $23 million compared to $21 million in the prior year period.

Adjusted free cash outflow in the quarter was $30 million, a significant improvement versus the $121 million outflow in Q2 of last year.

This is a particularly impressive results considering that Q2 is a quarter that we build up inventory in advance of our back to school season.

I want to thank our entire team for being laser focused on managing our working capital, particularly inventory.

And focusing on cash conversion, resulting in the strong year over year cash flow results.

Taken together these results reflect our relentless focus on driving operational excellence, even in light of the aforementioned topline pressure.

Now I'd like to cover our business unit performance, starting with our ODP business solutions Division on slide 13.

Notwithstanding the macro headwinds as Jerry mentioned earlier ODP business solutions continued to deliver strong operating performance expanding its margins on stable revenue results year over year.

Revenue was approximately $1 billion in Q2 up slightly with the same period last year.

Back to office trends, while continuing in a positive direction were somewhat muted by other macro factors impacting certain customer spend.

Our Federation companies are regional tuck in M&A entities continued to show solid growth in the quarter.

We've been successfully executing this strategy in growing this business, which now generate well over $500 million of revenue on an annual basis.

This market continues to be highly fragmented and our disciplined approach gives us tremendous runway to keep growing our platform strategically over time.

From a product and services standpoint, we saw continued demand across core supplies as well as increasing sales in certain adjacency categories include cleaning and break room and copy and print.

Sales of technology products, which were in high demand last year during the supply chain constraints were lower in the quarter.

Our adjacency product categories as a percentage of total revenue remained at 44%.

As a notable kpis for ODP business solutions. This percentage may fluctuate from quarter to quarter, but our long term objective is to consistently grow adjacencies. Both on an absolute dollar and percentage basis as we expand our value proposition and continue to leverage our strength in core categories for 2023, we expect this percentage to be flat to slightly.

Up over last year as back to office trend drive core supplies growth.

From an operating perspective, the ODP business solutions is on path to drive its EBITDA margins back to pre COVID-19 levels with an opportunity to expand long term margins beyond this level by staying true to our low cost model.

We made great progress on this goal during the quarter generating operating income of $45 million, a 25% increase relative to last year. This represents a 100 basis point margin improvement as a percentage of sales.

EBITDA was $50 million in the quarter up over 20% from last year, and representing nearly a 5% EBITDA margin.

This strong operating performance is a true testament to our low cost model, while we expect the macro environment to remain challenging in the second half we're seeing some of the best sales pipeline and opportunities ahead of us and we are excited about the modifications. We've made to our go to market strategy and how this will drive sales growth and future efficiencies in our operating model going forward.

Now turning to our consumer division results as shown on slide 14.

Our office depot consumer Division continued to provide excellent service and a compelling value proposition to our customers as demonstrated by NPS scores remaining above 70% some of the highest scores in any consumer business.

However from a topline perspective, the quarter presented its challenges as the slowing economy had the effect of moderating the level of consumer spending and overall activity in the U S.

We have seen this reported in the press and by other large consumer businesses over the recent quarters referencing how the lack of stimulus and overall weak economy is hampering the level of consumer activity.

Along with most other consumer businesses. This environment is creating some top line headwinds in our business is well reported revenues in the quarter were approximately $900 million down 13% driven by 68 fewer retail stores in service this year versus last year related to planned store closures as well as lower traffic and transactions in both our retail and E.

Commerce channels.

On a shifted basis same store sales were down approximately 6%.

More traffic and demand relative to last year were negatively impacted by weaker economic activity and higher unemployment as well as the recovery from the pandemic as a greater percentage of consumers return to the office.

From a product perspective stronger sales of copy and print were more than offset by lower sales in core supplies and in other categories previously and stronger demand. During the later stages of the pandemic, including technology cleaning and break room and furniture sales.

Sales per shopper was down mostly due to lower average order volumes, partially offset by higher conversion rates.

From an operating perspective operating income was $35 million in the quarter down compared to $49 million last year lower operating income compared to last year was primarily driven by the flow through impact from lower sales and higher input costs related to inflation.

While we expect the macro environment to remain challenging in the second half of the year, we continue to drive our low cost model approach, creating a strong operational foundation as we head into the higher demand back to school season over the next few weeks.

We also remain excited about the feedback we're receiving regarding the new category Assortments, we've selectively launch, including our dorm room offering as well as celebrations and party assortment categories.

From an E Commerce perspective, we've hired a new leader, who is realigning our digital marketing efforts designed to drive greater traffic and conversion.

So overall, while it was a challenging quarter for our consumer business.

Focused on driving the components of our business that we can control and believe we are well positioned to continue to drive this cash engine of our business.

Now turning to slide 15, I wanted to highlight <unk> financial results and provide insights into their operations.

We're very excited about the continued progress there has made during the quarter driving efficient services for its internal customers and gaining traction with third parties.

As Jerry mentioned earlier, they're specializes in b to B and consumer business service delivery with core competencies in distribution fulfillment transportation and procurement and this also includes our global sourcing operation in Asia.

They serve the needs of its primary internal customers office depot, and ODP business solutions as well as for other third parties through our procurement and supply chain business.

And as a reminder, from an internal perspective, a key component of their mission is to be an efficient supply chain provider to office depot, and ODP business solutions, which in turn drives the best results upon consolidation for our entire ODP enterprise.

Therefore, as I mentioned previously as they are undertaken actions to drive efficiencies and effectively serve its internal customers the intercompany revenue and corresponding allocated profit to their could fluctuate over time.

We put through our intercompany agreements is there drives greater efficiency for its internal customers. Much of this benefit is captured through ODP business solutions and office depot benefiting the entire enterprise rather than being reflected only in bayer's results.

Looking at ways to continue to optimize its network and drive the low cost model not only helped its internal customers, but also provides a strong value proposition for new external customers.

Regarding its financial results for Q2, there drove sales of $1 3 billion predominantly supporting the purchasing and supply chain operations of OTT business solutions and office depot, which are effectively eliminated upon consolidation excluding intercompany sales there continue to drive services to a third party customers and win new business with some great market leading law.

Those.

In the quarter of their drove approximately $10 million in sales to external parties up over 50% compared to the same period last year, highlighting continued strong traction in providing services to third party customers.

But as we discussed at Investor day external sales is not the only metric for there from a bottom line perspective. There is total operating income for Q2 was $6 million compared to $8 million last year, primarily due to the aforementioned intercompany transactions.

And third party activity.

From an external customer perspective, we continue to see solid early traction in EBIT generation in the quarter, we generated about $3 million in EBITDA from third party customers, a 140% increase over Q2 last year positioning us well on our way to more than double EBITDA from third party customers in 2023.

Now turning briefly to various on slide 16.

As a reminder, <unk> is our digitally native b to B procurement platform. While recently launched various had been working to add customers and suppliers to its network addressing customer feedback and making tech stack updates, while adding new features to the platform.

As <unk> continues to fine tune. This network and features that are working to smooth out onboarding customers, ensuring the right level of services delivered and available for its new customers at the right time, all with a long term goal of ramping up gross transaction volume through the network.

While there is off to a slower start to its revenue ramp this year than what we anticipated it continued to add new customers and suppliers keeps.

Keeping in mind that the platform only recently launched and ramping customers activity takes time.

Which from a results perspective led to lower sales momentum than what we expected at the start of the year.

During the quarter various generated about $2 million of revenue primarily from subscriptions derived from existing customers.

Overall, there has generated an operating loss of $14 million down from an operating loss of $16 million in Q2 of last year, driven primarily from lower employee related costs.

Now briefly turning to our balance sheet highlights as shown on slide 17.

We ended the quarter with total liquidity of $1 $1 billion, consisting of $335 million in cash and cash equivalents, which includes cash held internationally of approximately $100 million and $811 million in availability under our asset based lending facility total debt at the end of the quarter was approximately $181 million.

<unk>.

As Gerry previously mentioned, we have been buying back shares under our $1 billion share authorization in Q2, we repurchased 724000 shares for approximately $31 million.

Adding this tour activity since the program began we retired about $8 3 million shares for approximately $385 million.

We continue to be disciplined and focused on maintaining a strong balance sheet, allowing continued flexibility to invest in our business and repurchase shares.

And as we announced previously during the quarter, we successfully completed the sale and partial leaseback of our headquarters building.

We sold the building for approximately $104 million and expect an additional $10 million of cash tax benefits once our federal returns are finalized.

We continue to be a valued tenant in the space and with our smaller footprint. The sale helps us lower our annual operating expense, while better meeting our teams workplace needs through consolidation and collaboration.

Now turning to our 2023 guidance as shown on slide 18.

Our performance in the first half of the year was solid and we remain in a strong capital position with our low cost model and strong balance sheet.

While we are cautious on the state of the consumer in general macroeconomic conditions. Our continued focus on operational excellence has us well positioned to continue to drive solid operating results for the balance of the year.

As we look to the second half we're laser focused on managing the levers in our business that we can control and continuing to drive our profitable growth initiatives across our four business units.

Considering our first half performance current macroeconomic conditions and expectations for revenue trends in the second half of the year, we updated our revenue guidance to a target at approximately the low end of our previous guidance range or approximately $8 billion.

While reaffirming our guidance for other operating metrics, including adjusted operating income EBITDA free cash flow and Capex.

Also given our strong performance to date, we are announcing that we are increasing our adjusted earnings per share guidance to a revised range of $5 to $5 30.

Up from our previous range of $4 50 to $5.10.

Our guidance assumes some stabilization in overall economic trends in the second half.

Looking forward, we believe that we have good line of sight to our revenue guidance of approximately $8 billion. However, we are being disciplined on cost and price with an eye toward maintaining our focus on cash and EPS growth.

Additionally, baked into our revised guidance, we expect operating loss embarrassed to be slightly higher in the range of $60 million to $70 million for 2023 with no anticipated change in their Capex range.

Looking at this from a cash use perspective, we expect cash use embarrassed to approximately be $65 million to $70 million for the full year down from a cash use in 2022 of approximately $100 million.

So overall, despite the challenging macroeconomic conditions and softer top line, we remain in a solid operating position driving cash flow and with our continued focus on delivering capital returns to shareholders significant earnings per share growth.

With that operator, we will turn the call over for questions.

As a reminder, if you'd like to ask a question at this time. Please press star one on your telephone and wait for your name to be announced to withdraw. Your question. Please press star one one again.

Yeah.

Our first question comes from the line of Jeff Lake with B Riley.

Good morning, guys can you hear me yes.

Yeah, Good morning, Jeff.

Congrats on a great quarter, just starting with business solutions, obviously theres a lot of factors.

Factors going back and forth you do get to commercial office.

Situation then there is the back to work narrative that you mentioned.

Pipeline is heating up.

You didn't talk about fed rate Ya Federated strategy I'm, just curious as you look to the back half of the year.

How do you see all of those factors kind of playing out and I don't see gave us implied guidance do you expect business solutions to show a little growth in the back half.

Yes, we did this is Jerry.

Thanks for the comments, Jeff, but we do have a lot of pipeline, we have a number of new customer acquisitions that should be ramping in Q3, and Q4 and again, we're super excited by the largest backlog we've had in a long time, obviously some headwinds from a return to office.

We see good growth of the Federation and we see good performance.

Across a number of segments of education. For example is coming back and so I think we have a very balanced approach and our expectation is we're going to have growth in Q3, and Q4 and as you saw from operating margin perspective a.

Fantastic operating margins compared to last year as we talked about we started that process a year and a half ago driving low cost model for your business.

Drilling and his team have done a fantastic job of doing that and we feel like we're very well positioned that we took a bunch of cost out of the business were both up from a cogs as well as SG&A perspective that would be the second half as well as 24 were setup nicely.

Yeah, the only thing I would add Jeff.

If you think about the levers that we can control and I think that's really important when we're managing through a relatively choppy macro environment.

Same vigilant on cost staying vigilant from a cash conversion perspective looking at how we can continue to provide that value proposition to our customers without chasing any bad deals and thats. The key here driving what's going to make us successful in the long term leaning in on our private brand.

Driving the assortment expansion things that we can control and really drive that.

Value to our customers at the end of the day.

And then with respect to the office Depot Division.

You've referenced the sluggish economy I'm just curious if you could highlight things that where there was more sluggishness or maybe less and then obviously get into Q3 and Q4, if you could talk about the opportunities in dorm room back to school.

Celebration and any other adjacent categories, where.

Despite this.

The challenging economic backdrop, maybe theirs.

Some areas for some gains.

Back to school really launches here we've had.

<unk>.

By week school flights and the Big ones are this week next week and the following week and so too early to call but early.

Eliminated we like the trend that we're seeing there.

Clearly clear softness from a consumer perspective.

We have consumer we have small business and we have.

Work from home was our three segments, we focus on I think primarily because the consumers is the driver of that but I will say laser focus on labor costs labor focused on low cost model. Our Cogs initiatives are on track and ahead of schedule and so we're very confident that let's be clear. This is a great cash engine.

Kevin noted that very very clearly and I'm Super proud of the operating cash flow, we drove for the quarter our inventories in the best position. We've been a long time were set in the stores.

We're doing a really good job of focusing on Cogs cash inventory and obviously driving growth as well I think yes. The only thing I would add on the college collections and party supplies and just launched so early days early indications from feedback from our customers that it is a positive and they like to see those categories in our stores and it's refreshing to see that expand.

But it's early days, but we're starting to see some really exciting things on the horizon as it relates to that expansion and when we have a good relationship Crayola, we launched <unk>.

Much larger linear footage in the stores.

S markets that we did a pago off with our board a couple of weeks ago and Super excited by what our merchandising team learning team has done it.

Huge opportunity to it so far it's testing really well, it's really from crayola from.

Zero to five all the way through preschool, all the way through more and more fine art supplies.

Lower end of the market from a college in perspective and above perspective so.

It gets you have to get down here, we'd love to show you that but yes.

We're really excited by some of that core opportunity expansion as well.

And just if I cannot unveil the external will go.

The longer term goal 2025 30.

<unk> 30 million of EBITDA as you sit here today based on what Youre seeing in Q2s results, which seems like probably were incrementally better than you thought I'm. Just curious how are you feeling about that goal and what would you specifically point to that seems to be going.

Better than you thought.

Yes, I am.

Super proud of John and his team I think that for example, if you break it up from a what we call vendor consolidation, which is actually where we're delivering the product from the supplier to our distribution centers and we can do that obviously more cost to fund some of our partners can do that businesses up year to date.

More than it was the entire last year. So that's gone well, our backhaul, which is when the truck is empty when once we deliver something to you, but empty truck that's up 40% year over year, we have great logos across all of those pieces and the <unk> business, which is the core long term piece is.

<unk> exciting logos, so were $5 million.

Into the target.

The $8 million target, so I'm super optimistic were going to smash that and I am Super optimistic once we smash that we.

We're not going to give you a number yet Jeff and I know you won't but I'm very optimistic of beating that $30 million target in three years I have much higher target on John <unk> and his teams.

Forehead on a consistent basis and I'm excited for that business and Thats as you and I've talked about him and Anthony that's a multiple expansion opportunity.

A higher multiple business, we're demonstrating that I know, it's still small but.

There's some really good shades of green here.

I'm Super optimistic about.

And then last one on gross margin Anthony.

Year over year for Q1, and Q2, Europe 60 bps.

Variety of factors, obviously, there is a mix shift business solutions has a lower gross margin that that would be office depot.

I know last year Q3, I think represents your easier easiest compare for some of the supply chain issues. I think that's the case can you just talk about how to think about gross margin for the year.

You expect.

Given that there will be a structural or mathematical headwind with the mix shift would you expect gross margin to be up year over year. In Q3 Q4, yes. We saw some of that in Q2. So if you think about the disruptions that came into the channel last year, primarily on the ocean freight doesn't really start.

The build through Q2 Q3, and you saw that both in how we manage from a cash flow perspective, and how we managed from a margin perspective.

That's behind US now so as we're starting to land new product with a lower contain.

Container costs as we turned those products that will have a better opportunity from a margin recapture perspective, you saw some of that in Q2, and you should be able to see that continuing in Q3 Q4, assuming the growth top line that we've outlined in the release and Jeff One other thing to add is dancing I with Kevin and John again for US we started today.

Very beginning of the year, a two to three times a week, we call cash in Cogs review with all our merchants and all our procurement people.

Made significant progress working with our vendor partners on what should be cost should be and so we have a very aggressive targets and continue to drive cogs across the business. It takes a coordinated effort multiple RF skews going on but that's also a nice tailwind for us as we continue to have success across that and the <unk>.

Back half has been also setting up 24, as well and so yes. There is a mix shift ODP business solutions, we want Dave to grow like Crazy.

We also know that we're going to be in a better cost position and candidly we have the best balance sheet in the segments, our balance sheet won't name other people, but we are net cash positive a lot of others aren't and that puts us in a great position with our vendors as well as our customers going forward.

I think thats something very very strategic that all of you need to look at it and say, we're extremely well positioned over the next three years with our balance sheet and our liquidity.

Perfect I'll, let others jump in and ask questions and congrats again thanks.

Thanks, Jeff.

Our next question comes from the line of Michael Lasser with UBS.

Good morning, Thanks, a lot for taking my question you reduced your topline guidance for the year at the midpoint.

$8 2 billion.

$8 billion call it a $200 million reduction how does that $200 million.

Right down.

Tween consumer business.

Business solutions and presumably very.

A small piece of it given the modest topline growth of that business has right now.

Hi, This is Anthony it's predominantly going to be in our.

Office Office depot consumer business, we're expecting to Jerry's point, some growth and business solutions in the back half.

So we factored a cautious view of the six months given our first half performance.

So that's going to be primarily attributable to our <unk> business.

And on the <unk>.

<unk> growth in the business solutions business in the back half.

Does that break down between market share gains and underlying growth in the market, especially.

Unemployment rate right now is three 5% there is it.

A ceiling.

A stabilization and return to all trade.

It would seem like the demand environment for it.

The business solutions segment, not going to get any easier from here if anything it might just get a little tougher.

Yeah. It's a great question. It's one that we've obviously spent a lot of time analyzing as it relates to the return to office trend with the backdrop of some reductions in force that youre seeing from large organizations that obviously you have the kind of counteracting.

<unk> impacted growth.

But I couldn't be more prouder around that what the team has brought together from a market share perspective, we are seeing our fair share of bids to Jerry's point, our pipeline is as strong as it's been.

Ever since I've been here for the last three years. So we're really confident that we're seeing some opportunities to gain share as well as continuing to work with our customers to grow and our expectations is we're going to do both in the back half and setting us up for 24, where we can see some of that tailwind continue.

Barry ramp that's been a little slower than what you would expect and what is the issue that's been causing that.

Michael Good morning, Gerry it's primarily are.

The Tech stack, we're building, it's a very difficult text app to build and that's going to be a huge moat and a competitive advantage in the future took longer than we expected. So it shifted out a couple of quarters, but even this week. We've had some really good progress of getting through some of the issues that we are ramping customers.

And some of the tech stack issues that we're solving.

In the near term are allowing us to be broader and ramp customers faster. That's the primary driver of the business people love the value proposition, we have a number of.

Retail.

Wins from a global perspective, they're implementing and ramping.

As we get the tech stack in place and Terry and his team have done a great job of solving all the way through those issues, it's going to help us get to get the ramp back up on track, obviously, we've lapped it.

It shifted the ramp.

A couple of quarters, and so you'll see a sort of a shift to the right, but I'm still very bullish on on the various team we're seeing great customer feedback again, it's a hard pizza.

Allergy, but we do know what we're making progress on it once we get through this is going to be a technology advantage. Because this is not something people just can do easily this is hard to do what we're doing.

Two last questions number one in light of the softness.

Consumer side, and the fact that.

You have made a change in leadership.

In the E Commerce front does that suggest that e-commerce.

In the particular source of weakness.

On that on that business in.

Yeah.

Historically this is a business that comp down call it 5% for a long period of time now comps trending in <unk>.

8% range despite.

Recognizing that theres been a bit of improvement.

In the quarter the current quarter to date.

Are you just seeing an acceleration in terms of challenges overall on the consumer side of the business. Yeah. Let me let me start Michael We run office depot is a true omnichannel. So we don't break out e-commerce separately, but we saw a decline consistent to what you've probably seen through other pure play.

Providers.

And some of the e-commerce challenges.

Can be attributed to external search engine algorithms that are out of our control. So we were impacted by that in the first half.

And I would say, we expect that to improve in the second half, but consistent with what you've seen other what I would call pure play ecommerce declines as what we're seeing in our business as well so slightly higher than that historical average that you just mentioned and Chris and Kevin are doing a great job with our tech team Andy and <unk>.

We're all going after the structure issues.

The ability and some other pieces got a number of partners coming on to help us as well both of our agencies have done a great job. So we're really pushing the structural improvements and we're hoping those start yielding results in Q3 and Q4.

Yeah.

Okay and the last question is.

This year office people on pace to be call. It a 22% gross margin gross margin.

It's up considerably in the second quarter.

To the pandemic.

Office Depot, ODP consistently had a 23% to 24% gross margin.

Can it get back to that level and be what drove the improvement this quarter, especially in light of what it is probably some supply chain deleverage at least in the consumer business given the sales decline.

So I think Thats, what Anthony mentioned earlier and I also mentioned, it's a relentless focus on low cost model operational excellence.

Michael We started these reviews and we've been digging in deep myself, Anthony John Kevin All the teams and we're making substantial progress Karen Miller, Eric and the teams are driving Cogs improvements across the business working with our partners our supply chain costs are dramatically improved this year as well so we're really setting ourselves up.

Really nice tailwind in Q3, and Q4, I think structurally we're going to be in a way better positioned from a.

A 2024 perspective as well as our finance teams have done a great job with working with Kevin steam and Dave's team.

Driving our pricing models to make sure. We're as Anthony said earlier, we don't want it is priced bad deals either.

Adam Michael Miller has done a fantastic job be an overlay of that and so I'm very optimistic on the gross margin pieces and I think that's going to be a real differentiator for us compared to other people in the industry.

Michael Obviously mix plays a big part of our growth margin. So if you think about our prepared remarks being down in tech being.

Being down in certain categories that have a lower margin. So as you look at the mix.

Mixing into core mixing into other higher margin products will have an impact. So some of this is going to be the mix driving the overall GP.

Okay.

Okay. Thank you very much.

Thanks, Michael.

Our last question comes from Joe Gomes with noble capital.

Good morning, Thanks for taking my questions.

Good morning, nice to meet you.

Same here. So I just wanted to talk a little bit about the adjacencies in the ODP business.

Hmm.

Trying to get a better handle on what you have.

Think the long term growth rate for that sub segment.

Products should be for the the ODP business segment.

Yeah, I'll talk about structurally and let Anthony give specifics I mean, if I look at the close to the core piece of our cleaning and break room business.

I, absolutely believe that as the business grows substantially in the future.

That mean, whether people are work are not people that you have to keep your buildings clean we have a $700 million business today, which is a really big business.

There are multiple of course, it needs to be a higher multiple I got to get that in terms of looking over at me to make sure. He.

And he is right on that but the reality is that should be that should be a high growth business for us furniture and tech obviously tests in a tough place right now across all test, but that will recover in the future.

From a furniture perspective, and the other one is our copy and print businesses is a really solid business with really high margins and that's something we just got to continue to focus on growing and we're going to look at some other categories as well, whether it's safety and some other areas we can start.

Pushing that business across the line, but all of those business you'd be growth businesses.

David and Tom and Steve and Chris and Brian and team are doing a great job of driving that but we're also driving the core really well as well, but I mean, that's the.

Now the goal in my mind is that needs to be over 50% of the business. That's my sort of target internally.

That's all.

That's the core growth will keep taken that because it's high margin business. It is higher margin business and some of these days I think only thing I would add there Jeff.

Jerry hit all the key points is what we're looking at both the percentage increase in the dollar increase is important as we look at the core and some of these core categories that are low growth or no growth categories that we're maintaining our fair share growing them through market.

Acquisitions, but also looking at the overall growth from a percentage and dollar perspective, and making sure that we're driving those.

Jason sees as appropriate with our customer base.

Okay. Thanks for that.

The Federation.

Kind of maybe lay out what you perceive in terms of adding additional businesses to that segment here kind of in the in the near to medium term.

Yes, Joe This federation has been a huge success for us it's over $500 million of business all of our Federation partners have done a fantastic job of getting Cogs synergies from the business and driving increased profitability, we have a great IRR or all of those businesses and we're super happy with it we will continue to shop and add businesses to the Federation, we're just talking to overpay.

Four we have got a great balance sheet, we're going to continue to do it.

We've got a big target and Brian White and teams has done a great job of managing this business. We have to continue to drive the business and we think theres opportunities to grow that in the future. Obviously, we're not going to give specifics because.

We wanted to make sure as we negotiate these opportunities and we think we're a great place for the Federation companies come to us.

We give we love their sales teams.

Facing the customers, we love the leadership from the business, we consolidate some of the back office expense, we get huge cog synergies through these partners and so we want to continue to do that we think there's multiple opportunities in the next two to three or four years to go off and go do that.

Okay. Thanks, and one last one for me if I may.

You revised your EPS range up.

For the for the year.

I was just wondering what impact if any you're.

Calculating in there regarding future buybacks in the second half of the year.

Yeah, we are staying disciplined with the capital allocation that you saw in Q2. So we're expecting at this point to be at a pace roughly at the same dollar amount, which was roughly about $30 million and we'll look opportunistically as we close out Q3 on whether at all to that pace going forward, given where we are on our balance sheet liquidity and cash flow perspective.

So theres opportunity opportunities for us to revise that but at this time our guidance assumes a similar pace of what you saw in Q3, but I think again I think the majority of the driver of that is really operating EBIT performance and operating income performance confidence. So we affirm that confidence of EBITDA.

And obviously, yes.

Your bike buyback helps the primary percentage of that is just strong operational excellence and driving performance.

Low cost business model.

Okay, great. Thanks for taking my questions congrats on the quarter.

Alright, I want to thank everyone for joining the call today.

I wanted to just highlight that again I'm really proud of the team. Thank you team for.

Strong operating results demonstrating operational excellence in our five C culture at <unk>.

25% increase in EPS.

Reaffirm our guidance on operating income and EPS raise EPS our share repurchase program is strong our balance sheet is strong.

Performance by our Behr and ODP business solutions team and obviously, we will continue to drive a low cost model of operational excellence across the business going forward and look forward to talking to everyone. In Q3, Thank you and have a great day.

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

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Q2 2023 The ODP Corporation Earnings Call

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