OfficeMax, Inc. Q1 2009 Earnings Call Transcript

| About: OfficeMax Incorporated (OMX)

OfficeMax, Inc. (NYSE:OMX)

Q1 2009 Earnings Call

April 30, 2009 9:00 am ET


Tony Guiliano – Vice President, Treasurer and Investor Relations

Sam Duncan – Chairman, President and Chief Executive Officer

Sam Martin – Executive Vice President, Chief Operating Officer

Bruce Besanko – Chief Financial Officer


Matthew Fassler – Goldman Sachs

Kate McShane – Citi Investment Research

Mike Baker – Deutsche Bank

Chris Horvers – JP Morgan

Anthony Chukumba – FTN Midwest

Stephen Chick – FBR


Welcome everyone to the OfficeMax first quarter 2009 earnings conference call. (Operator instructions) It is now my please to introduce to you Tony Guiliano, Vice President, Treasurer and Investor Relations of OfficeMax, Inc. Mr. Guiliano you may begin your conference.

Tony Guiliano

Good morning everyone and thanks for joining us today. I am here with Sam Duncan, our Chairman and CEO; Sam Martin, our Chief Operating Officer and Bruce Besanko, our Chief Financial Officer.

Before I turn the call over to Sam Duncan I have a few administrative items. Today’s conference call will be archived on our website for one year following the call. Note that this broadcast cannot be rebroadcast without prior written consent from OfficeMax.

Certain statements made on this call and other written or oral statements made by or on behalf of the company constitute forward-looking statements within the meaning of the federal securities laws, including statements regarding the company's future performance as well as management's expectations, beliefs, intentions, plans, estimates or projections relating to the future. Management believes that these forward-looking statements are reasonable.

However, the company cannot guarantee future events will not impact the company's access to cash or the funds available under its revolving credit facility, or that its actual results will be consistent with these forward-looking statements, and you should not place undue reliance on them.

These statements are based on current expectations and speak only as of the date they are made. The company undertakes no obligation to publicly update or revise any forward-looking statement whether as a result of future events, new information or otherwise. Important factors regarding the company which may cause results to differ from expectations are included in the company's Annual Report on Form 10K for the year ended December 27, 2008 under Item 1A, Risk Factors and in the company's other filings with the SEC.

It is now my pleasure to turn the call over to Sam Duncan, Chairman and CEO of OfficeMax.

Sam Duncan

Thanks and good morning everyone. On today's call, I'll review our performance and Sam Martin, our Chief Operating Officer, will discuss our first quarter operating segment performance and current initiatives. Then Bruce Besanko, our Chief Financial Officer, will review financial details.

As we discuss our performance and outlook today you will hear that our hard work is paying off and that we are making progress on multiple fronts. We are committed to placing OfficeMax in a stronger position for when the macro economy and industry trends improve.

We continued efforts to cut costs and improve our business that helped offset anticipated sales challenges. Although total sales declined 17% in the first quarter we recorded operating income of $27 million and net income of $13 million or $0.17 per diluted share. Excluding the certain charges and income described on this morning’s press release, adjusted operating income was $37 million and adjusted net income was $17 million or $0.23 per diluted share. The macro economy remains challenging and some indicators such as white collar employment and overall demand for discretionary products are still showing signs of weakening.

However, we believe our areas of focus and the actions we have been taking to improve our operations significantly benefited our company’s performance this quarter. Sam will discuss the initiatives we are executing to continue making progress on three key areas of focus in 2009 which are growth, differentiation and productivity.

However, let me discuss briefly how we view these areas.

First with respect to disciplined growth we intend to be very strategic. Please understand we do not plan to chase new store openings and will in fact have a net reduction in stores for the year. Instead, we will seek innovative opportunities similar to the partnership we have with Safeway. This is a great example of how we can open new doors to drive incremental sales through our retail channel without the investment in brick and mortar.

We are also investing in our B2B sales force and continuing to target customer expansion particularly in the large and middle market businesses. We focused on offering our corporate customers total solutions with effective tools to manage their costs beyond traditional office supplies including furniture, technology and digital print. With this in mind we have also maintained our prudent promotional stance across our businesses and have not attempted to capture growth at the expense of margin.

Our second area of focus is differentiation. We are offering products that enable us to stand out in a crowded market place and appeal to our core customers. From a merchandise perspective we have found that a unique fashion core assortment that offers every day value is a compelling and timely proposition for our customers, more than 70% of whom are women. Not surprisingly our customers are being more economical on their purchases and while they are doing more research before buying they also want convenience.

Fortunately OfficeMax is well positioned to address this consumer behavior. It is part of the strategy we have been executing over the past couple of years. We continuously seek to offer an unmatched breadth of services as well as every day value products that allow us to protect our profit margins. We are simply pursuing this strategy more aggressively, finding new ways to work with customers and making our value proposition more prominent.

The more business customers do with us the more they save and customers are responding well to our offering in this challenging environment. We want to inspire our contract and retail customers and ensure they are completely satisfied no matter how they are shopping with us in our stores, through our catalogs or our refreshed website.

Finally, productivity is our third area of focus and where we have seen the most progress to date as we seek to maximize our resources. In line with this we have proactively taken steps to preserve capital because we believe this is an important factor in determining which retailers will be best positioned coming out of this downturn.

Ultimately we will do everything necessary to reduce costs in this reduced sales environment without sacrificing customer service levels. We have been making tough but necessary decisions in order to remain profitable and to continue to generate cash. As you know, over the past year we have suspended our dividend, reduced our investment in real estate, lowered payroll across the organization and tightly controlled discretionary spending. We have also made substantial progress in our efforts to streamline our operations and centralize decision making.

For example, we have continued to improve supply chain metrics related to cost to serve and inventory productivity and availability. You will hear more of this later in the call.

Overall, I am pleased with the progress that our teams have been making on these three areas of focus that I just discussed. I will return after Sam and Bruce’s remarks to discuss our additional thoughts on the near-term outlook.

Now I will turn it over to Sam Martin to review our contract and retail operating segment performance.

Sam Martin

Thanks Sam. Good morning everyone. We believe that economic issues continued to weigh heavily on the demand for products and services across our business during the first quarter and this has partially masked the substantial progress that we have made. The impact from our reduced sales in Q1 caused continued de-leveraging of fixed costs in both contract and retail. However, we have been taking appropriate actions to maintain profitability and have been very successful in taking significant costs out of the business while keeping an eye on the future.

As Sam mentioned we are confident that our current areas of focus which are centered on growth, differentiation and productivity, are positioning us for long-term success. Sales in our U.S. contract business account for almost ¾ of our contract segment were down about 19% in the first quarter compared to last year. This is primarily due to the decline of nearly 16% in recurring sales from existing customers as employment levels continue to trend down and customers change their spending behavior.

Not only do we see customers spending less, they have changed their purchasing patterns and are buying more on-contract items including paper which means a larger portion of lower margin consumables as well as fewer discretionary items such as furniture. Another key factor in the decline is that sales from new customers in the first quarter were less than sales from lost customers in the first quarter of 2008. This reflects the impact of the weak economy but also our disciplined approach to customer acquisition and renewals since the middle of 2007.

With that said we are pleased with recent trends in customer acquisition. For the last two quarters we believe we have won more large national accounts than we have lost and we have not compromised our profitability thresholds. However, it generally takes more than a few months to fully ramp up account spending. We are confident in the quality of our offering to customers and we are excited about the progress we are making in customer acquisition.

In this economy sales performance in our three vertical markets; healthcare, higher education and federal government has modestly out performed the remainder of the contract business. Each of these vertical markets continues to be a successful area of focus for us that meets our profitability thresholds. We also continue to win contract business through our global alliance with Lyreco which we established last fall.

Total account wins with our joint bidding with Lyreco has reached the low double digits. We are excited about our healthy pipeline of potential business. Overall we are encouraged that new customers of every size continue to sign up with us and we continue to compete effectively against all our major competitors. In many cases these customers have told us they find our total solutions approach very compelling.

As you will recall, our total solutions approach to selling is all about deepening and expanding our relationship with our customers. This helps us to differentiate our offering as we seek to address lower customer spend in this environment. The idea is to collaborate with customers and maximize their office supply savings with OfficeMax through analytics. This value proposition then opens the door to approach the customer with related spend categories as well as non-traditional areas in which we have expertise such as managed print and data center services.

We believe that a deeper business relationship results in better retention. One example of our success in total solutions is with our customer, Young Brands. Our relationship with Young has evolved from basic office supplies procurement into a broader solution which includes managed print services. Print is not a core activity for Young and they viewed OfficeMax as having a best-in-class solution that met their needs.

Other categories where OfficeMax has expanded its relationship with Young include certain data center services and other supply categories not originally priced with OfficeMax. Currently less than half of our business with the Young brand is traditional office supply procurement.

We also continue to make good progress with our contract middle market task force. Some actions that have resulted from work done by our task force include our refreshed catalog which has received very positive feedback from a large base of customers.

Second, adding about 50 new tele-sales positions as well as testing our four robust middle market sales models this year. Based on results measured in these four models we plan to implement the best practices in 2010. Our goal with this task force is to understand how to successfully gain share in the attractive middle market.

Another bright spot is the positive sales trend from which is shopped primarily by small business customers and consumers. We enhanced this website in March based on customer feedback. Early trends on sales, conversion rate and transaction size are encouraging. We believe we can realize a higher return on investment from online marketing as visitors now enjoy easier browsing and faster checkout.

Turning now to our retail segment, same store sales declined 12.7%. Store traffic and average ticket are down due to the weaker economic environment. While all three major product categories comped down the technology category continued to show relative strength, down in the high single digits.

Control center, our 24/7 PC tech support service offering was a high growth category albeit growing off a small base. Ink and toner, another sub-category of technology comped down low single digits.

In late March we made some significant changes nationally to our in-store marketing in an effort to stimulate buying and increase average ticket. Our retail stores have always offered value but as Sam mentioned we are finding this message must be even better articulated than before and we must find new ways to showcase value while continuing to protect margin.

We continue to be prudent in our promotional investment during the quarter to preserve gross margin where possible. We have also focused on maintaining very strong relationships with our vendors and they are working harder than ever with us during this difficult time to drive sales volume that meets our profitability threshold.

Touching on our real estate, in the first quarter we reduced our store count for the first time in three years to end the quarter at 1,020 stores. In the U.S. we opened and closed six stores to remain at 939. In Mexico we closed two to end the quarter with 81. For the full-year 2009 we are committed to opening up to 12 stores and expect to close between 15-25.

Across all our stores we continue to execute more efficiently due to new tools we have put in place to enable better centralized management of operations. These include the activity dashboard calendar that we mentioned on last quarter’s call. We are closely monitoring under performing stores, operating them differently by pulling various levers such as advertising and stocking.

Our average remaining lease term for our domestic stores is approximately 5 years. We continue to work collaboratively with our landlords on lease negotiations. We have approximately 30 leases up for renewal in the balance of this year and currently have several lease properties where the co-tenancy clause has been triggered due to loss of anchor tenants. As Sam mentioned, we are focused on growing our retail presence without additional investments in real estate. As you are aware we entered into about 1,600 Safeway grocery stores over the last 12 months to manage their office supply category. It has been a success for both parties and we are looking at ways we can expand this model to other retailers.

We continue to differentiate our merchandising from the competition through strong private label growth across our business. We recently rolled out several additional brands in contract which are highlighted in our new and improved catalog for our contract customers and in retail we have new strongly branded presentations in our stores. This month we rolled out our in place brand filing system which we developed in partnership with international organizational expert Peter Walsh.

One final item I want to discuss today is our supply chain. This is an excellent example of how we found a way to do more with significantly fewer resources. We continued to improve productivity and lower cost to serve across the enterprise which helped partially offset the de-leveraging of fixed expenses. Compared to the first quarter of last year we lowered both inventory per store and inventory levels at our customer fulfillment centers by about 10% while maintaining high in-stock availability. The quality of our inventory has never been better.

We have also reduced the number of delivery miles driven to our stores by approximately 600,000 this past quarter on a year-over-year basis, improving overall freight spend leverage. For our contract business we continue to increase stops per truck which has resulted in a 22% year-over-year decrease in the private fleet count serving our contract customers. We are also performing a network study to ensure we right size our distribution footprint. We have already reduced the number of our distribution centers over the past few years and we will continue to work to further optimize our network.

Overall we believe there are still a number of challenges ahead of us and we are focused on viewing many of these as opportunities. As discussed, we have already demonstrated our ability to do this on a number of fronts and are confident we can continue to make progress.

At this point I would like to turn the call over to Bruce Besanko to review the financial details.

Bruce Besanko

Thanks Sam. Good morning everyone. I will start with a detailed review of our first quarter performance compared to Q1 of last year and then I will wrap up with my observations of OfficeMax in my first 10 weeks on the job.

Let’s begin with the first quarter earnings statement. For the first quarter of 2009 we recorded net income of $13.1 million or $0.17 per diluted share excluding certain charges to income that are not indicative of our ongoing core business. Adjusted net income in the first quarter of 2009 was $17.4 million or $0.23 per diluted share.

Adjusted operating income, net income and earnings per are non-GAAP financial measures which we reconcile to GAAP financial results. We included a table in the press release to calculate adjusted figures for comparison. Items excluded from the first quarter 2009 adjusted numbers include a $9.9 million pre-tax charge related to retail store closures in the U.S. and Mexico with a corresponding $300,000 of after-tax joint venture income to account for our partner’s share of the charge as well as a $2.5 million pre-tax distribution from Boise Cascade, LLC recorded as “other” income.

Consolidated net sales in the first quarter of 2009 decreased by 17% to $1.9 billion. Contract segment sales decreased by 22.4% to $928 million compared to the first quarter of 2008 reflecting an 18.9% sales decline in the U.S. contract and a 30.1% sales decrease from international contract operations primarily due to an appreciating U.S. dollar. In local currencies international contract sales declined only 7.6% compared to the first quarter 2008.

Retail segment sales decreased by 11.2% to $984 million compared to the first quarter of 2008 with a 12.7% decline in same store sales. Our same store sales in Mexico were meaningfully weaker than the same store sales in the U.S. in Q1.

OfficeMax sales trends in April were somewhat lower particularly in contrast to what we saw in Q1 and we continue to anticipate sales will decline on a year-over-year basis for full year 2009. We saw slightly negative impact in April 2009 sales in both contract and retail due to Easter falling in April this year. Conversely we realized a slight benefit in sales in both segments of our business this March due to the Easter shift.

OfficeMax gross margin was down 110 basis points for the first quarter 2009 from the prior year period. Contract segment gross margin declined 170 basis points in a soft environment as customers purchased a higher percent of on-contract items including lower margin commodities like paper. Additionally, gross margin continued to be impacted by the de-leveraging of fixed delivery and occupancy costs which was partially mitigated by improved delivery costs.

Retail segment gross margin declined 100 basis points primarily due to the de-leveraging of fixed occupancy costs from same store sales decrease and new stores and a sales mix shift to a higher percentage of lower margin technology category sales partially offset by higher margins on certain product categories which was helped by strong vendor support and we maintained our positive relationships.

Fuel costs were a tailwind in Q1 due to lower diesel prices and we realized a $2.7 million decrease in fuel costs on delivery expenses for both contract and retail combined in the first quarter of 2009 compared to the prior year period.

OfficeMax’s total operating expense was 22.4% of sales in the first quarter of 2009 as compared to 21.9% in the prior year quarter due to de-leveraging of fixed costs from lower sales across the businesses.

Contract segment operating expense was 18.7% of sales up from 17.5% in the first quarter of 2008. A $37 million reduction in operating expenses was not sufficient to offset de-leveraging of fixed costs from sharply lower sales. Retail segment operating expense was 24.9% of sales down from 25.7% of sales in the first quarter of 2008 despite a sales decline of 11%. Operating expenses declined by $39 million in the first quarter of 2009 from the first quarter of 2008.

We are seeing the benefit of better execution across our retail store chain due to centralized decision making and new tools that enable stores to perform tasks more efficiently. We were also helped by approximately $3 million less depreciation expense in the first quarter of 2009 due to store asset impairment charges taken in 2008. With that said we have not yet cycled the significant management and staffing changes we made in 2008. We continue to review our cost structure at the corporate and field level to make sure it is aligned with our reduced volumes.

Our adjusted operating income was $37.4 million or 2% of sales in the first quarter of 2009 compared to $82.8 million or 3.6% of sales in the prior year period. This reflected contract segment adjusted operating income margin year-over-year decline of 290 basis points to 2.3% in the first quarter of 2009 and a retail segment adjusted operating income margin year-over-year decline of 20 basis points to 2.6% in the first quarter. Corporate and other segment operating costs were relative constant in the first quarter of 2009 compared to the prior year.

The effective tax rate was 37.6% in the first quarter of 2009 compared to 28% in the prior year period. Please note that last year’s rate included the impact of a favorable IRS audit related adjustment.

Now let’s turn to the balance sheet. At the end of the first quarter 2009 we had total debt excluding the Timber securitization notes of $342 million and cash and cash equivalents of $149 million. It is important to note that total debt excludes the $1.5 billion of Timber securitization notes since recourse on the notes is limited to the Timber installment notes receivable and not for OfficeMax.

We also had $486 million of available credit under our $700 million revolver. Our unused borrowing capacity as of March 28, 2009 reflects an available borrowing base of $551 million, zero outstanding borrowings and $65 million of letter of credit issued under the revolving credit facility. Our revolver has minimal financial restrictions and expires in July 2012.

As you know we have frozen pension plans. As of the end of 2008 our under funded status in these plans was $435 million. However, due to IRS funding policies and our favorable past funding practices our 2009 minimum cash contribution is expected to be approximately $7 million.

We are currently evaluating a funding option recently introduced by the IRS that would require our 2010 cash contributions to be between $10-20 million which is significantly lower than our prior expected contribution of $50-70 million. We are forecasting approximately $25 million of P&L expense for the full year 2009. Please keep in mind that our financial market performance could materially impact our funded status and these expected payments.

Turning to cash flow, for the first quarter of 2009 we generated $3.1 million of cash from operations, a decrease of $139.3 million primarily due to lower earnings and the timing of associated decrease in payables and accruals mitigated by reduced inventory levels. We ended the first quarter of 2009 with inventory $169 million lower than the end of the first quarter of 2008 with lower inventory per store and per distribution center partially offset by store growth over the past year.

Accounts payable at the end of the first quarter 2009 was $185 million lower than the prior year period primarily reflecting lower inventory levels and timing of payments. Receivables at the end of the first quarter were $110 million lower than the prior year period reflecting volume declines in the contract segment as well as relatively consistent day sales outstanding.

Capital expenditures totaled $11 million for the first quarter of 2009. For the full year we are planning capital expenditures in the $50-70 million range, a significant reduction from prior years as more discretionary projects have been cut or postponed until we see the economic recovery.

Now turning to outlook, given the weak economic environment we remain cautious in our expectations for 2009. We will be impacted by two years of declining comp sales and will cycle significant expense reductions that we completed last year. As a result of these factors we expect continued costs and expense de-leveraging for the full year. We are taking a realistic approach to our business in 2009 given these challenging market conditions and we continue to enforce tight cost controls and make the tough decisions necessary to maintain a healthy balance sheet.

We remain confident our cash position and existing access to capital are more than adequate to address the challenges we face from the external environment. Our expectation for the full year for cash flow from operations to exceed capital expenditures and for our revolving line of credit to be only utilized seasonally with no borrowings at year end.

Before I turn the call back to Sam I would like to share some of my key take away’s during my first 10 weeks on the job. First, this is a very disciplined management team and I am thrilled to be part of it. This team is also very comfortable balancing short-term needs with long-term strategic goals. OfficeMax has been proactive in responding to the economic downturn and has been making the necessary reductions in expenses to remain profitable while at the same time positioning the company for the next business cycle.

One of my near-term priorities is to ensure OfficeMax continues to have adequate liquidity. I want to underscore that I strongly believe that to be the case as we have an appropriate amount of cash and revolver availability on hand and appropriate access to additional sources of liquidity.

In conclusion, we recognize that some of our new growth initiatives will take some time to significantly improve and move the bottom line. As we have discussed, we still anticipate a very weak 2009 due to continued sales declines and continued de-leveraging of fixed expenses but we expect cash flow from operations will exceed capital expenditures for the full year and our liquidity position will remain more than adequate to carry us through the economic environment.

At the same time I am excited about our prospects and feel we are taking the right actions to position the company for long-term growth and shareholder value.

Now I will turn the call back to Sam Duncan.

Sam Duncan

Thanks Bruce. Our near-term outlook on the macro environment has not changed. We expect that it will remain tough for at least the next 12 months. However this is not causing us to lose focus on our goals or to accept our current results. While we are conserving capital we are not ceasing progress. I am pleased by the continued improvement in our operations which are helping us compete more effectively. We are confident that we have the right management team, strategies and financial foundation to successfully navigate through this downturn. We believe the results of our actions will be transparent in our top and bottom lines when the economy turns the corner.

Before opening up the call for questions I would like to take a moment to thank all of our associates for bringing their passion to our business every day. This is evident in the progress we continue to make. I have witnessed quantum leaps in the way we operate our supply chain since I joined the company. Kudos are deserved to Reuben Slone’s group including Larry Hartley and the supply chain operations team, Doug [Shankman] and the inventory management team working with Steve Embry and the merchants and Jim Borg and the procurement team for making great strides in product availability, inventory productivity and cost productivity.

I am also pleased with the significant improvements in store execution and service in our retail stores and would like to extend a special thank you to Paul [Hertz] store operations team including Chris Richardson and the territory senior vice presidents and district manager’s all of their hard work. We are also proud of the recent advertising awards OfficeMax campaigns have won. OfficeMax took top prize in the rating awards which honor the very best advertising and marketing campaigns in the retail industry for our multimedia penny pranks campaign during the 2008 back to school season. We have also received an overwhelmingly positive response from our customer feedback panel for the new catalog we launched a few months ago.

Congratulations go to the Ryan Vero marketing team including Bob [Backer] and Julie [Krueger] who have all done an excellent job satisfying our customers through this channel. Now I would like to open the call for questions.

Question-and-Answer Session


(Operator Instructions) The first question comes from the line of Matthew Fassler – Goldman Sachs.

Matthew Fassler – Goldman Sachs

I would like to ask two questions. First, just to dig into the contract gross profit dollar rate to a slightly greater degree. Historically I guess when your contract revenues were light there was some element of self-discipline driving that and that showed up on the gross margin line. That was less the case here. I know you spoke about customers moving to contract items and to some lower margin products in the mix but a little more color on your selectivity played into that and whether you think there is anything you can do in this type of environment to migrate customers to a better margin product. Then I have a quick follow-up.

Sam Martin

Our contract efforts have been around expanding our assortments in what we sell to our contract customers. Our opportunity there is most of these expanded categories have higher margins than our current core supply category margins would generate. We have had some success in that. It has been offset largely by the movement of most of our big contract businesses to really being more disciplined in how they purchase supply items and really focused on the stuff that is more consumable in nature and staying away from the more durable goods that have higher margins such as furniture.

So those are the two things that really have levers that we pull against the operating margins. In addition to the fact we have indeed reduced the cost to serve through the supply chain and a number of our customers were able to negotiate through and get different delivery cadences so we can have larger amounts of merchandise on each truck as we talked about in the script.

Matthew Fassler – Goldman Sachs

The second question I have relates to pension. You talked about the expected P&L impact of pension and potential cash flow impact. Was there some pension accrual reflected in the first quarter P&L and I guess as I think about that I am very focused on the corporate line where you didn’t have an increase from last year’s run rate. That is where we expected the pension accrual would show up.

Bruce Besanko

Let me make a few comments on our pension plan. First as you know it is a frozen plan so there are no new folks entering it. Second, we have suffered just like everyone else has as the market went down and so as a consequence we are somewhat under funded as are many folks. We had indicated we would make a cash contribution of about $7 million this year. There wasn’t much made in the first quarter so we will see that over the course of the next three quarters. I do want to point out some good news regarding the pension fund though too which is that as you may know the IRS has recently introduced a new funding option which we are evaluating that could potentially result in the cash contribution in 2010 being close to the $10-20 million range versus our earlier projection of $50-70 million. As we evaluate that option we will certainly let you know.

Matthew Fassler – Goldman Sachs

What about that $20-25 million…tell me if I misunderstood that $20-25 million of full year P&L expense for 2009. Did I hear that right and was any of that booked in the first quarter?

Bruce Besanko

You are exactly right on the terms of the amount and about a quarter of that was in fact put into the P&L.

Matthew Fassler – Goldman Sachs

Does that show up as corporate line or is that sprinkled throughout the income statement?

Bruce Besanko

It is in G&A.


The next question comes from Kate McShane – Citi Investment Research.

Kate McShane – Citi Investment Research

Can you talk a little bit about how much deflation could help your margins this year especially in light of your exposure to private label and you see stronger growth in that category and that business for you?

Sam Martin

We haven’t modeled out for the year what cost deflation might be. It is still somewhat foggy as to how that is going to impact us. Certainly there has been some impact in our history in the quarter with our movement to private label. At the same time, the sales come down a little bit, the margin comes up a little bit and net/net it is much of an offset. There hasn’t been a huge movement or significant movement either direction so we don’t see it any different going forward.

Kate McShane – Citi Investment Research

A few of your competitors indicated they are seeing a pick up in small business. Is this something that you are seeing and do you think there is anything else contributing to the slower growth in April or the Easter shift?

Sam Martin

April is majorly affected by the shift in Easter of course. Our small business models or what we really use to attract small business customers is a number of things. Our retail stores of course, our catalog business, our call centers, our e-com website all are targeted if you will at small business customers in some fashion. While we do see some improvement in those areas from the declines that we have had we can’t expect much different than we have seen in the past. It is currently trending a little better than it was in Q4 in Q1. So we are seeing that happen in e-com particularly and around the response we have seen in our catalog as you have seen in our retail store comp sales being somewhat similar to Q4 but slightly better.

Sam Duncan

I’m not sure how anybody can say there has been an improvement when you have double digit negative comps. We will say there has been improvement when we see our retail stores in the low negative comps or positive whenever that happens. That will happen when the economic environment improves.


The next question comes from Mike Baker – Deutsche Bank.

Mike Baker – Deutsche Bank

My question is on we are seeing in pricing the delivery business are you seeing some of your competitors be aggressive there and then I guess are you sort of still in the process of [up] share for pricing and do you feel like you are losing share?

Sam Martin

If you recall back in the end of 2007 and into the first part of 2008 we talked about centralizing our pricing decisions. That has helped us to be more disciplined in how we price and we have talked about that on each of our calls. So the pressure on our pricing or the pressure on our margins has really come more from customers have selected to purchase, not from our pricing necessarily. As we go to looking at how we price…I’m sorry, I lost the second half of your question in my mind.

The share question. The way we see it in the first quarter we have indeed signed on more new customers than we have lost. As you know, looking back at what we said in the late 2007 and early 2008 time period we were shedding customers because of our disciplined pricing approach. That is no longer the case. However, it takes time for those comp sales to start ramping up in the new customers and it also took some time for that loss of customers to work through the system. So we are still seeing, like I said in the script, our new sales from new customers is lower than our lost sales from lost customers a year ago but the number of accounts we signed on in the first quarter of 2009 is indeed more than the number of accounts we lost. Although the economic conditions are affecting our current existing customers it also affects how new customers spend versus what their historical patterns were.

So the business we lost was higher per customer than the business we are gaining in the first quarter of 2009.


The next question comes from Chris Horvers – JP Morgan.

Chris Horvers – JP Morgan

I wanted to follow up on the contract customer sign ups as well. Earlier this week Office Depot talked about signing up half the RFPs that they received. Staples talked about earlier in the quarter during a meeting that they won half of the business as well so it seems like you are adding up to a number that is larger. Obviously you don’t know exactly what they are talking about but maybe you could shed some light on perhaps the differences in how you might be looking at it versus what they are talking about?

Sam Duncan

I don’t know what math competitors or anybody else uses. All I can tell you is what we see and what Sam said is that in the first quarter we signed up more new customers than what we lost. I am looking at a sheet that shows customers with over $1 million of volume annually and our numbers are quite a bit more won than what we lost. Again, you have to find out what the other companies mean by the more then win than they lose. What dollar accounts, is it above $1 million or below $1 million. I don’t know what they are talking about so I can’t really comment about it.

Sam Martin

I will add to that if I can. We have won against each of our major competitors in each of the product segmentations we look at. So we are winning accounts in large markets, middle markets as well as across the board in government, healthcare and education and I would say we feel we can compete with those competitors and do so effectively.

Chris Horvers – JP Morgan

Sam do you think maybe right now it is the regional guys that are losing share in the tougher times where they can got to the big three who can provide maybe a little bit better pricing and some efficiency opportunities versus the regional players?

Sam Duncan

You know, I don’t know what the regional players are doing. You might be able to talk with them. I can just tell you what we see and the accounts we monitor and how we look at our business.

Chris Horvers – JP Morgan

A follow-up question for Bruce on the expense side. Can you help us frame out a run rate first on G&A, is the level you saw in Q1 a good indication of how the subsequent three quarters could look like? Overall, are there any incremental expense reductions you think are coming down the pipeline in Q2?

Bruce Besanko

Great question. In terms of the G&A run rate I think you can assume that what we saw in the first quarter of this year as a run rate for what we would expect in the latter three quarters in terms of the year-over-year savings. In terms of the second question in terms of what kinds of cost reduction might we see out into the future, let me just take a moment and provide some context around cost reductions.

Since 2006 the company has taken out a substantial amount of cost without really negatively affecting the business and in fact because of those decisions we have made the business not just more efficient we have actually made it more effective. We reduced G&A over the past two years by about $50 million. We have reduced operating expenses over that same period of time by about $85 million. Now some of that is variable with revenues that have gone down but some of it is fixed as well. At the same time in-stock levels have improved, inventory per stores have been reduced, store level service in our view is improved. In addition to that we have been excellent stewards of the capital. We have suspended a number of programs and reduced our real estate investment until we have parity on the economy.

So there is still room for more cost containment however and when you think about the fact that as Sam mentioned in his prepared remarks at one point the count of distribution centers for our contract business was substantially higher than it is today at about 27 and so we feel like not just in the G&A line but also in the operating expenses in the business there is still more opportunity.


The next question comes from Anthony Chukumba – FTN Midwest.

Anthony Chukumba – FTN Midwest

I just have a question in terms of what you are seeing in the competitive environment. I know one of your competitors earlier this week pointed to some areas where they are seeing more competition and I guess about Sam’s Club really going after small business customers. I was wondering what you are seeing and how that has changed over the last couple of quarters.

Sam Martin

I would tell you that competition in the office supply industry is very broad. If you look at the total industry it is spread amongst a number of competitors who are into this space from the retail side, the contract side, regionally, nationally and specifically what you are talking about most of what is happening there we feel is that we are positioned well to compete with from an assortment standpoint, a service standpoint and expertise in our stores. We haven’t see where that has been any more or less competitive than what we have seen in the last few quarters. I know it is a small effort at this point in terms of the national footprint but there has been that kind of pressure from the mass marketers, from the clubs. They have been in the business for some time. Their expansion in it hasn’t shown to be that much of an impact on us specifically.


The next question comes from Stephen Chick – FBR.

Stephen Chick – FBR

Just a question maybe to clarify or get a little more granular on what you are saying about April trends and I apologize if I missed it but can you speak to are retail comps currently running below the 12.7% and are U.S. contract trends currently below the 18.9% and can you give us a little more quantification on what the Easter benefit was to Q1 and detriment to Q2 would look like for each segment?

Bruce Besanko

Let me start and then I will turn it over to Sam Martin who can be a little more specific in terms of retail and contract. Why don’t we take a step back because when we talk about outlook we should first inform you we refrained from providing it given the current environment and the recession it is just a very difficult thing to do. We can provide some color. Let me start with the full year and we will work ourselves down to April.

We are still anticipating a very weak 2009 due to continued sales declines. We talked about the de-leveraging of fixed costs. We have also said that CapEx would be in the range of $50-70 million which would be a significant reduction over the prior year of about $144 million. We talked about cash flow from operations being likely to exceed our spending on CapEx and then we talked about on a borrowings perspective there would really be only seasonal borrowings on our revolver and we would end the year with no borrowing. That is sort of the full-year picture we have provided.

Now when we turn to the second quarter here is what we can say. First, it is always the weakest of our four quarters so we expect it will be a very, very challenging second quarter. Second, in the first period of the second quarter that is the month of April we have seen sales trends that are lower than what we saw in Q1 particularly in contract. So as I think about the second quarter I think about one that is going to be significantly softer than what we saw in the first quarter.

Sam Martin

Just to be a little more specific if you think about what happens around the Easter holiday a lot of businesses on the B2B side, our contract business, close down on Friday, ramp down a little bit on Thursday for Good Friday and then some of them don’t open up on Monday so we have virtually no sales for those couple of days around Easter. That of course helped us a bit in March because Easter fell in March last year and hurt us a little bit in April for those very same reasons. In retail it is not as significant but certainly the same sorts of things happen for small businesses. Fewer small businesses probably close up on Friday and fewer close on Monday so they still have some consumable needs. However, the consumer side of course takes a break on working around that period of time.

Those implications would be in the small single digit total but it gets complicated by the fact it was a help for us in March and a bit of a headwind for us in April.

Stephen Chick – FBR

So I guess my question is if you kind of best effort to try to normalize for that shift would the trends in the two segments still be on decelerating trajectory or would they be pretty similar?

Sam Martin

I have given you the color around it we can give you. I don’t have any more specifics to talk through.


This concludes our Q&A session. I will now turn the call back over to Sam Duncan for closing remarks.

Sam Duncan

Again everybody thanks for joining us. I would just like to remind you that as we said earlier we are positioning our business for the long-term and we believe the progress we continue to make on our key focus areas of growth, differentiation and productivity reflects our commitment to operational excellence and thanks for everybody joining us today.


This concludes today’s OfficeMax first quarter 2009 earnings conference call. You may now disconnect.

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