The ODP Corporation

Good morning and welcome to the ODP Corporation's third quarter 2021 earnings conference call. All lines will be in 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. Mr. Perrott, you may begin.

Good morning, and thank you for joining us for the ODP Corporation's Third Quarter 2021 Earnings Conference Call. This is Tim Perotte, and I'm here with Jerry Smith, our CEO, and Anthony Scaglione, our Executive Vice President and CFO. Also joining us today is David Bleich, our Executive Vice President and Chief Legal and Administrative Officer. During today's call, Jerry will provide an update on the business, focusing much of his commentary on our accomplishments in the third quarter including our operational performance, as well as the progress we are making on all of our initiatives to drive shareholder value. David will then provide commentary on the previously disclosed proposal made by USR, an entity controlled by Sycamore Partners, the owner of Staples, to acquire the consumer business of the ODP Corporation. After David's commentary, Anthony will then review the company's financial results, including the highlights of our divisional performance. And following Anthony's comments, we will then 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. Security and Exchange Commission. Also during the call, we will use some non-GAAP financial measures as we describe business performance. The 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.theodpcorp.com. Today's call and slide presentation is being simulcast on our website and will be archived there for at least one year. I would now turn the call over to ODP's Chief Executive Officer, Jerry Smith. Jerry?

Thank you, Tim, and good morning to everyone joining our call today. We appreciate you joining us this morning and hope that all of our listeners and their families continue to remain safe and healthy. I'm happy to be here with you today to discuss the results and accomplishments for the third quarter. Our performance in the quarter reflects our team's continued commitment to our low-cost model approach and to the core tenets that drive our business, positioning us to deliver solid operating results while making progress on our strategic initiatives to unlock shareholder value. I'm extremely proud of our team's efforts in delivering these results against a much more demanding industry backdrop related to supply chain challenges and the resurgence of the COVID-19 Delta variant during the quarter. As I've mentioned on our previous calls, our performance and strategic actions are aligned and supported by the key tenets that form the foundation of our business as outlined on slide four in our presentation. These tenets form our foundation as we address market dynamics, pursue new avenues for growth, and continue to position our business to unlock future value for shareholders. This foundation is rooted in driving a low-cost model, expanding our value proposition, and moving into higher-value businesses through the addition of new growth engines. As reflected in our results, we've been executing along these priorities utilizing the strength of our business model and the flexibility of our infrastructure to address the market demands. At the heart of our approach is our winning 5C culture. This quarter, I will highlight one of the key components of our 5Cs, and that is creativity. We have leveraged this component of our culture over many years to create a highly flexible supply chain operation backed by strong relationships and a well-developed infrastructure to allow us to navigate many of the current challenges impacting the macro supply chain and economy. This approach has helped our team deliver solid operating results while continuing to advance our digital platform business and making progress on our plans for separation. The highlights of these accomplishments for the quarter are shown on slide five. First, as I've stated on previous calls, maintaining a safe environment for our associates and our customers continues to be priority number one. We continue to monitor state and national health guidelines, and we're maintaining safety measures as necessary to help protect our associates and customers. Now for the highlights. We delivered solid operating performance despite the industry-wide challenges related to sourcing and supply chain, as well as a slower pace of back to office due to the spread of the Delta variant. We were happy to see a more normal back to school season as a greater number of students and teachers returned to the classroom this year with core supply categories, helping to offset lower sales for products previously in strong demand during the height of the pandemic. Our continued low cost model focus and flexible supply chain operations hope to drive solid operating results against a more challenging backdrop. Next, supporting one of our key tenants of driving new avenues of growth, In higher value markets, we continue to advance our digital platform business, Verus. We continue to make great progress on building out the team and capabilities, leveraging new customers on the BuyerQuest platform, while advancing our collaboration with Microsoft. The progress we are making places us in an excellent position to drive value in the large and growing digital business commerce market in the future. Also, we're continuing to make progress on our plans to separate ODP into two independent, publicly traded companies. We announced the top leadership for both companies, and we're making meaningful progress on the various commercial agreements between the feature entities. Finally, we're happy to report that we've been executing upon our share repurchase program, buying back over $100 million of stock during the quarter and through the end of October. Now turning to more details regarding our accomplishments in the quarter, beginning on slide six. Our overall performance reflects both the positive attributes of our team's approach to operational excellence, as well as the value of other investments we made in our infrastructure as we faced a more challenging industry backdrop during the quarter. This backdrop included the spread of the Delta variant, delaying the return to office plans for many of our enterprise customers, as well as the global supply chain constraints and inflation have created the recent industry-wide sourcing and cost challenges. While our top line did see pressure from a reduction in our store footprint and lower demand for certain pandemic-related products, our team's continued focus on driving a low-cost model while leveraging the flexibility of our supply chain assets allowed us to deliver solid operating results. Supporting our performance, we drove stronger year-over-year growth in our contract channel as private enterprises slowly began to return to the office. The back-to-school season, while still not back to 2019 industry levels, saw more students and teachers returning to the classroom, contributing to our performance as well. In all, our teams disciplined and utilized their supply chain strength and continued efficiencies across their business offset many of the challenges and helped us drive $122 million in adjusted operating income in the third quarter. Now turning to our divisional performance, starting with our Business Solutions Division, or BSD, as highlighted on slide seven. Our BSD segment, consisting of both our contract and our e-commerce channels, continues to provide a strong value proposition for customers with a broad product and service assortment backed by robust sourcing and trusted supply chain operation. This segment of our business serves nearly half of the Fortune 500 companies, as well as medium and smaller enterprises, and other consumers through our digital presence. BSD's revenue performance was highlighted by the increase in sales in our contract channel, driven by stronger demand in core categories from private enterprises, more than offset by lower sales through our e-commerce channel. Overall, revenue was down about 2% year-over-year. Let me provide more details. The business environment in the quarter was stable in general. However, as I stated earlier, The pace of back-to-office for many of our customers was slower than we anticipated due to the spread of the Delta variant. Despite this challenge, we drove an increase in sales in our contract channel, led by the stronger demand from enterprise customers for our core supply products, furniture, and managed print services. While we are happy to see this progress, it is slower than we anticipated given the Delta variant effect. Much of this progress was offset by lower sales on our e-commerce channel compared to the very strong period last year as the demand for pandemic-related products, including PPE and furniture, was lower in the quarter. I would add that a more challenging sourcing environment for technology products contributed to lower sales in this category. Revenue generated from our adjacency categories, including cleaning and break room, furniture, tech, and copy and print, remained flat in total with last year as a percentage of BSD sales. As return to office begins to accelerate, we expect our core categories to overperform until the pace normalizes. From an operating perspective, we continue to maintain our focus on our low-cost model approach, flexing our assets and utilizing pricing strategies to help offset increased costs related to supply chain operations and other inflationary impacts. Our sales team is continuing to do a good job in both retention and winning new business. Our retention rate is at the highest it's ever been, and we're earning new business. Moving forward, we're also encouraged by the indication of the positive impacts to our business as customers return to the office. In general, on a per customer basis, our recent data shows that we do experience a lift in sales as more employees return to the office, and as just discussed, primarily in our core supply categories. This high correlation with return to work in the office will drive higher consumption of our breadth of products. And while the return to office has been slower to materialize than we had hoped for in the second half of this year, we are confident that we are well positioned to capture the demand as activity increases in the new year. Now, turning to our performance in our retail division, as shown on slide eight. Our retail division continues to provide strong value and support for our consumers, including education, home office, and small business customers, through a network of over 1,080 retail stores and the convenience of a buy online, pick up in store, or BOPAs offering. I'm proud of our associates for maintaining strict safety protocols and providing a positive shopping experience for our customers, leading to continued strong net promoter scores. Revenue performance in the quarter was lower versus last year, primarily due to 160 fewer stores in service. However, when adjusting for the store closure impact, we estimate revenue was down in the low single digits. some of the dynamics in the quarter include the resurgence of the back-to-school season as more students and teachers came back to the classroom. While we're happy to see the return to a more normal back-to-school season, as I mentioned earlier, the total supplies industry has not yet recovered to pre-pandemic levels in 2019. That said, the back-to-school season was positive for us as we drove solid year-over-year growth in our school supplies and related categories. In fact, for the categories which we participate, the data shows that we picked up market share in back-to-school categories versus last year. In all, we are encouraged by the improved year-over-year trend and looking forward to the industry fully recovering to pre-pandemic levels in the future. These positives helped offset some of the impacts from lower foot traffic and lower sales for product categories that were previously in very high demand during last year's third quarter. During the height of the pandemic last year, we experienced very strong demand in our cleaning and break room, home office and technology categories as customers procure PPE and set up home offices near the beginning of the pandemic. As COVID-19 cases have begun to recede, demand for these items were lower compared to the strong performance in these categories last year. Additionally, we did face challenges in the quarter related to supply chain and sourcing availability for a number of SKUs we sell. The number of out-of-stocks we had this quarter continues to run higher than pre-pandemic levels most notably for technology products and PCs, driven by the continued chip shortages, as well as overall challenges for components, including certain ink and toner. We are continuing to work with our vendors and partners to efficiently source these products and improve our inventory levels, but we expect these challenges to persist in the near term. Operationally, our team's continued focus on our low-cost model helped to offset some of these challenges, including the increase in overall supply chain costs. Through strong cost controls, the benefits of our maximized B2B plan, and the new labor model we implemented last year, our team drove an increase in offering margins versus last year. Overall, we're encouraged by our progress. Our store footprint continues to become more profitable, and our omnichannel presence continues to be a popular choice among our customers. Demand through our BOPUS offering, while slightly lower on a comparable basis relative to last year, is up about 70% versus the same period in 2019. Feeding off the success of our 30-minute guarantee, we recently launched our 20-minute guarantee for in-store and curbside pickup. We are the only company in retail that we know of to offer such a guarantee, which has been well received by our customers. Coupled with the growth of independent delivery channels, we expect this will drive sales and continue to generate good customer satisfaction scores in the quarters to come. Now, as shown on slide nine, I'd like to take a moment to discuss the impacts related to the industry-wide supply chain disruptions and how ODP is in a position of strength to navigate this challenging environment. Much of the recent well-publicized global supply chain challenges began with the onset of the pandemic. During the COVID-19 outbreak, labor resources were constrained both in manufacturing and transportation, factory hours were limited, and a demand shift from services to products added additional stress to the system. One of the obvious early casualties was the microchip shortage, causing sourcing and supply challenges in everything from vehicles to PCs. And I know how frustrating this challenge can be, as I was the former COO with global supply chain responsibilities of a major technology and PC manufacturer. These factors continue to put strain on global supply chain assets, including manufacturing, ocean carriers, port operations, long haul, last mile, and labor. Many raw materials used in everyday manufacturing have become scarce and more expensive to ship, causing suppliers to increase costs to their customers, creating an inflationary effect. Transportation costs in the spot market have skyrocketed, with ocean carrier spot rates up hundreds of percentage points over the historical rates, and labor scarcity and costs have continued to rise. All these factors have made it more challenging for all industries to source, import, distribute, and deliver goods, and do so at a reasonable cost. These factors have an impact to our operations, causing sourcing challenges for certain products and increasing costs related to supply chain product and labor. That said, because of the investments we have previously made in our supply chain infrastructure and longstanding relationships, ODP is better positioned than most companies to navigate through these challenges. Why is this so? Well, it boils down to the investments we've made in our infrastructure, including our private fleet, the flexibility of our distribution network, and the long-term relationships we've had with transportation partners and suppliers that place us in a position of strength. Starting at the source, we leverage our large global sourcing office in Asia, a unique asset that provides us with a significant presence in the region, allowing us to stay on the pulse of the manufacturing market dynamics. We have a diverse number of manufacturing partners for a private label and numerous vendor relationships that supply the products we source. We're continuing to work closely with our vendors, focus on accurate forecasts for our inventory, adjusting lead times and leveraging safety stock when needed, helping to reduce the number of out-of-stocks and delays. For the products that we source directly over the ocean and into the U.S., we have long-established contracted rates with a number of different ocean carriers that protect us from the high spot market rates that you've heard about in the media. These are longstanding relationships with contracts that are continuing to be honored. And when we do have a need, we have a backup plan comprised from relationships with non-vessel owning carriers, which also helps us protect some of the costs that we're seeing from higher spot market rates. Regarding port congestion, we utilize a flexible approach with the capability to route to other ports to help alleviate congestion challenges where it is cost-effective and available for us to do so. Additionally, we do a good job at planning well in advance to source and ship goods as necessary. Also, when we saw some pressure building earlier in the year, we put actions in place to help set inventory levels early. This helped us during this year's back-to-school season, which was a good example of how we manage sourcing challenges. Next, a key advantage for ODP is that we have invested in and built our own large private fleet helping manage some of the increases in over-the-road trucking and last-mile delivery costs. And because we deliver to retail stores, we have a strong backhaul program and can use our closed-loop transportation to bring in our goods as well as our vendors' goods. We essentially run our own Less Than Truck Load, or LTL, network, leveraging this network for backhaul and vendor consolidation, hoping to mitigate some of the industry rate increases. For last-mile delivery challenges, We leverage our private fleet and our relationships with over 25 national and regional small parcel carriers with which we have longstanding relationships. Last mile capacity has been severely constrained and capacity limits are in place. While everyone has been scrambling to establish agreements with carriers, we are already there. This helps to mitigate costs, helps to ensure reliable delivery to our customers. Lastly, labor costs continue to be pressured given the tight labor market and supply chain and retail in general. Wage inflation has become a real challenge in industry, increasing labor costs for us and others, which we expect will continue in the near term. We're remaining market competitive for labor resources by using creative approaches that are more short-term orientated, including incentive base, which offers us flexibility in the future. All these are leading to higher supply chain product costs and greater challenges in sourcing and managing inventory. While we're impacted by this environment, expect the challenges to remain for some period of time, we do have pricing flexibility that allows us to pass through some price increases to help alleviate cost pressures, and we can pull other cost levers to help manage margins. Now turning to the progress we're making in our digital platform business, as shown on slide 10. We're very excited about the progress we're making on our digital platform business, Veris, and the impressive team that we have assembled to drive future growth in this valuable market. We've fully integrated BuyerQuest, an industry-leading digital e-procurement technology platform, and are continuing to attract and integrate new customers. We're continuing to advance our collaboration with Microsoft in preparing to bring the capabilities of BuyerQuest to Microsoft's business central customers in the future. We are continuing to generate strong interest from the supplier community as they recognize the expansive reach and capabilities of our new platform. Our progress is placing us on the right path with the right team and technology platform to pursue growth in the large and growing digital business commerce market. While we are still in the early stages, we're extremely excited at the pace at which we are executing and look forward to sharing more as we position the business in 2022 and beyond. Before I turn the call over to David Bleich for a brief update on Sycamore, I wanted to spend a few moments to highlight our progress on our separation initiatives as shown on slide 11. Our plans to separate ODP into two independent, publicly traded companies continue to progress in the third quarter. We are making advancements in all areas of the separation, including organizational structure, operating and supply chain mechanics, IT support, and on the commercial agreements between the companies. As part of this progress, we announced the selection of CEOs of both companies to become effective upon completion of the spinoff as well as the company names for each of the two entities. We announced that Kevin Moffitt, who currently leads our retail business, will be appointed CEO of Office Depot upon completion of the spinoff, and I will lead the ODP Corporation, a leading supplier of B2B solutions serving small, medium, and enterprise-level companies. The timing for completion of the separation currently remains the same. As a reminder, a description of the anticipated post-spend companies and their related assets is shown on slide 12. Separating a highly integrated company like the ODP Corporation is not an easy task. However, we believe that creating two highly focused, pure-play companies enhances our strategic flexibility and unlocks opportunities to meet customer needs while aligning our assets and investment profiles to generate greater values for our shareholders. We remain on track with our plans and expect to provide additional detailed information in the coming quarter. With that, I will now turn the call over to David Bleich, our Executive Vice President and Chief Legal and Administrative Officer, who will provide commentary on the previously disclosed proposal made by Sycamore Partners, the owner of Staples, to acquire the consumer assets of the ODP Corporation.