Categories Earnings Call Transcripts, Retail

Office Depot, Inc.  (NASDAQ: ODP) Q1 2020 Earnings Call Transcript

ODP Earnings Call - Final Transcript

Office Depot, Inc.  (ODP) Q1 2020 earnings call dated May 06, 2020

Corporate Participants:

Tim Perrott — Vice President, Investor Relations

Gerry P. Smith — Chief Executive Officer

David Centrella — Senior Vice President of Financial Planning and Analysis and Interim Finance Leader

Analysts:

Christopher McGinnis — Sidoti & Company, LLC. — Analyst

Elizabeth L. Suzuki — Bank of America Merrill Lynch — Analyst

William Kafoure — Elevation — Analyst

Christopher Horvers — J.P. Morgan — Analyst

Michael Lasser — UBS — Analyst

Presentation:

Operator

Good morning, and welcome to the Office Depot’s First Quarter 2020 Earnings Conference Call. [Operator Instructions]. At the request of Office Depot, today’s call is being recorded.

I would like to introduce Tim Perrott, Vice President, Investor Relations. Mr. Perrott, you may now begin.

Tim Perrott — Vice President, Investor Relations

Good morning, and thank you for joining us for Office Depot’s First Quarter 2020 Earnings Conference Call. This is Tim Perrott, and I’m here with Gerry Smith, our CEO; I’m also joined by David Centrella, our Senior Vice President of Financial Planning and Analysis and Interim Finance Leader who will provide additional details on our financial results.

During today’s call, Gerry will provide an update on the business, focusing much of his commentary on our operations in the first quarter and the impacts to our business from the COVID-19 pandemic, as well as discuss the strength of our financial position and our strategy to address the challenges posed by this health crisis, including actions we are taking to ensure business continuity.

David will then review the Company’s financial results for the quarter, including our divisional performance. And following David’s comments, Gerry will have some closing remarks and then we’ll open up the call for your questions. Before we begin, I need to inform you that certain comments made on this call include forward-looking statements, which are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

These forward-looking statements reflect the Company’s current expectations concerning future events and are subject to a number of risks and uncertainties that could cause actual results to differ materially. A detailed discussion of these risks and uncertainties are contained in the Company’s filings with the US Securities and Exchange Commission.

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 the non-GAAP financial measures to the most directly comparable GAAP financial measures are all available on our website at investor.officedepot.com.

Today’s call and slide presentation are being simulcast on our website and will be available there for at least one year. I will now turn the call over to Office Depot’s CEO, Gerry Smith. Gerry?

Gerry P. Smith — Chief Executive Officer

Thank you, Tim, and good morning to everyone on joining our call today. We appreciate you joining us today during what we know is a very challenging time, and we hope that our listeners and their families are safe and healthy. I’m happy to be here with you today to discuss our strong results for the first quarter, and provide perspectives regarding the COVID-19 outbreak and its effect on our business as well as highlight our strong position as we navigate through the challenges caused by this pandemic.

First, I would like to thank all of our associates for the tremendous commitment and energy in supporting our customers and our business during this health emergency. This has been an incredibly stressful time for our associates. From those in our retail locations helping customers in the front-line, to those in our supply chain working hard to ensure flow of products, for our CompuCom technicians who are serving their customers, as well as those who are working with our enterprise customers to help them remain operational during this period.

I can’t express enough gratitude to our team in living up to our designation as an essential business and what we’ve accomplished in such a short time under challenging conditions to help serve and help our customers. I am very proud to be the leader of this Company with such a capable and committed team.

While the global pandemic has quickly impacted the business environment in general, the actions that we’ve taken over the past few years have reinforced our foundation to serve our customers’ expanded needs, preserve cash, and deliver the necessary products and services to help our customers succeed through this uncertain time.

The strong results we’ve delivered in the first quarter reflects the commitment and tireless work of our team as we supported the essential needs of businesses, consumers, educators, health-care workers, students, and first responders during the global health crisis that unfolded in our nation.

Before I provide you with the specific highlights for a strong performance in the quarter, I would like to discuss what we are doing to remain safe, help our customers in how we are leveraging our unique and strong position to drive our business forward. These points are shown on slide 4. First and foremost, safety is our priority number one, and our primary focus is on the health and safety of our associates, customers and families in our communities. In the very early stages of this outbreak, we took actions to enhance the safety protocols in order to help protect our employees, and create safer environment for our customers.

In advance of the stay at home orders that were required by most local jurisdictions, we issued a work from home mandate for all the employees who do not need to physically being in the office or facility. This included most associates in our corporate headquarters, as well as non-essential personnel in all facilities who have the ability to work remotely and maintain social distancing guidelines.

In our retail stores, which is a primary source for our customers requiring essential products and services they need, we have installed counter shields and required employees to use masks and gloves to help protect customers, employees during these interactions. We quickly offered a curbside pickup option at all our locations, including at some locations which are operating on a curbside pickup only fashion per local laws.

We’re also cleaning and sanitizing our facilities. Our employees at our supply chain and distribution operations are required to wear personal protective equipment or PPE, a term that’s become synonyms with this outbreak. We are also promoting social distancing with our distribution centers by stating starts [Phonetic], shifts and breaks increase spacing in common areas.

And at CompuCom, our tech support teams transitioned to a work in home environment very early in the crisis, which helped them provide uninterrupted support for many of their customers who began the transition to a distributed workforce. These early actions taken by CompuCom and support they have provided have added their credibility among its world-class customer base.

We received numerous correspondence praising the CompuCom team for its high level of service and support during the crisis. Also, during this challenging time, we’ve been active in the support of our local communities. Office people have donated well over $300,000 to schools, school districts and charitable agencies to help promote virtual learning for those in need through the crisis.

Given the nature of the products and services we offer, we are designated [Phonetic] as an essential business in nearly all jurisdictions. The products and services we offer through our B2B distribution platform in retail stores, including cleaning and breakroom supplies, technology, office furniture, and other products and services that support work from home and virtual learning needs are all essential, therefore our operations are up and running and our stores are open helping customers through this pandemic.

Although a few retail locations were required to close for a period of time in certain jurisdictions, nearly all of our retail stores are opened and safely operating. Our B2B supply chain and distribution channel continues to be resilient, serving business customers, including hospitals, medical facilities, and healthcare workers, providing with essential products to help them on the front line.

Our global sourcing capabilities are continuing to work to procure additional sources of essential products in PPE, and our supply chain is operating efficiently despite the additional demand placed on the system. CompuCom’s high quality support teams are fully functional, working closely with customers to provide technology products and services to support main businesses which have temporary transitioned to a work from home environment.

We’re also working closely with schools and higher education customers to support a remote learning environment for students and teachers as many schools have canceled in-person classes for the balance of the school year. Next, we are uniquely positioned to weather the storm and navigate through the crisis.

Our balance sheet is exceptionally strong with significant available liquidity, positive net cash position, and attractive debt maturity schedule. This strong cash position and balance sheet also allows us to pursue additional opportunities to expand our customer reach during the crisis, to expand our product and service breath and help customers at this crucial time. We are keenly focused on maintaining a low cost model, driving efficiencies in our business, and using leverage in our variable cost structure to provide us the ability to better match our cost structure with our top line revenue.

Our global sourcing and supply chain capabilities are critical assets, and key differentiators that position us to continue to deliver and expand essential products and service including PPE. Lastly, the combination of our business and technology products, combined with the technology support and expertise of CompuCom, position us well to support the needs of a distributor workforce in virtual learning environments.

This has been a powerful combination helping many enterprise and individuals adapt during the rapid change in the work environment. Overall, despite the near term headwinds caused by this pandemic, we’re experiencing an acceleration of the strategic pivot we embarked on three years ago, to become a leading integrated B2B provider of business products and services.

I believe that this is happening for a number of reasons, most notably, the advantages related to our global sourcing, and supply chain capabilities, and which we are providing a much broader set of in demand products and services to our customers, and deliver them in a consistent manner.

During this pandemic, these conversations we’re having with our customers are changing, and customers are taking notice and discovering more of what we have to offer beyond traditional office supplies. The consistency of our supply chain is building significant credibility as a reliable source of essential products such as cleaning and breakroom and PPE with a high level of service and support.

And it’s not just an expanded product set, but also services and technology support. Sourcing and making available technology products and having CompuCom in the mix for critical test and support for enterprises during this pandemic is leading to more visibility and credibility with our customers.

I’d like to now turn to the performance in the first quarter, and discuss the directional impact of the COVID-19 outbreak on the various parts of the business. This is shown on slide 5. We entered the year with good momentum in our B2B businesses, which helped us generate the overall strong results we drove in the quarter. We saw a steady pace of net new BSD customer wins and new business at CompuCom and demand for our adjacency categories, and its supplies were relatively strong.

The effects of the COVID-19 outbreak beginning in March had a mixed impact to various channels and product segments, but the overall net effect in the quarter was positive to sales. During the initial phase of the outbreak, demand for essential products like cleaning and breakroom supplies, technology and home office products were very high in our retail stores and through our e-commerce channel.

The heightened demand for these products was the key driver of the increase in our same-store sales comparison in our retail division, which was up 2% year-over-year. However, in our BSD division, despite a strong start to the year, the COVID-19 outbreak disrupted the business operations of several of our customers, causing some to temporarily pause operations or temporary transition to a work from home environment.

These impacts, combined with a number of school systems to have shut down for the school year have had a negative impact in our contract channel within our BSD division. We are working with our customers to support them during this transition, supporting their needs with our distribution capabilities and tech support, and ready to support them as more of the country opens up and resume to normal operations.

At CompuCom, the COVID-19 outbreak resulted in a number of customer delays of previously scheduled project work, which negatively impacted revenue and operating results in the quarter. That said, CompuCom provides critical technology support for many enterprises and their core competencies built around supporting large, distributed workforces. We think their unique capabilities positions them very well to capture future growth in this environment.

The strong start of the year to our B2B businesses combined with increasing demand for a central products in our retail and e-commerce channels drove exceptional results in the first quarter. We drove increases in our operating performance and free cash flow generation, further strengthening our balance sheet.

Highlights in the quarter are $2.7 billion in revenue, down slightly over last year, largely related to fewer stores and service and lower revenue in our BSD division. Adjusted EBITDA of $157 million, up 33% over last year, adjusted operating income of $108 million, up 61% over last year and adjusted earnings per share of $0.12, up $0.05 over last year.

Free cash flow generation in the quarter was stellar, generating $173 million in adjusted free cash flow, up 12 fold from the prior year. This increased cash generation has further strengthened our balance sheet and enhanced our position as we head in the challenges of the balance of the year.

I’m very proud of our team and all the hard work to generate these terrific results. Notwithstanding the strong performance, because of the global business disruption and uncertainty caused by the COVID-19 pandemic, we are withdrawing our previously issued guidance for 2020 which did not include possible impacts from the pandemic.

While we are not providing specific guidance in the current environment, we will discuss some of the trends that we’re seeing in the near term, and provide some color on our expectations for the second quarter. Due to the increased demand, supply for essential products, particularly in the cleaning and breakroom category have been constrained beginning late in the first quarter and continuing to date.

While we’ve been able to negate some of the lack of supply available [Phonetic] while using alternative vendors, we expect to continue to experience temporary disruption in supply until output level normalize. In addition, we expect demand in the second quarter to decrease as several of our enterprise customer operations continue to be disrupted including K through 12 schools and higher education.

At this time, we are assuming that these effects are temporary, however, they have caused pressure on near-term revenue beginning in late March, and thus this effort has continued to date in the second quarter. Revenue trends are currently lower in our contract channel and BSD as well as lower in our retail division given decreased traffic trends in accordance with continued stay at home orders imposed by our local jurisdictions.

These trends have thus far been partially offset with increase in demand in our e-commerce business. Slide 6 highlights our strong financial position, and our priorities to help mitigate the business challenges caused by the COVID-19 outbreak. As I said earlier, first and foremost, our primary focus is on helping maintain a safe and healthy workplace for our employees and helping our customers continue demand for businesses through this crisis.

While significant challenges remain, we are implementing several strategies to help mitigate the challenges and believe we’re in an excellent position to navigate through this crisis and strengthen our business in the long run. Our priorities are focused on one, maintaining and utilizing our strong balance sheet and cash position. Two, maintaining a low cost business model and conserving cash. Three, supporting customers as well as pursuing growth opportunities. And four, supporting customers in work from home and virtual learning environments.

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Let me start with our strong balance sheet. Our conservative approach to our capital structure along with our strong cash flow generation has placed our balance sheet in a very strong position, about [Phonetic] $1.7 billion in available liquidity, including $840 million in cash.

When concerning a relatively low level of debt, we have nearly $200 million of net positive cash, our highest net cash position in recent years. In April, we further enhanced our balance sheet by refinancing our existing credit facility, which increased the borrowing amount and extend the term to 2025, at the same time, we retired our relatively expensive term loan, which is expected to result in annual cash savings of approximately $90 million.

Therefore, the net effect of our recent actions resulted in an increase in the amount we can borrow, significant annual cash payment reductions, and an extension of our credit facility to 2025. We started this refinancing process late last year and this activity was not in response to the pandemic, but it’s certainly placed us into a stronger position as we head into this challenging environment.

We’re happy to state that the credit — the new credit facility was significantly oversubscribed with strong lender support and provides substantial financial flexibility to continue the Company’s transformation efforts including the dynamics of the planned holding Company reorganization.

Next, we remain committed to maintaining a low cost business model, and are implementing additional cash conservation measures in response to the COVID-19 pandemic. These measures include among others, restricting travel, limiting store hours, eliminating non-essential third party support, and implementing a limited number of temporary furloughs in areas of our business that has simply affected by the outbreak.

We also have a high degree of variable cost in certain areas of the business, which can be a lever to help us better match cost with expected revenue performance. We have continued to pay rent due for our store locations, however, we are working with landlords and the equipment vendors on rent and lease abatement opportunities to obtain better terms and limit exposure.

Additionally, as we continue to select and close unprofitable stores, our exposure continues to be reduced. Moving forward, we will continue to focus on actions to improve our cost structure and maintain a low cost business model. As another component, preserving liquidity and financial flexibility in the current environment, we are temporarily suspending share repurchases, and the quarterly dividend.

We do not expect to repurchase shares in the near-term under the current repurchase authorization, which has a balance sheet of about $130 million remaining, and we’re temporarily suspending our cash dividend beginning with the second quarter of 2020. As business conditions related to the COVID-19 evolve, and as appropriate time, we will reevaluate our capital return program.

Next, we remain in a position to pursue numerous growth opportunities utilizing our global sourcing capability, expansive supply chain, and distribution network. Leveraging these key assets is at the core of our transformation to become a leading B2B distribution Company. These assets and capabilities are more important than ever during this crisis, and create an unique opportunity for our Company.

We have the ability to continue to source the essential product categories like cleaning and breakroom as well as supply such as toilet paper and paper towels. Additionally, we are working to expand our product capabilities in the areas of PPE, like protective masks, gloves and other gear critically needed during this pandemic as well as after the health crisis when businesses start to re-open.

We expect that PPE for employees will be essential for many businesses to operate going forward. Having a strong balance sheet and cash position, helps us tremendously as we work to procure some of these products for our customers. Next, as many of our enterprise customers have temporarily shifted to work in home environment, we will continue to focus efforts and help the customers remain operational in a distributed work environment.

This includes continuing to serve their work from home needs including technology, hallmark of supplies, office furniture and services to enable our customers who are working in an office facility to be effective at home. This temporary transition is causing a significant amount of disruption in the business environment.

However, our enterprise customers had the continued ability to purchase their business support needs through the respective current agreements. Instead of serving them at a central office, we are working to serve customers at their homes. And it’s not just product related support, it’s also technology services support or enterprises as they work to remain operational in this environment.

CompuCom’s technology support infrastructure and large field force is particularly suited to support distributed workforces. CompuCom’s performance in the early stages of this pandemic has proven their capability to quickly and efficiently support our customer needs and our efforts have garnered significant credibility from CIOs at a number of companies.

CompuCom’s focus on connecting people, technology and the edge with a seamless experience combined with a large field support team uniquely positions them to support the growing needs of customers in this distributed work environment, creating more long-term growth opportunities.

And lastly, we will remain focused on our accelerating B2B pivot and strategic plan and executing upon our Board approved holding Company reorganization directive. I believe our opportunities are evolving as we expand our value proposition to customers, sourcing and distributing a broader set of in-demand products and business support services.

We are uniquely positioned to support our customers in this challenging environment, and are focused on evolving our B2B platform and executing our pivot remains resolute. Summing all this up, we believe we are in a strong position to weather the storm and improve our business in the long run and we are ready to serve more customers as business operations resume to normal levels.

As you might expect, we have run a multitude of scenarios of varying degrees of possible impacts to revenue during this downturn. While I don’t plan to share the different scenarios because this is a dynamic situation, we believe that our strong financial position and cash conservation focus will be able to withstand even the most challenging economic and market conditions.

Moving to Slide 7, let me turn our attention to a few additional highlights with our business segments beginning with our BSD division. Our BSD division, the largest component of our B2B platform began the year with significant momentum, winning net new business and experienced relatively strong demand in traditional product and adjacency categories.

However, as I stated previously, the COVID-19 pandemic impacted revenues late in the quarter and the spread has continued to date in the second quarter. Demand for cleaning, home office and technology categories increased significantly during the quarter. Cleaning and breakroom supplies were up over 20%, and technology products were up over 10% resulting in adjacency category sales growing to 39% of total revenue.

However, traditional supply categories were lower in our contract channel related to the business disruption caused by the COVID-19 outbreak. Our e-commerce channel, continue to see increasing demand and we are working closely with our enterprise customers to support their work from home needs, delivering directly to residences as required.

Consequently, we are working to address the increasing costs related to the additional amount of residential deliveries that we have been required to make to serve our customers in this environment. Our supply chain has remained resilient despite the challenges to source additional essential pandemic related products, and continue to be a crucial source for our customers, including hospitals, medical facilities and health-care workers.

Our targeted growth remains intact, utilizing intelligent tools to improve our sales processes, drive sales efficiency, and enhance our value proposition. We are working to source additional products in the cleaning and breakroom category, which continues to be in very high demand.

And importantly, we’re working to source additional critical PPEs, [Technical Issues] masks and gloves, which we believe represent a very large opportunity for us now and in the future. Despite the challenges caused by the pandemic, we are building a significant amount of credibility with customers as we have been a consistent and dependable source of essential products and work in home support during this health crisis.

We are delivering to and supporting customers when others can’t, and our supply chain and sourcing capabilities has been consistent and many customers are taking notes. As I stated earlier, amid the crisis, our strategy is in effect [Phonetic] being fast forwarded, shining a bright light on the core of what we are all about, a B2B focused Company with expanded set of products and services backed by reliable supply chain and distribution network. We are looking forward to continue to support our customers through this process and expanding our value proposition for the future.

Our value proposition is expanding, and our customers are beginning to realize the breadth of products and services we have to offer. Now, let me turn to CompuCom on Slide 8. CompuCom has continued to execute upon its refocus strategy of connecting people, technology and the edge, and a seamless experience placing greater emphasis on its core offerings, expanding its value proposition.

We’re excited about the progress that Mick Slattery and his team are making, both in terms of improving operational performance and the continued progress in winning new business. With CompuCom’s expanding influence and visibility, they delivered another quarter of business wins in excess of $300 million in lifetime contract value including eight new logo customers.

While as I mentioned, CompuCom’s operational performance in the quarter was negatively impacted related to COVID-19 outbreak as some customers delayed near term project work, this impact was partially offset by increases in demand for new technology products like laptops and related equipments. That said, during the COVID-19 outbreak, CompuCom’s support and extra efforts enabled customers to remain operational as many companies pivoted to a work from home environment or experienced other challenges related to the pandemic.

We have received numerous accolades from the CIOs of many companies who have praised CompuCom for the significant efforts during the crisis. I would like to share a few examples of the type of support CompuCom is providing to put this into context for you.

CompuCom supported the migration of over 6,000 users to a work from home environment for a major power company in a matter of weeks. We partnered with a customer developed innovative solutions to ramp up our service desk, control desktop patching security and to service our control rooms through our dispatch team. A storm interrupted the power in the customer service area, and the customer is able to restore power using a remote workforce, something they had never done before.

Second, CompuCom supported the move of thousands of essential workers at one of the world’s largest pharmaceutical distribution firms to work from home environment over a three to four-week period. Third, we are also supported by the technology to quickly stand up COVID-19 testing center in Canada, and finally, we were crucial and supported a large grocery chain, added capability to maintain high reliability, and availability at point of sale systems and onsite support.

These are only a few examples, but it helps us illustrate the many ways that CompuCom is helping in supporting customers through this crisis. In fact, with the changing nature of work CompuCom’s unique capabilities to support distributed workforces with the state of art technology, and a rare unique field force of over 6,500 field techs and support personnel, have it well positioned to capitalize on opportunities in this growing area.

Now, let us move briefly to our retail business on Side 9. Our Retail division has done a heroic job during the pandemic. Working to safely serve increasing demand from our customers, and keeping our stores open. At the onset of the health crisis, our retail team quickly implemented safety measures and worked to keep our stores open and operational in order to continue to serve our customers.

The retail division was off to a good start in 2020 having recently made changes to its store operating model moving from a specialist to a generalist model, to reduce cost and increase the level of service. This change happened at the right time to help our service levels and drove improved cost efficiencies during the crisis.

Our total revenues were down versus last year related to the fewer stores in service. Demand in the quarter increased significantly for products such as cleaning and breakroom supplies, technology and Home Office products. This had a significantly positive impact to revenue, and helped to drive a 2% positive same-store comp relative to last year.

The curbside pickup option put in place at all of our locations was a popular choice as our buy online pickup in-store sales increased over 20% in the quarter. These positives taking together the strong execution of our business acceleration program and other cost measures helped us drive higher margins, leading to a 30% increase in operating income in the first quarter.

The tremendous effort by our retail team in serving customers under challenging circumstances have resulted in significant improvements in our Net Promoter Score as customer experience improved significantly. This is a true customer testament to the quality of services they have received during the pandemic.

While traffic trends were strong earlier in the quarter, not surprisingly, this trend reversed as stay at home orders were put in place and replenishment of essential supplies became more difficult. Likewise, revenue was negatively impacted late in the quarter and this trend has continued into the second quarter to date.

Moving forward, we will work to replenish essential supplies, support home office, and continue to service customers in the safest manner possible, and continue the safety measures we put in place. We will also continue to focus efforts to drive efficiencies and a low cost model in our retail business.

Our operating model change is one aspect of this approach. As I have mentioned in the past, we will continually evaluate the profitability and strategic value of each of our retail locations in order to optimize our footprint. We are expecting a higher number of store closures this year versus last year.

While this has a negative impact to our sales, these actions improve the vitality of our network and drive increases in profitability. With that, I will turn the call over to David for more details on our financial results.

David Centrella — Senior Vice President of Financial Planning and Analysis and Interim Finance Leader

Thank you, Gerry, and good morning everyone. I’m happy to be here today to discuss with you our financial results for the first quarter of 2020. Consistent with previous quarters, we have provided our results on both a GAAP basis and on an adjusted basis. My comments will primarily address our performance on an adjusted basis.

Total revenue of $2.7 billion in the first quarter was down 2% largely driven by lower sales in our retail division, related to fewer stores in service and lower sales in our CompuCom and BSD divisions, which were negatively impacted by the business conditions late in the first quarter related to the COVID-19 outbreak.

GAAP operating income in the first quarter was $80 million, up from $24 million last year. Included in operating income was $16 million in merger and restructuring charges, $8 million of which is associated with our business acceleration program.

We also recognized $12 million in asset impairments, mostly related to operating lease right-of-use assets associated with our retail store locations. Excluding these and other items, our adjusted operating income for the first quarter was $108 million, up 61% from $67 million in the prior year.

Unallocated corporate expenses were $22 million in the quarter, compared to $31 million in the prior year, reflecting lower professional fees and lower deferred compensation expenses. Adjusted EBITDA was $157 million for the quarter, up 33% compared to $118 million in the prior year.

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This includes depreciation and amortization expense of $49 million and $48 million in the first quarter of 2020 and 2019 respectively. Excluding the after tax impact from the items mentioned earlier, adjusted net income from continuing operations for the first quarter of 2020 was $66 million or $0.12 per share compared to $39 million or $0.07 per share in the prior year, an increase of $0.05 per share.

Cash generation in the quarter was very strong. We generated operating cash flow of $188 million which included $10 million of cash expenditures related to the business acceleration program. Capital expenditures in the quarter were $25 million compared to $46 million in the prior-year period, reflecting lower investment in our retail operations while continuing investments in our service platform, distribution network, and e-commerce capabilities.

Reported free cash flow was $163 million, adjusting for $10 million in cash expenditures related to the business acceleration program, adjusted free cash flow in the quarter was $173 million. Let’s now turn to Slide 12, which highlights our performance of our BSD division. As a reminder, BSD is the largest component of our B2B integrated distribution business, servicing customers from the Fortune 500 to small and medium-sized businesses.

Reported sales in the first quarter for BSD were $1.33 billion, a decrease of 1% compared to the prior year period. The year-over-year comparison reflects the impacts of the COVID-19 pandemic as well as the actions over the past year to reduce unprofitable sales in our contract and e-commerce channel. The COVID-19 outbreak caused the portion of our B2B customers to either pause operations or temporarily transition into a remote work environment.

As a result of restrictions imposed in March 2020 aimed to reduce the spread of COVID-19. This effect resulted in lower sales in our contract channel, partially offset by higher sales in our e-commerce channel as demand increased for certain essential products. These effects are continuing into the second quarter, negatively impacting revenue. Product sales in the first quarter of 2020 decreased 2% while service revenues increased 14% driven by increases in sales of our managed print and fulfillment services, copy and print services and shipping services compared to the prior year period.

These actions were partially mitigated by the positive impact of customer acquisitions, and growth in certain adjacency categories. For example, cleaning and breakroom and technology products were in high demand during the pandemic, helping to drive total adjacency category sales to 39% of total BSD sales.

Operating income was $40 million in the first quarter of 2020 compared to $46 million in the prior year period with flat comparable, operating margins. The decrease in operating income versus last year was related to the flow through effects of lower sales, product mix and higher distribution costs related to the COVID-19 impacts.

Higher distribution costs continue to be a challenge in the second quarter, as we’re making many more deliveries directly to residences instead of corporate offices. We are implementing strategies to address, including working with our distribution partners and evaluating delivery schedules and fees.

Looking to Slide 13, we highlight the performance of the CompuCom division. Sales in the first quarter for CompuCom were $235 million, down 5% versus the prior year period. The decrease was largely due to lower project related sales as a number of customers delayed projects in response to the COVID-19 outbreak as well as deliberate efforts to reduce or eliminate certain unprofitable sales and support activities to improve future profitability.

The CompuCom division reported operating income of $3 million in the first quarter of 2020 compared to an operating loss of $15 million in the prior year period.

BAP cost efficiency measures and other cost reduction efforts helped to drive the year-over-year increase. On a sequential basis, operating income was down as we incurred costs in anticipation of supporting new service contracts as well as supporting new project related work in the quarter that did not materialize due to the business disruption caused by the COVID-19 outbreak.

As Gerry addressed earlier, CompuCom’s support for its customers during this pandemic has been stellar. Combined with their core competency in supporting enterprises in a distributed environment, we believe that CompuCom is in an excellent position to capture future profitable growth.

Turning to slide 14, reported sales in the quarter for our retail division declined 2% to $1.16 billion. The decline in sales was related to the impact of store closures over the past 12 months as we had 64 fewer stores compared to a year ago. While product sales were flat, sales of services were down about 11% as copy and print services and subscription offerings were negatively impacted by the effects related to the COVID-19 pandemic.

These impacts were offset by increases in demand for essential products during the early phases of the COVID-19 outbreak, helping drive a 2% increase in same-store sales relative to the same period last year. Higher average order volumes and a 26% increase in BOPIS sales added to this performance. The retail division reported operating income of $87 million in the first quarter, up 30% over the same period last year. As a percentage of sales, this represents a 180 basis point improvement in margins.

The increase in operating income versus the prior year reflects higher gross margins, lower SG&A from cost efficiency initiatives and an improvement in distribution and inventory management costs. Turning to the balance sheet and cash flow highlights on slide 15, we ended the quarter with total liquidity of over $1.7 billion, consisting of $842 million in cash and cash equivalents and $851 million of availability under our asset-based lending facility.

Total debt at the end of the quarter was approximately $652 million resulting in a positive net cash position of $190 million, our highest net cash position in two years. As we previously announced, subsequent to the quarter end, we successfully refinanced our asset-based credit facility with a new five-year agreement and retired our term loan credit agreement due to 2022.

Our new $1.3 billion asset-based credit facility matures in April 2025 and replaces our previous credit facility that was due to expire in May 2021. Upon closing of this transaction, we borrowed a total of $400 million under the new credit facility. We used these proceeds along with available cash on hand to repay the remaining $388 million balance on the term loan and approximately $66 million in other debt.

By eliminating the term loan, we expect to eliminate approximately $14 million in annual interest expense, and $75 million in required annual amortization payments. We are happy to report that the new credit facility was significantly oversubscribed with strong lender support and provides us with substantial financial flexibility to continue the Company’s transformation efforts.

Moving to cash flow, for the first quarter, cash provided by operating activities was $188 million which included $10 million in restructuring costs and $4 million in acquisition and integration-related costs. This compares to the cash provided by operating activities of $67 million in the first quarter of the prior year.

Capital expenditures in the quarter were $25 million versus $46 million in the prior year, reflecting lower investments in retail operations, while continuing investments in our service platform, distribution network, and e-commerce capabilities. The cash charges associated with our business acceleration program in the quarter were $10 million.

Accordingly, adjusted free cash flow was $173 million in the first quarter of 2020. On slide 16, we highlighted our balanced approach to capital allocation. Our priorities in the quarter were focused on investing in our business, including our business acceleration program, servicing dividends, expanding our distribution network, paying down debt and selectively executing share buybacks.

During the quarter, we generated $188 million in operating cash flow. After considering the $25 million in capital investments to further strengthen our B2B platform, as well as significant cash investments in our business acceleration program, we bought back $30 million of our shares, paid $13 million in dividends, paid down $19 million in debt and invested $18 million in high quality acquisitions.

Moving forward in the current environment, we will remain focused on preserving liquidity and maintaining financial flexibility. In support of this focus, we have temporarily suspended our stock buyback program and our quarterly dividend, beginning in the second quarter, and we’ll reevaluate these programs when appropriate.

Overall, we delivered strong operating results in the quarter and our team remains committed to creating value for our shareholders and building upon our B2B platform. With that, I’ll now turn the call back over to Gerry.

Gerry P. Smith — Chief Executive Officer

Thanks, David. As you heard today, our team delivered very strong results during the onset of the global pandemic that has gripped the nation and the world. I can’t thank our team enough for their dedication and efforts during this health crisis to ensure we remain operational and serving our customers. It is evident that we’re heading into a more challenging period related to the effects for this outbreak, which we expect will negatively impact revenue and operating results in the near-term.

And that said, we believe we are in an excellent position to weather the storm and even become a stronger Company when the crisis is over. We have a strong balance sheet and liquidity position. Our global sourcing and B2B supply chain remains resilient and reliable source of essential products, and our tech support capabilities help enable customers to work and learn remotely. As I mentioned earlier, despite the near term headwinds caused by this pandemic, we are experiencing an acceleration of the strategic pivot we embarked upon three years ago to become a leading B2B provider of business products and services.

Customers are beginning to recognize the power and consistency of our global supply chain and distribution capabilities as well as an expanded set of products and services we have to offer. Given the current environment, we’ve adopted a more conservative approach to our capital return program, to preserve maximum liquidity and financial flexibility.

As you heard, we have temporarily suspended our share repurchases and our quarterly dividend, beginning in the second quarter of 2020. We will reevaluate our capital return programs when appropriate. We will also continue to take actions to support our low cost business model with a focus to drive additional efficiencies and cost structure improvements throughout our entire business.

This supports our belief that the low cost model wins. Finally, we remain committed in our strategy and working to implement the Board approved holding Company reorganization plan which we expected to complete by the middle of this year.

And again, thanks to all who have joined us on the call today. Operator, we will now turn the call over for questions.

Questions and Answers:

Operator

[Operator Instructions]. Our first question comes from the line of Chris McGinnis. Please state your company name and proceed with your question.

Christopher McGinnis — Sidoti & Company, LLC. — Analyst

Good morning. Chris McGinnis from Sidoti & Company. Thanks for taking my questions and hope all is well with your families given the environment. Maybe can you start out with some of the commentary around the current environment accelerating the B2B pivot and I guess how sustainable do you think it is, and how do you think the environment changes on the B2B side going forward, given the pandemic?

Gerry P. Smith — Chief Executive Officer

Right. Hi, thanks Chris. And Chris, thanks for all your work you did on our coverage. We really appreciate that. So Chris, I think if I look at it from an overall environment obviously and as we’ve said, guidance is very hard to predict. We’re encouraged by — I’d say three or four key things, number one, we have the opportunity of these new categories and we’re excited with the opportunities of PPE in some of the cleaning and breakroom growth, technology growth we’ve seen. We’ve focused on those, but adding these new categories have been a very important. Really pleased with our cash position, because it’s allowing us to source some of these products right now, and obviously cash is important during that, especially in the PPE category.

I think I want to call out especially our supply chain, and how reliable and dependable it is, and I think that helps us on our B2B pivot. I think that our sales team has done an incredible job, Steven and his team of selling into the categories. I really think our sales engines are getting stronger. And I think as we push the low cost model, and have more of a variable model across our business, I think the ability to support the B2B business has been accelerated.

But I’ve always said from the beginning, we want to be a platform that sells B2B products and services and I think this has helped highlight how we can do that. And John Gannfors and his supply chain team with Stephen Mohan and the whole organization has done a great job of showing that in our B2B business. And obviously we’re going to lean in hard to ensure that we continue to do that going forward, and I can say, we also have our retail teams support in terms of small and medium business out there as well. Kevin and his team has done an incredible job, and our online business has been extremely strong. I think a lot of that small and medium business that needs product in our supply chain can deliver, and Jami and the team have done great.

So we’re very well positioned for the B2B pivot, and I think it’s — that’s what we’ve been trying to strive forward and this is a very challenging time where we’re taking our strategies lined up and we’re executing well across that.

Christopher McGinnis — Sidoti & Company, LLC. — Analyst

Great. And just I guess to touch on one piece of what you’re talking about. That — the strength of the balance sheet, the ability to source products, given I would imagine financial constraints around some of your competitors within that market, how are you maybe changing your go-to-market strategy to capitalize on — on that opportunities?

Gerry P. Smith — Chief Executive Officer

Well, we’re using our cash, obviously we’re conserving cash wisely. But we’re also using our cash to go source those products as our customers have a big demand for that, and we’re listening to our customers and giving them the essential products and services that they need. And I think again being conservative with our balance sheet and our cash position for the last couple of years has helped us be in this position.

Obviously, you saw some of the actions we are doing to further accelerate that. But I think we’re in a very good position to go off and improvise those products for our customers, and I won’t comment on our competitors, but it’s good to be in this position.

Christopher McGinnis — Sidoti & Company, LLC. — Analyst

Fair enough. Thanks for taking my question. Good luck and take care.

Gerry P. Smith — Chief Executive Officer

Thank you. Chris, appreciate it. Look forward to meet you in one of these days.

Operator

Your next question comes from the line of Liz Suzuki. Please state your company name and proceed with your question.

Elizabeth L. Suzuki — Bank of America Merrill Lynch — Analyst

Great. Hi guys. Liz Suzuki from Bank of America. Can you just talk about the impact to operating margin from COVID versus BAP? In other words, how much of the savings from BAP are offset by costs and/or deleverage associated with COVID?

David Centrella — Senior Vice President of Financial Planning and Analysis and Interim Finance Leader

Yeah. Hi Liz, it’s David. Yes. So when we think about the BAP program, we saw a significant improvement in our SG&A expense line item from that consistent with what we’ve seen in previous quarters. What we experienced from COVID-19 on gross margins was a little bit of pressure as a result of product mix shift, out of some of our core supply categories into, what I’d call slightly lower margin in cleaning and breakroom and PPE.

Also Read:  TransAlta Corp (TAC) Q3 2020 Earnings Call Transcript

Elizabeth L. Suzuki — Bank of America Merrill Lynch — Analyst

Okay, great. So more of a gross margin impact than necessarily SG&A.

David Centrella — Senior Vice President of Financial Planning and Analysis and Interim Finance Leader

That’s correct.

Elizabeth L. Suzuki — Bank of America Merrill Lynch — Analyst

Okay. And as we start — as we model out our second quarter, you mentioned that B2B is experiencing lower revenue trends in the Q2 ’20 and retail is experiencing reduced traffic and lower revenue expected in the second quarter. Is that, when you say lower, is that quarter-over-quarter or year-over-year and how much lower are we thinking about just directionally?

David Centrella — Senior Vice President of Financial Planning and Analysis and Interim Finance Leader

Obviously, we’re like — we can’t give specifics on that, but we clearly talked about the fact that there was challenges in the last half of March and early in April, and I think it all depends Liz on what happens from a reopening perspective. And why it’s so hard to predict and I wish I could is, we don’t know how quickly all the states are different — and we’re looking at actually literally every state, every jurisdiction. So we’re going to monitor closely. I think the most important thing is, is to make sure we have the right business model in place, which we think we do, drive low cost model keep our cash position well.

And we’re going to lean into these categories, like we talked about, even though some of the margin levels aren’t as high as some of our core categories, driving growth in those are important, because obviously bringing gross margin dollars and growth in the business is what we strive for, and having a whole basket of products we sell to our B2B customers whether it’s — whether they are small, whether they’re medium, whether they’re large enterprise customers.

And to be honest with you, also driving CompuCom in those business as well, and we’re pleased with the fact that CompuCom is very well positioned for this new work from home, learn from home environment.

Elizabeth L. Suzuki — Bank of America Merrill Lynch — Analyst

Okay, great. And if you don’t mind, if I can squeeze one more in. I mean are you finding that any of your small and medium business customers are pulling back significantly on spending or on their — have re-negs on any contracts that were already in place or have any of your customers been driven out of business?

David Centrella — Senior Vice President of Financial Planning and Analysis and Interim Finance Leader

Well, we have over 10 million customers across from a B2B perspective. So clearly, there’s been some customers who have been impacted. But we are here to support our customers. We obviously, we’re listening to their needs, and there is a lot of need to have a dependable reliable supply chain, which we have. There’s a lot of need to, hey office people give us more, give us broader range of products and services, which we’re outsourcing and creating, which I think was — listen, my whole — [Indecipherable] message, it is actually accelerating our strategy of being a broader provider of products and services.

And as they come up and the economy reopens and they get opportunities, we’re going to be there for them with, whether it’s our traditional products, whether it’s our — whether it’s Tech or furniture or cleaning and breakroom, whether it’s PPE or whatever other categories they need, we’re here to support them, because we have that backbone of the stores, the online business, CompuCom as well as our supply chain and sales force.

Elizabeth L. Suzuki — Bank of America Merrill Lynch — Analyst

Okay, great. Thank you.

David Centrella — Senior Vice President of Financial Planning and Analysis and Interim Finance Leader

Thank you, Liz.

Operator

Your next question comes from the line of William Kafoure [Phonetic]. Please state your company name and proceed with your question.

William Kafoure — Elevation — Analyst

Hi, this is William Kafoure from Elevation. I appreciate the commentary on the variable cost model. I wonder if you give a bit more color on how we should think about kind of the fixed versus variable cost structure in BSD?

Gerry P. Smith — Chief Executive Officer

Well, this again this is really highlighted the importance of being and having a variable cost of business. And from the day one, I’ve joined here, I’ve had this decision to driving us to be a B2B Company, and the more we can pivot towards, you’ve heard me use low cost model, many, many, many times. I’ll continue to do that. We’re going to continue to try to grow the B2B business but always look for ways to get to a variable cost model because that’s how you survive ups and downs over periods of times. To be honest, that’s how you get competitive and more competitive from an operating — operating entity perspective as well as giving customers a better value.

So throughout the year, we’re going to constantly look at ways to optimize cost, and look for ways to always be most efficient whether it’s remotely helping companies work remotely whether it’s learn from home. We’re going to go after all those and look for ways to do that.

Dave, why don’t you jump in here as well?

David Centrella — Senior Vice President of Financial Planning and Analysis and Interim Finance Leader

Yeah. Will, and I would add to that that if you recall last year we implemented [Technical Issues]acceleration program which was directly to address some of our fixed cost challenges. And so what you see in our SG&A line is the benefit of having gotten ahead of that a little bit and we’ll continue to monitor our variable expenses as we transition through this period. And look to long-term challenges with fixed cost, we’ll address those as we go, but to Gerry’s point, as we transition to a B2B business, we’ll continue to transition to a more variable business.

William Kafoure — Elevation — Analyst

Got it. Thank you.

Operator

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

Christopher Horvers — J.P. Morgan — Analyst

Thanks, good morning. J.P. Morgan. So I just want to ask questions on trying to peel back on what the organic trend was prior to COVID, because it has a lot of puts and takes in terms of benefiting some businesses and hurting some other product categories.

So first on BSD, can you talk about what the organic trend was prior to mid-March and to what degree acquisitions benefited sales overall on the quarter? And then second, similarly, can you talk about what the retail comp was prior to mid March? Obviously the tech sales and cleaning and breakroom benefited on the last two weeks. Just trying to get a sense of what it looked like prior to that.

Gerry P. Smith — Chief Executive Officer

Yeah, Chris, what I would tell you is that on the B2B side, if you recall, we came out of Q4 with a little bit, down 2% and coming into Q1, we saw improving trends, our B2B business was starting to see some — some signs of improvement. Certainly, as we progress through the quarter, we were fortunate enough to kind of get into some of the cleaning and breakroom products a little heavier, as we were preparing for back-to-business and so we were able to kind of leverage some of the initial volumes that came in for due to the pandemic. But certainly saw improving trend throughout the business.

And I would say that from an acquisition standpoint, you can probably say 100 basis points, 150 basis points of our performance was driven by acquisitions.

David Centrella — Senior Vice President of Financial Planning and Analysis and Interim Finance Leader

Yeah, and on the retail side, we’ve actually saw strength throughout February and early March, as we said in the script, obviously in the last couple of weeks as more — more and more counties and cities and states were under stricter stay-at-home orders and we saw an impact. But because the fact people needed some of the adjacency products like cleaning and breakroom and tech and furniture, that’s what drove the robustness, and it wasn’t the last two weeks of March, it was actually February and early March that we saw this demand, and as people started to shift to work at home, and again one of the highlight we’ve had really, really strong success with our online business. And I think we’re fulfilling a lot of people’s demands of products and needs through that. I can’t give specific on that, obviously for competitive reasons on the retail comp, but as — we believe as the economy reopens, and again, we don’t know when that is, we’re going to be ready and well positioned to ensure we continue to give them those essential products and services.

Christopher Horvers — J.P. Morgan — Analyst

Got it. And then, two questions on, just on the corporate structure side, can you talk about what the benefit is of operating as a holding company? And then secondly also announced the poison pill this morning, so I understand it’s — you’re proactively giving what the stock market gyrations, but in the — it is only one year, and then, but on the other hand your stock price has been around this level over the past year, maybe not as low as the depths of March.

So, to comment on that as well, please. Thank you.

Gerry P. Smith — Chief Executive Officer

Well, on the holding company, obviously we wanted to simplify the legal and tax structure of the Company. I think it was important that, that happened, and David Bleisch and his team have done an amazing job doing that. And we also wanted to improve the alignment of the operating assets with the respective operating channels. And I think the third piece, I think it’s super important, it gives us a lot more operational flexibility in the future. And I think that that’s important for us, that’s from the holding company, reorganization. And again as we said, we were pushing to have this completed by middle of this year.

From the pill perspective, obviously that’s something to ensure that we want to ensure our shareholder value is maintained. And we think over a period of time that the market will recognize that value. We thought that was an important thing to do, and that was strategic for the Company.

Christopher Horvers — J.P. Morgan — Analyst

Thanks very much.

Operator

And our final question comes from Michael Lasser. Please state your company name. Then proceed with your question.

Michael Lasser — UBS — Analyst

Good morning. Thanks a lot for taking my question, it’s UBS. Gerry, if one of the enduring legacies coming out of this situation is that white-collar workers, work from home more often, is it that a net negative for the office supply industry?

Gerry P. Smith — Chief Executive Officer

I don’t think it is at all [Phonetic], firstly, I mean that’s if you define yourself narrowly, I think the way we’re defining ourself is a traditional just a pure paper and ink type of Company. We’re super excited with the tech, the furniture, the other categories that were seeing a very strong year-over-year growth rates in. And to be honest with you, the CompuCom business is perfectly positioned to provide services for people to connect technology, people, technology and the edge. And as we say in a seamless experience. We’re going to need more and more of that. I’m so proud of our CompuCom team, our India and Mexico city sites went to work from home almost immediately. And they did it flawlessly and they were able to provide tons of enterprise customers — excuse me, that the technical services they need to make that transition.

And I think over a period of time, we can be that Company that can be out there and continue to support those companies. I’ve been working from home, as well as lot of the leadership team, and I’m printing surprisingly more than I thought it would. And obviously as you work on things and I think the efficiency and productivity we’re seeing from work for home is something we’re going to lean into and we think is going to actually be helpful for us longer term. As companies will need their employees to have access to the right products and services to make them effective, we can provide those products for them across many categories.

And, have a supply chain that can deliver to them through their homes, whether it’s still a small business. And we have the ability to deliver next day to 99% of the zip codes in United States. Very few people have that capability.

Michael Lasser — UBS — Analyst

Few more quick ones. When should we expect to see positive sales growth from the CompuCom division?

Gerry P. Smith — Chief Executive Officer

Well, I think, Mick and his team have done a tremendous job of getting the right cost structure in place, getting the right strategy in place, getting the right offerings in place. I think obviously as we get through some of this COVID-type of responses and as we said in the script, we — they had a lot of — they had over $300 million in new lifetime value bookings, they had eight new logo wins. I think as we see get some of the project business back up on track, I’m confident sometime in the future Mick and his team will be able to drive — to be able to drive growth, and obviously our profitability this quarter, this year versus last year is significantly different. I think that shows and we had a couple of really good quarters of position here. So we’re getting our cost structure right.

We’ve got the right team in place, we’ve got the right strategy announced, a matter of executing and obviously getting the economic conditions more positive over a period of time.

Michael Lasser — UBS — Analyst

Two last one, can you quantify what sales have done in April, so we can calibrate our models accordingly? And then —

Gerry P. Smith — Chief Executive Officer

No.

Michael Lasser — UBS — Analyst

Okay. And then…[Speech Overlap]

Gerry P. Smith — Chief Executive Officer

I mean, if I could predict economic activity, we would do that. I mean it’s extremely challenging. We want to make sure we’re credible. We’re literally watching it every single day, and we’re seeing, we’re across all of our routes to market and we’re making investments to make sure we have the right sort of resourcing [Phonetic] products to our customers and we’re doing our best to make sure we’re bringing the strengths of our business to our customer base.

And obviously we — our prayers and for all our — and our thoughts are with all our customers in the country and we never want to be safe and healthy and we’re doing our best to make sure we deliver that from a — if we can bring the right products to customers to help them, we’re going to go off and go do that.

Michael Lasser — UBS — Analyst

Last quick question, a lower operating lease costs due to the newer lease accounting standard was a driver of the profit improvement and retail business, how much did that change [Phonetic] for you during the quarter?

Gerry P. Smith — Chief Executive Officer

Yeah, that was less than $5 million. So very immaterial.

Michael Lasser — UBS — Analyst

Understood. Thank you very much and good luck.

Gerry P. Smith — Chief Executive Officer

Thank you. [Speech Overlap] All right. I wanted to thank everyone for joining us on the call. Most importantly, please stay safe and healthy, and we look forward to talk in the next quarter. And thank you very much.

Operator

[Operator Closing Remarks]

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