The ODP Corporation (ODP) Earnings Call Transcript & Summary

This call is not for media representatives or Bank of America Securities investment bankers or commercial bankers, including corporate and commercial FX. All of such individuals are instructed to disconnect now. A replay will be available for Bank of America Securities investment bankers and commercial bankers, including corporate and commercial FX. The replay is not available to the media. Good day, and welcome to the Office Depot, Inc. Today's call is being recorded. For opening remarks and introductions, I'd like to turn the call over to Elizabeth Suzuki. Please go ahead.

Great. Thanks, everyone, for joining the Virtual Bank of America Consumer Retail and Technology Conference. I am Liz Suzuki, Head of Bank of America's U.S. Hardline Retail team, and I am joined by Tim Perrott, VP of Investor Relations for Office Depot. And so before I get into my questions, I will hand it over to Tim to set us up and give us some intro comments.

Super, Liz. Thanks so much. Really appreciate the opportunity to be here, at least virtually. And I really applaud you and the rest of the BofA team for pulling this off and they can change so quickly. So I appreciate that. In a few moments that I have, I would like to maybe tell you perhaps a different story and actually a different reality about Office Depot than I think most people believe about our business today. I'll summarize these points pretty quickly, and we'll move to Q&A. And it really starts, first and foremost, with who we are as a company. At our core, our company, Office Depot, is a leading and trusted integrated B2B distribution company, providing business products and services, primarily to business customers through an expansive B2B platform. We provide a full complement of business products and services, supplies and adjacency categories, like Cleaning & Breakroom and Jan/San as well as technology solutions. We deliver this through a very unique and highly customized distribution system that serves nearly 10 million business customers, including about half of the Fortune 500. So this is somewhat of a different view of Office Depot than I believe most people perceive of us, which most people typically view us as participating only in the retail space, but in fact, over 60% of our total revenue is generated from our B2B businesses, which consist of our BSD and CompuCom businesses and generate the majority of our operating income. And this has been a concerted effort on our part. It just didn't happen naturally. We've been on a transformation of our business to rely less on retail dependency and more on our B2B relationships. And utilizing our very unique distribution and supply chain network, which is really the key of core asset for our company. Our supply chain and distribution network, that's something that most supply chain networks do not do in the U.S., which is serve about 99% of the population in the U.S. overnight. But uniquely, we do it directly to the desktop, which means the products and services that our business customers order are not just left on the loading dock, they're actually -- arrive at your office. Very, very few of the supply chains in the U.S. are set up that way or capable of providing service in that fashion. And I think this truly exemplifies the trusted nature of our B2B platform and the relationships that we have developed with our customers. So in addition to the supply chain, being the core asset of our B2B platform, as I mentioned, we have a very large business customer base, with nearly 10 million business customers that we serve today, which includes about 200,000 enterprise accounts and obviously growing. And these are the large enterprises that we've been serving for a number of years and continue to deliver added business products and services too. And represents what we call our Business Solutions Division, or BSD, which is the largest component of our B2B network. We also have the capability to provide technology solutions to this market through CompuCom, which is the other component of our B2B business. And at its core, CompuCom is a company or an organization that enables enterprise employees to be productive. And it's refocused its strategy of connecting people, technology and the edge in a seamless experience, has a well position to capture growth in a market that we perceive as large and growing. In fact, we estimate that the current addressable market for managed device, workplace and infrastructure services in North America with an excess of $130 billion and growing. The industry is highly fragmented and despite the company's 32 years of business, we've only captured a very small portion, leaving a significant potential for growth. So we're very excited about CompuCom and the opportunity to grow and very excited about Mick Slattery, he's our new leader at CompuCom with extreme experience and really refocusing the strategy for future growth, and we're expecting growth in 2020. Another key aspect about the business, Liz, is, and I don't think many people understand this, but I think it's becoming clearer is the strength of our balance sheet. We have a very strong balance sheet. Our liquidity position is very significant. And obviously, our cash position currently is very significant. Considering the final maturity of the timber notes, which I'm very happy I won't have to explain any more in the future, we have a total liquidity position of about 100 -- I'm sorry, about $1.7 billion including about $780 million in cash. Currently, we have a net cash position. We're not considering the operating leases, and this gives us significant flexibility for the future, and we'll continue our balanced approach to capital allocation and how we invest in our business. So 2019 was all about improving the business model for future growth. We implemented our business acceleration program or what we referred to as a BAP. And that is a multiyear effort, which is designed to create a more competitive business model and driving significant cost efficiencies that provide additional sources of capital not only to improve customer satisfaction, but most importantly, to fuel future growth. And in 2019, we exceeded our goal with BAP, which we overachieved on our cost savings and driving improved operating performance throughout the business. In fact, profitability was up in each of our divisions after starting this program, which has led to lower cost and a sustainable and more competitive business model. So this is not a one-and-done event. This is really changing the way we do business, and really changing our cost structure for us to grow upon for the future. In the year ahead, we're focusing on investing our resources into growing our B2B businesses, while continuing to optimize our retail base. So utilizing our B2B platform, we'll continue to invest to drive growth. We're going to be adding selling resources, using tools, growing BSD and CompuCom and continuing to take advantage of broader and expanded product and service offering and will also continue to optimize our retail footprint for the benefit of shareholders. And what does that mean? That means that we continue to evaluate all of our retail locations, we look to improve the profitability. We did close some stores last year, some parts of our retail footprint that were not profitable. We'll have some more of that for this year, but this is creating a more healthy retail base. I would mention that retail continues to be an important part of our business. Although we are not dedicating many investment resources to retail, our retail locations still within 2 to 3 miles of 6 million or so small and medium businesses that utilize our retail footprint. So it's still a very important part of the business. But our resources are going to go to growing the B2B side of our business and driving that for the future. And of course, and last but not least, we're going to continue to be creative -- committed to creating the long-term value for our shareholders. We will continue, obviously, our balanced approach to capital. And -- which includes looking at the term loan, we have opportunities there, which is still somewhat burdensome as well as continuing to evaluate to be opportunistic with share repurchases, and continuing to invest in the overall business to continue to grow B2B. So we're excited about that. We're also excited about completing our previously announced feasibility review, the potential holding company, reorg that we announced actually in the third quarter of last year and discussed again on this past quarterly call. So we expect to have more information on that in the not-too-distant future. So a great 2019, all about profitability. And 2020 is about driving the top line growth in B2B. So with that, I'll turn it over to you, Liz, for our Q&A.

Great. Thanks. So first, I'm going to start with a couple of kind of macro-focused questions. I guess, as a diversified business services provider and retailer, Office Depot probably has a pretty good view into the state of U.S. business trends, the changing needs from a business security and technology perspective as well as the needs of the U.S. consumer as well. So what are you seeing in the broader economy right now? And where have you seen any big changes in the last several months or so?

Yes. I think we haven't seen any significant changes in the overall customer behavior, I'm taking this without many of the recent events right now of the coronavirus here and what's going on there. But I would say the broader economy currently has been pretty consistent. I think that, particularly with last several weeks and last several months, there's obviously been more of a strain on some of the demand for certain products within our business, particularly in the Cleaning & Breakroom and disinfecting area. So that's something that has been somewhat different. But just in general, the broader business market has been pretty consistent. And so we haven't seen much of a change there. In fact, if anything, I think that the -- a lot of the efforts that we have taken, particularly on the supply side as we prepare for the tariff discussions from the last 1.5 years has really helped us from a supply ecosystem standpoint, which is helpful now. So we haven't seen any near-term disruption in the supply environment. Business customers are still acting very similarly than they have in the past. But obviously, with the recent events and dynamics, we have to keep close watch on changes in customer behavior, and really take advantage of the opportunity because we can be very helpful to customers both those that work in a distributed nature and continue to supply them with the business, products and services that they need. In fact, it's interesting that CompuCom, there -- much of their business plan is really focused on the distributed nature of work and the changing nature of work and how employees and businesses are more mobile and more distributed, and that's something that can certainly be advantaged by having CompuCom serve them in that way. So that's another thing that's pretty important for us. So I would say, overall, customers want more from us. Not just office products but adjacencies. Obviously, we've grown significantly in Cleaning & Breakroom this past year, Cleaning & Breakroom was up in the high single digits. Jan/San, other products that we are evaluating new categories that could be very interesting for us when you consider we have a very large supply chain and distribution network in a large business customer base that we can put more products. So right now, nothing significant in terms of change. Obviously, we're watching it, given the recent events, and we'll continue to do so.

Great. And have you noticed any particularly strong or weak regions in the U.S. in either recent months or in the last couple of years? Any changes that you've seen where you have certain areas that are stronger than others from a regional basis?

Not necessarily any big changes from the strongest weakness on a regional basis. We obviously finished the year strong. Obviously, focused more on profitability, as we built a more sustainable and lower cost and stronger model. The only thing is the recent events is obviously as you might expect, and it's not just us, but anyone who has Cleaning & Breakroom and rather Cleaning & Jan/San product is in very high demand. So that's probably the only difference.

Okay. Yes. And then it's just kind of going on that the theme of the coronavirus. Just could you remind us how much of your product is sourced from China and whether -- how much of that has shifted over the last 18 months? And then if your suppliers are starting to come back online?

Yes. Our direct imports from China, it's actually -- it's probably about 3% or so of our overall COGS. What's tougher to get your arms around is what component and some other vendors' product is also exposed to China. So I imagine that number is a little bit higher, but it's probably not quite as substantial as you might think. We're pretty diverse, I would say, as I mentioned earlier, in the tariff discussions, we took a lot of contingency plans and acted on them to diversify our sourcing ecosystem in a broader way. So we did review some of the dependence, obviously, on China and then several other areas around the world. So that has helped. The -- from what we see, the supply environment is recently, I think, many suppliers and vendors are getting back up to production in several areas outside of the U.S. But we continue to look at it, focus on it, and it's a very smooth situation. So we continue to evaluate it. We did say on our recent call, that we didn't expect any near-term impact from the supply environment since we had done some forward buying. And -- but we have to look at it and continue to keep our finger on the pulse, and we're continuing to develop contingency plans in the event that supply is constrained in certain areas, but from what we can see that suppliers are beginning to ramp up some of the production in certain areas now. So that's somewhat for us good news.

Great. Could you -- you mentioned CompuCom, and I was just curious if you could expand on how Office Depot is providing solutions for businesses and individuals that are trying to adapt their practices to at least temporarily a more work-from-home culture. Just if you can give some examples across the business of how you service that need, that would be really helpful.

Yes. It's -- I would say, one of the key aspects of CompuCom is, is really focused on the distributed nature of work, right? Workplace -- distributed workforces and being able to initialize them with their product, managing the whole technology life cycle, supporting all the IT services from that standpoint. So it's very unique that we have that capability. The other capability that we have that many in the market do -- that many others in the market do not have is a very large field force. We have 5000-plus technicians that are in the field that can help support customers. And I think one of the things that we see is that if there's any positive side of this is those that have not considered events like this, where perhaps they have to have a workforce that needs to be supported from a remote standpoint. That's really one of the core competencies of CompuCom, and that's something that I'm sure Mick and team at CompuCom, are going to continue to work with their current customer base as well as many other customers to continue to do that. So it's something that's been in the core competencies for a number of years. This is a very recent development. So relative to this, I don't have the specific examples to share with you, but knowing that, that's really the core competency of many companies that they will support on a distributed nature is something that we can take full not only advantage of that really help our companies achieve their goals and help their employees become productive, even if they're not directly in the office and that's what CompuCom was really built for.

Got you. And I know small- and medium-size businesses have been a big area of focus for the company recently. Can you talk about just how the trends for those customers have changed over time? And where you've seen the biggest areas of opportunity?

In the small and medium businesses? Yes, both, I would say, both from a BSD standpoint and the retail locations are both important. Small and medium businesses utilize our services, they'll utilize retail locations if they're big enough, BSD will serve them as well. They'll use copy and print, small business solutions that are tailored to their needs. And also something that's interesting that is being launched by CompuCom, which is really geared towards that market, more of the upper, small and medium-sized enterprises is something that we're going to refer to as powered by CompuCom, which is a menu of package services to support different types of companies with different types of needs. So this is not customizing a whole platform for an enterprise, every time you do it. We really have a menu of services that you can choose from. Here is a menu of service from menu A for this type of customer, here is menu B, C and D that are highly repeatable and highly valuable solutions that are going to be launched by CompuCom to really target that market. So I think that's something that's very exciting for us with the small and medium-sized businesses, that is a -- still a very large and untapped market and a market that has not been overly penetrated, still fragmented. So that's that on the technology side. And then, of course, continuing to utilize our distribution network. We continue to expand the geography where we serve. We continue to have more and more components of the Office Depot network, both on the BSD side as well as allowing more and more of a service-oriented structure within our retail locations, particularly in markets that are heavy business. Office heavy business and office needs markets, Austin, Texas, Orlando. These markets that the retail footprint is important. So I think that what you'll see is we'll continue to leverage all of those assets to the benefit of that market and really be much, much more aggressive and provide more services and more benefits to customers and throughout this SMB market.

Great. And just sort of for the purpose of everyone's education and to get some context around a couple of questions I want to get into. Could you break out the percentages of revenue and EBIT for the company's business groups and how you expect the business to evolve in the next 3 to 5 years?

Sure. Maybe I'll take the question backwards to forwards here. What we expect is, as we have mentioned several times, it's just growth in B2B. That's really where we see more and more of the opportunity. So we would expect that both BSD and CompuCom to continue to grow over the next not just 3 to 5 years, but the next year, and that's what our guidance will suggest on the top line. We'll continue to rationalize the retail base for some period of time. But when you look at BSD and CompuCom together, BSDs of over a $5 billion revenue business, probably about $5.3 billion today with a margin of about 5% or so. Operating margins, so that's roughly 2 -- in the high $270 million, $280 million in EBIT. CompuCom is a tough comp for this year. Obviously, they had a very difficult start to the year as we all know, we thought it's the story. But they're about $1 billion business. The revenues have come down a little bit in the last year as we have gotten rid of some unprofitable areas of the business that are not sitting in with our refocused strategy. I would say, over the last 3 quarters, quarters 2 through 4 of 2019, the EBIT's begun to climb, so that's good news. And we're expecting both BSD and CompuCom together to grow in 2020 and beyond. Retail, we're continuing to optimize the retail footprint. So we're always dealing with that and traffic challenges in retail. Retail has done a fantastic job in mitigating some of those pressures and delivering an increase in operating income. It's just fantastic. So -- but we will have some of that -- some of those trends will continue, we expect, in the near term, but those would -- we expect to be offset by growth in BSD and CompuCom. And keep in mind, BSD and CompuCom, as I've mentioned, are 60%, or a little over, of our total revenue for the entire company. And obviously, the majority of the operating income. So I hope that helps.

Yes. And over time, I would imagine that the longer-term plan for Office Depot is for BSD and CompuCom to comprise an even larger portion of your total company revenue?

Absolutely. Yes. Continue -- obviously, continuing to grow one of the things we did on the BSD side with our new leadership there, Stephen Mohan. I mean he's done a great job in really analyzing not just what the market opportunity is, but just the opportunity within existing customers. They've done a tremendous amount of research to identify the spend on each of our customers and really how much we serve. There is tremendous opportunity within the existing customer base to serve not only our existing products today, but there are other categories, and I'll call it adjacencies on -- from an external standpoint, but internally, we just call it a category, that we believe we have the right to be there and the right to serve. So we're analyzing those as well as looking for ways to further penetrate our existing customer base and, obviously, grow new customers in BSD and CompuCom. And we expect that to continue to grow. So that's very exciting for us. As you know, BSD, these adjacency categories, about 37% of total BSD revenue, which is substantial, is generated from outside of our traditional office product categories, and we expect that to continue to grow.

Great. I was hoping you could delve into the business acceleration plan a little bit, what some of the long-term goals of that effort are? What's been accomplished so far? And then what the key performance indicators are that you're tracking?

Sure. No, that's a great question. The business acceleration program, which we came up with the acronym, BAP, for a better bet. It's really -- it wasn't just a onetime or one-and-done, let's get cost out of the business exercise. It was really a several month effort to analyze how we do business. There are a lot of areas that we knew that we had a change in terms of how we operate it. And really improve the way we do business and build a much stronger, lower cost and more sustainable business model. That's what this is all about. So in 2019, as we mentioned on the call, exceeded our expectations. We achieved a significant amount of cost savings, probably higher than we expected, so early. We did spend some money on it. We're using greater use of technology and automation. We've eliminated significant amount of non-value-added tax and sales practices, improved our sales ops, and we still have more to go. I mean, I think when we head into 2020, we will continue to drive more and more savings from our business acceleration program, which has generated roughly half of the SG&A savings so far, but we think that there's more to go in 2020, which we will take a portion of those savings and redeploy that. When we talk about investing in top line growth for 2020, that's what we're doing. We're taking a lot of these savings. We're taking the opportunity to invest in more selling resources, more tools, more automation, more intelligence in order to go after greater amounts of growth in our BA -- in our B2B businesses. So that's something that's helping us fuel additional growth on the top line for 2020.

Great. And just what the key performance indicators are that you track for BAP? Is it really just operating margin over time? Or are there other factors that you're looking at to see if that's been a -- just to track the success of that program?

Yes, it's really related to efficiency, right? Efficiency savings, cost savings where we can automate where it makes sense. Really looking at ways to improve what our sellers do in BSD. I mean, when we started that process, we found out that the majority of their time was -- of our salespeople, were spent on non-selling type of activity. So that's not for sales organization. So a lot of the tools and processes that we put in place allows them to be more effective and more efficient. Certainly, there are areas of the business that when we use automation and other processes in our operations has resulted in less resources necessary. So that's created a significant amount of savings. So it's really geared towards savings, efficiencies which therefore goes into our profitability of our business. So those are really the metrics that we look at. And are we not losing sight of what this means for our customers because that's really, at the end of the day, what -- are we able to initialize new customers with -- in our BSD network quicker than we were in the past? Can we set up accounts? Can we bill? What can we do to help improve the customer satisfaction and their experience with us as well as reduce the cost? So it's really in both of those areas that we continue to monitor in a number of areas to ensure that our BAP is delivering what it has promised. So we're really excited about what we've accomplished so far. More to go in 2020, and also helping us fuel additional growth.

Great. I have a couple of more questions, but I want to make sure we give anyone on the line the opportunity. So Mary, if you could prompt everyone to let them know how to get in the Q&A if they have questions, that would be great.

[Operator Instructions] No questions at this time.

Okay, then I'll keep asking mine. Okay. So you mentioned that you have a pretty sizable cash position. I'm curious if you could talk about your priorities for cash, and how that might be deployed in various channels? I mean, the stock market is very volatile, so there's some opportunity there, but that market is pretty cheap as well. So maybe talk about how you're looking at capital deployment? That would be really helpful.

Yes, it's a great question. And to the matter, I think getting that question a lot lately, just given the cash position that we have. It's to continue the balance approach to capital, right? I think I mentioned that. Looking at opportunities, if I were looking at those areas on the balance sheet that we can address. I think we've mentioned this, where we still have a rather burdensome timber -- I'm sorry, burdensome term loan that's been out there for a number of years that is now -- the call premium has gone, so that's now at par. Some opportunities that we can take there in a number of different ways to help address that. We still have $160 million left on our share buyback program and authorization from the Board. I mean, I think we'll continue to be opportunistic there, particularly at pretty ridiculously attractive valuation, and continue to invest in the business. Again, resources would go into BSD, which is important for us in terms of selling resources, in terms of technology and what we're doing on the BSD side to grow our enterprise and business footprint. We'll continue to look at attractive smaller tuck-ins, where appropriate. We'll continue to invest in CompuCom. And we think that CompuCom, all that has been -- it's been a work in progress, right? We still have a lot more work to do with CompuCom, but we certainly think it's been moving in the right direction. So we think there's great opportunity there. When you've considered our overall valuation, I don't think much of it is attributed to CompuCom at this point. So turning that into a valuable asset for us, I think, will be really key. I think we -- obviously, we have the service dividend and -- but also -- so a balanced approach was. It's really looking at the opportunities we have, probably, the only difference is, looking at the term loan and the opportunities there.

Great. And just highlighting some of the -- in addition to the cash position, there are a number of assets that Office Depot has been highlighting in recent conference calls and meetings. Can you run through what some of those assets are and how Office Depot plans to unlock value from them?

Well, sure. I think when you look at the assets, such as just our distribution reach and supply chain, for example. I mean, there's a number of opportunities that obviously serves the entire business and is a very unique asset and how we utilize that. And it's obviously, it's attracted a lot of interest from other potential partners, as you've heard in the past year, companies that wanted to be a part of that network. And I think that we're going to continue to look for ways to leverage assets like our supply chain. Look, when we talk about our B2B platform, one of the questions is, well, what does that mean? Well, it's really the backbone. It's the backbone of the business, the supply chain distribution network, the $10 million roughly business customers, the large enterprise accounts that we have, the vendor relationships. I mean, we have so much in terms of our asset base that we can capitalize on. Sometimes, quite frankly, it's overshadowed by this broad brush of us -- people thinking about us as retail only, right? Retail is still a very important part of the business. But I think it's somewhat overshadows the value of our B2B business, which is obviously a very interesting business with a great asset base. So I think what you'll see us do is continue to highlight those assets. We are looking at, as we had mentioned, a holding company reorg, which we've been involved in a feasibility study of that reorganization process, which essentially would create a holding company structure for Office Depot with a company by the name of ODP at the top with subsidiaries that are underneath that, which will better align assets with their respective operating businesses and really provide flexibility in the future to unlock the value of these assets that I mentioned and that we can take advantage of. So it's pretty exciting. More to come on that as we get further down the road, but really excited about what that can mean for our company, and continuing to drive these assets and utilize everything from our supply chain to our balance sheet, even. These are all great assets for our business, and we'll continue to look for ways to unlock the value and highlight that.

And are there any clear synergies between the operating groups of North American Retail, BSD and CompuCom? Like do they have their own offices, distribution centers, management teams, systems and -- or is there shared back office and supply chain operations?

It's kind of yes and yes. There are parts of it that are integrated, there are parts that are not. Significant amount of synergy between BSD and CompuCom. In fact, and we haven't done enough of this yet, but we've done a significant amount of cross-selling between the 2. BSD and CompuCom together are very powerful. As I had mentioned this powered by CompuCom offerings coming for the mid-market will be another great tool for our sellers and BSD to bring to their enterprise and their midsized companies to not only supply them with office supplies and adjacencies, but also a full technology solution. We've done to date, Liz, and I think we're still scratching the surface, probably in total contract value anywhere from $150 million to $200 million of kind of cross-selling between the 2. We're probably being a little conservative. But there's a lot more that we can do in terms of the synergies between BSD and CompuCom, and that's a path that we've been going down. So we're excited about that. There are shared assets between the entities. The supply chain is integrated, and some of it is dedicated as well. Obviously, we have a private fleet of over 1,000 vehicles. We have a number of distribution centers across the U.S. and we have cross docks that serve a lot of the retail stores and keep them stocked et cetera. But these are ways that we can really take advantage of some of the synergies, but also be independent enough to make sure that we can highlight the value of our businesses as need be.

Great. Well, I will let the operator, if you wouldn't mind just checking one more time for questions. And otherwise, we will wrap it up.

[Operator Instructions] We have no questions over the phones.

Okay, great. Well, thank you very much. Thanks, Tim, for joining us. Really appreciate the time, and thank you all for joining on the line of this conference. Thanks.

Super, Liz. Thanks so much, and thanks to everybody for joining. Appreciate it, and bye-bye.

Great.