Saligram searching for margin

Report on OfficeMax's Q2 conference call as CEO Ravi Saligram says he is "laser focused" on margin improvements.

OfficeMax CEO Ravi Saligram says he is “laser focused” on improving gross margins at the big box reseller as the prospects for near-term top-line growth remain slim.
 
The markets initially reacted favourably to ‘Max’s second quarter results yesterday, the company’s share price soaring by over 20% in early trading, before sliding back to end the day only 4% up on the back of fresh concerns about the US economy.
 
 This lack of economic tailwinds certainly appears to be hitting ‘Max and its power channel peers. Top-line growth has proved to be frustratingly elusive for some time now. To what extent this is down to the economy, a secular decline in the traditional office products channel or to their own operating deficiencies is a matter of debate, but reports from independent dealers and the results of the main wholesalers suggest that there is growth to be had.
 
Turning back to ‘Max’s results and yesterday’s conference call, it’s clear that most of the headline numbers were in negative territory.
 
US same-store retail sales were down 2.3%, US contract sales fell by 2.6% and international contract sales declined 5.5%. The only pocket of top-line growth was in Mexico where same-store sales were up 17%.
 
The performance in Australasia and Canada was described as “disappointing”, as was the 5.4% decline in sales to existing customers in the US contract unit.
 
In retail, most product categories showed year-on-year declines, including the largest ink and toner category which fell in the low single digits in line with recent data from POS tracking data from NPD.
 
Even the ImPress print and document services offering was only slightly up, whereas larger gains might have been expected.
 
Drilling down a bit further into the two segments, there was a smattering of positive news amongst the overall declines, which Saligram was keen to highlight in yesterday’s call.
 
Contract
 
·    The US decline of 2.6% was less than in the first quarter, representing a sequential improvement of 50%
 
·    The net number of customer wins versus losses was positive for the first time in 12 months
 
·    The customer retention rate of over 92% was the highest since tracking began in 2007
 
·    Excluding the federal government, sales were up in two of ‘Max’s three geographic regions in the US
 
·    The situation improved at the underperforming East region
 
·    There was double-digit growth in the furniture category, including Workspace Solutions
 
·    A new President of the Contract division is expected to be named by the end of this month
 
Retail
 
·    There was a sharp decline in customer service issues compared to the first quarter
 
·    Product and services attach rates were better
 
·    Retail gross margin increased by 0.4%, boosted by improved product margins, more private label products and better mix
 
·    An expanded technology offering has been rolled out in a number of stores
 
·    The CtrlCenter tech services offering is now in more than 200 stores and is expected to be in all US stores by the end of the year
 
·    E-commerce sales on officemax.com increased in the double digits
 
·    The appointment of Michael Lewis as President, Retail – his initial focus will be on improving store productivity and addressing the issue of optimal store size
 
 
Nevertheless, ‘Max is not expecting its third quarter sales to be higher than last year. July comps in the US were worse sequentially than the second quarter percentage declines and it revealed that back-to-school is trending down compared to 2010.
 
In this environment, Saligram is being forced to look at ways of reducing costs, and he announced a number of changes.
 
The Canadian sales team is being restructured, and call centre and some finance functions in Australia have been consolidated into existing operations in New Zealand.
 
Three customer fulfilment centres in the US – Carlstadt (NJ), Houston (TX) and Nashville (TN) – are to close.
 
Presumably, retail store productivity improvements will also lead to some job reductions.
 
Saligram was adamant that he would not allow any “muscle” to be cut from the company and that any changes and cuts had to be sustainable.
 
However, one wonders how much more can be achieved in meaningful savings following five years in turnaround mode. Perhaps the time has finally come to generate some cash by offloading the international business – at least in Australia and New Zealand – and to focus on operations closer to home.
 
Saligram said that details of OfficeMax’s go-forward strategy would be revealed late in the autumn, referring to “course corrections” in the five-year plan that former CEO Sam Duncan unveiled in March 2010.
 
That plan had targeted 2014 as the date for a return to peak operating income margins of 3.8% (achieved in 2007) on the back of mid-single-digit sales growth.
 
The ‘Max CEO said yesterday that the margin target of 3.8% has been pushed back a year to 2015.
 
With no visibility on when a return to top-line growth could happen, one wonders what his strategy will be.
 
Part of it will surely be a close control on capital expenditures. The 2010 plan had called for $200 million in investments in the first two years. Saligram has already kicked that idea into touch with what he calls a ‘pay-as-you-go’ investment strategy that will see CapEx restricted to $75 million this year.
 
It is likely that other parts of the strategy will include ‘new channels’ (the store-in-store initiative), improving e-commerce, a greater focus on services such as copy and print, managed print services and tech services, increased private label penetration and a focus on small business customers.
 
There’s nothing new there, so it will be interesting to see what changes Saligram brings to the table with the new management team which will have had a chance to ‘bed in’ by then.