Office Depot rewrites plans to improve operations

DELRAY BEACH, FLA. —This was a year Office Depot would like to forget.

Weak results in the first quarter were followed by an even more disappointing performance during the second quarter as profits declined, same-store sales dropped 5% and store expansion plans were scaled back.

Those factors caused Office Depot shares to plummet throughout the summer. The situation worsened in late October when the company was forced to delay the release of its third-quarter results after it discovered serious accounting errors related to vendor funds. The mistake cost four merchandising executives, including senior vp of merchandising Scott Koerner, their jobs and caused Office Depot to restate earnings for four previous quarters.

When third-quarter results were eventually released, the figures were not pretty and showed continued deterioration in profitability, another 5% decline in same-store sales and a further reduction in store expansion. The company’s share price sank further and, by late November, was trading around $17 a share, less than half of the $38 price where it began the year. Then, to add insult to injury, Staples released strong third-quarter results on Nov. 27, which suggested it was a beneficiary of Office Depot’s woes.

Where Office Depot goes from here isn’t entirely clear, as the company has installed a new head merchant and hired a firm to undertake the vague task of reviewing its capital structure. From the perspective of chairman and ceo Steve Odland, the company’s third-quarter performance was very disappointing, but he continues to believe the right strategies are in place to drive long-term growth.

In the near term however, Office Depot has some major obstacles to overcome, not the least of which is weakness in the housing market. A large portion of the deteriorating results the company has experienced in its retail operations and business services division can be blamed on weakness in the housing market, especially in Florida and California, where Office Depot derives about 25% of its sales and profits. The company hired a third-party firm to conduct something called a multivariate regression analysis to identify the correlation between its sales and the extended amount of time required to sell the inventory of homes on the market.

To compensate for the lack of consumer demand and an anticipated slow pace of recovery, Office Depot, for the second time this year, dialed back new store growth plans. The company began 2007 with an ambitious objective of opening 150 stores this year and 200 in 2008. At the end of the second quarter, those targets were reduced to 125 openings in 2007 and 150 openings in 2008. More recently, the figures were reduced to 70 openings this year and 75 next year.

“We continue to believe that we have significant opportunities to expand our store count…but we have moderated our roll-out strategy in response to the current environment in order to lower expenses and redirect operating cash flow,” said Chuck Rubin, president of Office Depot’s North American retail division. Although store expansion has been pared, remodeling activity will continue as the company looks to upgrade its store base to a design called M2 that it contends is more efficient to operate and generates a higher rate of return.

As Office Depot wrestles with the issue of improving the performance of its retail operations, it does so with a new executive in charge of its merchandising organization. Shortly after Koerner and three other merchants with oversight of the supplies business were dismissed in connection with the improper accounting of vendor funds, the company appointed Kim Maguire as evp and chief merchandising officer. Maguire has a diverse background in merchandising, and most recently spent nearly two years as evp and chief merchandising officer at QVC. Prior to that, he was with Circuit City for three years and also spent more than 20 years with Target. “Kim’s track record of driving sales and profitability with world-class merchandising teams makes him the perfect leader for this very important organization within Office Depot,” Rubin said.

Other key personnel changes involved the appointment of Kevin Peters as evp of supply chain. Peters was previously with W.W. Grainger and The Home Depot. In merchandising, Stephen Olsen was appointed vp of merchandising over the supplies business. His previous responsibilities will be handled by Randy Wick, who joined the company as vp of merchandising, strategy and services.

Heading into 2008, a key priority for the merchandising group will be to drive even more sales from private brands, which just a few years ago represented less than 10% of the company’s sales. The company now believes it can increase the penetration rate of private brands to 35% to 40% of sales, and doing so will be critical to growing profits.

Changes are also planned at the store level, where there is an ongoing effort to simplify operational tasks so employees can spend time serving customers.

“We don’t know how the retail environment will [develop] for the holidays,” Rubin said prior to Thanksgiving. “We have a conservative outlook with tight controls on expense and inventory. As we look to 2008, we have the action plan in place to deliver improved sales and margin, particularly in the second half of the year.”