Staples Inc SPLS
Q1 2013 Earnings Call Transcript
Transcript Call Date 05/22/2013

Operator: Good day, ladies and gentlemen and welcome to the Quarter One 2013 Staples Inc. Earnings Conference Call. My name is Mathew and I will be your operator for today. At this time, all participants are in a listen-only mode. We will conduct the question-and-answer session toward the end of this conference. As a reminder, this call is being recorded for replay purposes.

Now, I would like to turn the call over to Mr. Chris Powers, Director, Investor Relations. Please proceed, Sir.

Chris Powers - IR: Thanks, Mathew. Good morning everyone and thanks for joining us for our first quarter 2013 earnings announcement. During today's call, we will discuss certain non-GAAP metrics to provide investors with useful information about our financial performance. Please see the financial measures and other data section of the Investor Information portion of for an explanation and reconciliation of non-GAAP measures and other calculations of financial measures that we use to analyze our business.

I'd also like to remind you that certain information discussed on this call constitutes forward-looking statements for purposes of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

Actual results may differ materially from those indicated by such forward-looking statements as a result of various important factors, including those discussed or referenced under the heading Risk Factors and elsewhere in Staples' 10-Q filed this morning.

Here to discuss Staples' first quarter performance and business outlook are Ron Sargent, Chairman and Chief Executive Officer and Christine Komola, Chief Financial Officer. Also joining us are Demos Parneros, President of North American Stores & Online; Joe Doody, President of North American Commercial and John Wilson, President of Europe. Ron?

Ronald L. Sargent - Chairman and CEO: Thanks, Chris, and good morning everybody. Thanks for joining us today. This morning, we reported our results for the first quarter of 2013. Total Company sales were $5.8 billon, which was a decrease of 3% versus Q1 of last year.

Earnings per share from continuing operations came in at $0.26, and we generated $306 million of free cash flow during the first quarter. Excluding the negative impact of stores closed during 2002 and the stronger U.S. dollar, total company sales were down 2% year-over-year.

I'm pleased to report that our reinvention plan is on track and is gaining momentum. We're driving sales from our expanded assortment and we're accelerating growth online. During the first quarter, we saw growth in North American contract and We reported our best European retail comp sales in almost three years, and sales per square foot were stable year-over-year in our North American retail stores.

Before we get into the segment results, I'd like to give you a quick update on the progress we're making on our strategic reinvention. During Q1, we continued to expand our assortment. We added 20,000 new products on in areas like teaching and education, office decor, facilities and breakroom and safety supplies. Over the past year, we've added over 90,000 new SKUs to the site which are driving close to $1 million of incremental sales per week and we're seeing nice traction from the increased assortment on as well.

We also expanded our offering of Staples – of Apple accessories beyond during the first quarter. We now offer Apple products to our midmarket contract customers and in half of the stores in the United States.

In terms of driving growth online, we're gaining momentum in with sales up 3% compared to Q1 of last year. This improving trend is supported by our expanded assortment as well as the investments we're making in customer acquisition and website improvements.

In mid-March, we relaunched our Staples Rewards program, which now offers customers 5% Back in rewards on all products and all services. We've also improved the program to offer free shipping with no minimum purchase. Our new Rewards program further differentiates Staples from competitors and the early response from our customers has been encouraging with enrollments up nicely year-over-year.

Beyond the investments we're making to accelerate our online sales, we're also adding new leadership and new expertise to drive this key growth initiative. We've recently announced the addition of Faisal Masud to the Staples team. Faisal joins us from Groupon and he's also worked at eBay and Amazon. He will assume the new role of Chief Digital Officer and will be responsible for driving growth in and will play a key role in implementing our omni-channel strategy.

During Q1, we also announced the nomination of Raul Vazquez for election to our Board of Directors. Raul is the CEO of Progreso Financiero and previously served as the CEO of He is a multichannel veteran. He has deep digital expertise, and he would be an outstanding addition to our Board of Directors.

We also are driving growth in our services business. Copy and print sales in North American stores and online were up in the mid-single digits during the first quarter. We've increased our focus on customer acquisition and building strong relationships with our top customers.

We've also realigned our in-store and online offerings and our retail sales force continues to build momentum. EasyTech sales also grew in the mid-single digits during the first quarter despite tough trends in the PC category. The replacement cycle for computers has lengthened and as a result more customers are relying on Staples for services like virus removal, diagnostics, and PC cleanup.

Turning to omni-channel. Here we are in the early innings of this initiative. We've successfully rolled out our new cross channel features like reserve online and pickup in store and we've improved our in-store kiosk, which gives our retail customers an endless aisle shopping experience. We've implemented incentive plans to drive omni-channel sales and improve our in-store conversion rate.

I'm also pleased to announce that earlier this week we opened our first two 12,000 square foot omni-channel stores in Norwood, Massachusetts and Dover, Delaware. This new format provides customers with a much more interactive experience and helps drive increased awareness in sales of our expanded offering on

We are excited about the omni-channel opportunity. We expect momentum to build throughout 2013 as we invest in associate training and continue to increase customer awareness of our unique integrated offering.

Our funding the future activities, they are right on track. We remain committed to driving $150 million in gross savings for the year. Through the first quarter, we've completed over 90% of our vendor negotiations and we're tracking ahead of plan.

In terms of square footage reduction, we closed 13 stores. We downsized and relocated seven stores in North America during Q1. We streamlined our store labor model in the U.S. to reduce cost and increase efficiency.

We're also reshaping our contract sales force. Reducing administrative task and focusing more time on selling. During the first quarter we hired category experts and retrained our sales force to accelerate sales and categories beyond core office supplies.

In Europe, we continue to make good progress, reducing headcount, consolidating subscale operations, and streamlining back-office functions.

Now let's take a look at our Q1 results for each of our business units. I'm going to start with North American stores and online. Sales for the first quarter were $2.8 billion, down 4% compared to Q1 of last year. In the last 12 months, we closed 48 stores in North America. This negatively impacted our Q1 sales growth by approximately 1%.

First quarter same-store sales, which excludes sales declined 2%, average order size was flat and customer traffic was down 2% year-over-year. sales grew 3% versus the prior year.

During the first quarter, growth in tablets, facilities and breakroom supplies and copy and print services were more than offset by weakness in computers, business machine, software and technology accessories.

North American stores and Online Q1 operating margin decreased 107 basis points versus last year to 6.2%. This was driven by investments to drive growth in, deleverage our fixed expenses and costs associated with streamlining the store labor model in the United States during the first quarter.

We remain focused on reducing square footage and improving the productivity of our retail stores. Our plans for 2013 now call for approximately 40 net store closures in North America versus our previous guidance of 30 net store closures. We also continue to expect the total of 45 relocations and downsizes for the full year.

Moving on to North American commercial. Sales for the first quarter were $2 billion. That was an increase of 2% compared to last year. Sales accelerated during the first quarter with low single-digit growth in both contract and We're building momentum with our expanded assortment on Top line growth remained in strong adjacent categories like facilities and breakroom supplies which was once again up double-digit during the first quarter. This was partially offset by weakness in core office supplies which were down in the low single digits during the first quarter.

North American commercial operating margin for Q1 decreased 56 basis points versus last year, to 7.3%. This reflects investments in marketing and sales force to drive growth, as well as reduce product margin, partially offset by the favorable comparison to Q1 of last year, which included headcount reductions and the settlement of a contractual dispute.

In international operations sales for the first quarter were $1 billion, a decline of 11% local currency and 13% in U.S. dollars versus Q1 of last year. The sales decline reflects weak top line trends in Europe and Australia. Over the past year we've closed 49 stores in Europe. This negatively impacted Q1 sales growth for international operations by about 2%.

In Europe, retail same-store sales were down 3% during the first quarter. Our best comp since Q3 of 2010. Average order size increased versus Q1 of last year, but was more than offset by a decline in customer traffic.

Our European delivery businesses remained under pressure, as the difficult macro trends in Europe. We tendered pressures from our enterprise customers and weak demand for core categories like ink and toner continue weigh on results.

During Q1, international operating margin decreased 18 basis points versus last year to a loss of 1.1% of sales. This was driven by lower product margin and deleverage of fixed expenses in our European delivery businesses and Australia, partially offset by the favorable comparison to Q1 of last year, which included headcount reductions and the settlement of a contractual dispute.

Our European restructuring program is on track. While we don't expect rapid improvement in our top line trends during 2013, we do expect to see margin improvement going forward as we benefit from the actions we've taken to reduce our cost structure and simplify our business going forward.

With that, I'll turn it over to Christine to review our financial results.

Christine T. Komola - CFO: Thanks Ron. Good morning, everyone. During the first quarter, total company sales were $5.8 billion, a decrease of 3% in U.S. dollars versus the first quarter of last year. In the 12 months preceding Q1 of 2013, we closed 97 stores in North America and Europe which negatively impacted total company sales growth for the first quarter by about 1%. The stronger U.S. dollar also negatively impacted sales growth by about 50 basis points during Q1. Excluding these two items, total company sales were down about 2%.

Our first quarter earnings per share from continuing operations on a fully diluted basis decreased 7% to $0.26 versus the first quarter of 2012. Gross profit margin for the first quarter decreased 58 basis points to 26% of sales, which reflects investments in pricing to accelerate growth and deleverage of fixed expenses in our international and North American stores and online businesses on lower sales.

SG&A decreased 4 basis points versus last year's first quarter to 20.9% of sales. This decline was driven by a favorable comparison to Q1 of last year, which included severance expense and the settlement of a contractual dispute.

We also had savings related to headcount reductions and a change in management compensation during Q1 of this year. These favorable items were offset by investments in sales force and website enhancements to support our strategic reinvention.

Total company operating margin decreased 52 basis points during the first quarter to 4.9%. Our effective tax rate for the quarter was 32.5%, which was unchanged versus Q1 of 2012 and our first quarter capital expenditures came in at $41 million, down from the $52 million we spent in the same period last year.

With operating cash flow of about $348 million, we generated free cash flow of $306 million, and we remain on track to generate more than $900 million in free cash flow for the year.

During the first quarter, we repurchased 4.9 million shares for $65 million and our plan is to continue repurchasing common stock through open market purchases during 2013.

As you think about our other uses of cash in 2013, please do keep in mind that we do plan to repay with cash $867 million of debt, which matures in January and on an annualized basis we plan to pay over $300 million in cash dividends.

At the end of Q1, Staples had approximately $2.5 billion in liquidity, including cash and cash equivalents of about $1.4 billion and available lines of credit of about $1.1 billion.

Turning to our outlook, our guidance for 2013 is unchanged. We expect full year 2013 sales to increase in the low-single digits compared to 2012 sales on a 52-week basis of $23.9 billion and we expect full year 2013 diluted earnings per share from continuing operations to be in the range of $1.30 and $1.35.

As we mentioned last quarter, our strategic reinvention is focused on accelerating sales and earnings growth and we expect momentum on the top and bottom line continue building throughout 2013.

Thank you for your time this morning. I will now turn it back over to our conference call moderator, Matthew for Q&A.

Transcript Call Date 05/22/2013

Operator: Dan Binder, Jefferies.

Dan Binder - Jefferies & Company: I had a couple questions for you. First on the delivery business, I was wondering if you could breakout for us what your – in terms of the positive sales that you saw there, how much of it was generated from acquisition of accounts versus growth in spend for existing accounts?

Joseph G. Doody - President, North American Commercial: First, let me break (it out) a little bit between Quill and contract. Now, Quill had a very good quarter; in fact, Quill had their best quarter in more than five years, with a positive 3% growth. There, it was heavily driven by new business, also the marketplace ramp up with the expanded assortment was a clear driver of growth for them, and they continued to have a strong growth in facilities and breakroom. But, clearly, it was a combination thereof both, the new business and some increased sales to existing customers, primarily though the assortment expansion and facilities and breakroom. In contract, there we had positive sales growth, over 200 basis points improvement from Q4. Sales to existing customers were up slightly. We also continued to see very strong growth facilities and breakroom. Our new business acquisition was up slightly in terms of number of new accounts and as far as new business from those accounts, it was up more significantly. So little bit bigger average new customer it was brought on and that we continue to see a very strong growth in facilities and breakroom there as well.

Dan Binder - Jefferies & Company: Once you get to the SKU count that you want to online in delivery, I know you noted that there was about $1 million per week coming in from those extra – from those new SKUs that you've added over the last year. I think you're doing like 300,000 or 400,000 SKUs, but what do you ultimately think that can generate in terms of incremental dollars either per year, per week however you want to frame it?

Joseph G. Doody - President, North American Commercial: I don't think we've really given out a forecast on that Dan. First I'd say that the $1 million per week right now is essentially the run rate on our site. We also noted that is getting some good growth there as well, probably more like a third of that, that in terms of size of magnitude, but we're very happy with the ramp up and we continue to add new SKUs, get incremental sales and incremental margin dollars from those.

Dan Binder - Jefferies & Company: Then Ron, my last question was around the sales guidance for Europe. Obviously, with the negative number in Q1 you sort of start out, bit of a whole you have to make up some ground. I'm just curious, at what point do you think the business could inflect. Is it as early as next quarter or are we thinking more back half?

Ronald L. Sargent - Chairman and CEO: It's hard for me to predict what our sales going to be three months from now, but our plan is certainly to accelerate from the first quarter every quarter this year and I think the online expansion is a big part of that, but we've also got a lot of new things coming on our retail side of our business. I do think we will have a drag from the stores we closed throughout the year, but we expect the sales to continue to grow from here and in the year at slight positive top line sales growth, which I think would be not only our plan, but what we're expecting even after the first quarter.

Operator: Gary Balter, Credit Suisse.

Gary Balter - Credit Suisse: I wanted to ask more a theoretical question of the direction where you are taking the company, because in the past years – not last year, a year before, but in past years you used to give us, here is the goal for operating margins in North American stores and commercial and international, contracting international and now we are looking at it and this quarter we had overall 50 basis points, but bigger declines in the North American side of the business and it seems like you're constantly making investments to drive the top line. What – could you step back maybe and talk to us about what you see is the strategic direction where Staples is going now. Are you looking more for market share and willing to sacrifice margin? Do you view these as temporary investments, how should we be thinking about it?

Ronald L. Sargent - Chairman and CEO: Well, I mean I think, when I – I look at our two biggest challenges, we got to get the top line growing again and I think we've got to improve our results in international. I think as we outlined during the – when we announced the strategic reinvention plan, we think we've got four areas to grow the top line and whether that's online or omni-channel or services or assortment. Those are the areas we're going to make the investments in and we think, obviously, if you're growing the top line, I mean, sales tends to cure all ills and I think the bottom line will follow. So it's a little hard for me to say, this quarter, next quarter, whatever the operating margin is going to be, because I think the focus has really been on delivering the guidance that we gave you this year, which is the $1.30 to $1.35 while continuing to take cost out of the business and reinvesting a good portion of that cost we're taking out of the business to grow the top line. So we're really trying to run the business for the next several years, not just quarter to quarter, but we think the investments in online and other growth areas is really important and we'll continue to do that. But we still feel very confident that the $1.30 to $1.35 earnings per share that we articulated is there.

Gary Balter - Credit Suisse: Well, maybe to say it another way. How much margin deterioration are you willing, like is the top line the goal right now and it will come at whatever is necessary on a margin line? Is that the way we should be thinking about it?

Ronald L. Sargent - Chairman and CEO: No, I wouldn't say that we're going to grow the top line at all cost because we know we have kind of bottom line expectations from our shareholders as well. But I think we tried to frame it with our guidance this year, that we expect to get the top line growing again and we think that will accelerate even further in '14 and I think you'll see that as the quarters unwind this year. But at the same time, I think our bottom line guidance is relatively flat from year-over-year and I think this is the investment year and we, obviously, expect those investments to payoff in '14, '15 and '16.

Gary Balter - Credit Suisse: Is there any assumption built into the second half of the year about when the merger of your competitors closes?

Ronald L. Sargent - Chairman and CEO: No, there is not at all. I mean we're basically just kind of working the plan that we articulated, first of all, last September, but more recently last quarter. If there is any benefit of that merger happening, that would be on top of and in addition to anything that we're planning on ourselves. So we're assuming that we're a standalone industry that is going continue to grow with our plan versus expecting something from somebody else.

Operator: Michael Lasser, UBS.

Michael Lasser - UBS: Two questions, one, are you seeing any evidence that you are seeing share gains right now (other than) the acceleration in your contract business may suggest that that you are – maybe if you dig down into the new contract wins who are you (unceding) as the incumbent?

Joseph G. Doody - President, North American Commercial: Yes. Michael. I think it's definitely not due to anything related to the merger announcement. It is due to the work that our team has been underway for many months. So, nothing has really changed there. As far as the average customer just doesn't get impacted by the merger announcement, doesn't really affect them until they see a change and they've not seen a change and they won't see a change to probably 2014. So the gains that are going on are part of our plan for the year and the team is executing well against it so far.

Michael Lasser - UBS: What about the uncertainty as those incumbent contracts are up for renewal? It would seem to be an easy pitch to going on (indiscernible) have that business and is that influencing…

Joseph G. Doody - President, North American Commercial: Let me make it a little bit easier and I'd also, you could also argue that our existing customers that are coming – our existing customers coming up for renewal. It would make it easier for them to stay intact with us. So, I think it will help as far as the major customers are concerned, the more educated enterprise customer because its major switch for them when they switch vendors, but for the midmarket customer, which is the majority of our contract business. Not a big issue to them now and won't be a big issue until it directly affects them.

Michael Lasser - UBS: Follow-up question is for Ron. You have outlined your reinvention plan and you're making progress there. The risk of asking something kind of corny; do you think that you need to make bigger cultural changes within the organization to really effectuate change? Or do you believe that that's going to be outcome of what you're doing?

Ronald L. Sargent - Chairman and CEO: Well, I think the industry has certainly changed and our Company has changed over time and, obviously, when you look at more than half of our business being online today versus, gosh, when I joined the Company was 100% retail. I mean, I think those are fundamental changes and I think we're trying to; one, bring in talent that will support those changes; two, we've kind of done some reorganizational things, particularly joining the dotcom business with the retail business. But, yeah, I mean, I think there is a cultural shift from being kind of a traditional retail bricks-and-mortar company to being an online company. I think we're navigating that pretty well. I've got to tell you, I think we have long way to go.

Operator: Brian Nagel, Oppenheimer.

Brian Nagel - Oppenheimer: So a couple of questions. First, Ron, in your prepared comments you talked about – you, I guess, updated us on the store closing number, I think, from 240 from 30. Not a big change, but the question I have there is, is it just simply a tweaking or is there some type of strategic shift you are making there with respect to the real estate portfolio?

Ronald L. Sargent - Chairman and CEO: No, it's really tweaking. I mean, Demos' team has done a wonderful job kind of looking at every store that's up for renewal. As you know, we've got couple of hundred stores coming up for renewal every year. We are not only looking at what's a great store versus an average store versus a not so good store, but we're also looking at kind of the implications of networks, where you've got handful of stores and could you close one and benefit every other store surrounding it. I don't know, Demos do you want to add anything to that?

Demos Parneros - President, North American Stores & Online: Sure. Definitely a tweak in our approach. We, as Ron mentioned, take a very hard look at store-by-store and then network-by-network. We look at individual store profitability and margins as well as the network. A thing that's been encouraging for us is that we've got good line of sight for the next three years. It's about 750 to 800 stores coming up. It really comes down to a deal-by-deal situation and if it really makes sense to pull the trigger and close the store, we've been aggressive in doing that as it makes sense for us. If we feel like the store's profitability is good enough and even with risk for the next few years, it's fine. We renew on a very short-term basis and we've been successful at doing so. So I think we're adjusting and navigating sort of real-time going forward and this feels like the right place at the current time.

Ronald L. Sargent - Chairman and CEO: The good news is that the key metric for us is sales per square foot and that's been declining for a couple of years and now that has stabilized and we expect sales per square foot to go up. That's what you want in terms of sales productivity on a retail store.

Brian Nagel - Oppenheimer: Then a second question, and maybe a bigger picture, but some of the other questions focus on top line, too, but as you look at the top line I mean, what I'm gathering from the comments you are making here is, it seems like there was more – even more of a stabilization in the business broadly speaking here in Q1 versus the prior quarters. Lot is going on with internal initiatives, macro. The question I have, are you seeing – is the macro environment overall manifesting itself and the buying patterns of your customers, is that turning better for you here that is helping you kind of aid the stabilization of your business?

Ronald L. Sargent - Chairman and CEO: I think things are getting a little better. In North America, where we are seeing a continued sluggish growth economy, I think things are getting better, but I've got to tell you they are getting better at kind of a glacial pace in North America. The other completely opposite story is in Europe where the economy remains in deep recession. I think they've had six straight quarters of contraction to the Eurozone. Unemployment, I think, is now up to about 12%, and there in Europe, we don't really see recovery until the 2014 or '15 timeframe. The good news is I think jobs are coming back. Lot of the jobs that have been added over the last couple of years have been in areas that are not big consumers of office products, things like manufacturing and hospitality and utilities and transportation, but I think the higher consumer of office supply industries, things like financials and services are starting to come back as well. I think the worst is over for the economy, but the improvement is glacially slow.

Operator: Brad Thomas, KeyBanc Capital Markets.

Bradley Thomas - KeyBanc Capital Markets: I wanted to follow-up on a comment that you made, Ron, you noted that sales per square foot in retail during the quarter were stable. Obviously, the Company is taking action to improve the cost structure in retail. What kind of comp or sales per square foot, do you need to generate to maintain profitability in retail?

Ronald L. Sargent - Chairman and CEO: That's a hard question. I don't know what you mean like maintain profitability because our retail business is very profitable.

Christine T. Komola - CFO: I think just, Brad its Christine. As we think about the metric around sales per square foot, it really does drive – get driven by sales and managing the overall cost, so there are several things that use to drive that and I think, we will continue to see improvement moving upwards. There is no specific target around it, but we are expecting that between all of the activities that we've got going on, as well as the cost takeout within the four walls of the store. That's how we're starting to really think about it and drive our teams to think about it.

Demos Parneros - President, North American Stores & Online: If I could add just one quick comment. Just kind of big picture the way that we're thinking about the store network is to continue to take out unproductive square footage as we've been doing. So we're on track to deliver our three year square footage reduction and we do that through closings, as well as downsizing. In the meantime, we have just opened our brand new prototype store that is 12,000 square feet, which we believe is the most productive store we've ever had in combination of strong omni-channel components, as well as a very additive and carefully selected assortment. In addition to that, we've just launched a brand new more productive leaner labor model. So all those things together posted a really good position going forward, as we continue the prudent square footage and really focus on what's inside the box from a sales and margin standpoint, so hopefully that helps.

Bradley Thomas - KeyBanc Capital Markets: That's helpful. Just a follow-up on sort of the overall level of promotion from the Company and in the stores and online channel, it seems that there is a number of investments you're starting to make, improving our rewards, doing free shipping. Do you feel this is the right level of promotion today to hit the topline goals or do we need to see more investments over the next couple of quarters?

Christine T. Komola - CFO: Hi, Brad. Again this is Christine. We do think that we'll continue to invest in the topline over the next few quarters, but equally aggressively we are taking cost out as Demos mentioned, we are – we've realigned our store labor model to take cost out within the stores as you downsize these stores and you take cost out from – everything from occupancy to fixture cost, capital. So it's a dual effort. So I expect that over time it will be a invest some, take cost out type of model and that it'll start to continue to pay for itself.

Operator: David Gober, Morgan Stanley.

David Gober - Morgan Stanley: Just one high level question and then, hopefully, we'll kind of dig in in the follow-ups. But Ron, I guess, as we kind of think about your commentary about revenue growth accelerating into the back half and into 2014, what gives you the most confidence in that kind of playbook playing out. Is it the – I guess, rank ordering just – the overall economic situation or the jobs growth that you're expecting to see or is it more internally driven and maybe some of the progress that you're seeing on some of those initiatives that you've been working on for the last year or so?

Ronald L. Sargent - Chairman and CEO: I wouldn't give a whole lot of (hopes) for the economy, because we're assuming the economy is going to continue kind of in a slow growth kind of mode and it's not going to really help us much. But I think many of the changes we've made in the business, the investment in services where we're seeing kind of mid-to-high single-digit growth. The expansion of the assortment and I think that's probably been the one that has surprised me the most. I mean we kind of defined ourselves historically as a place to buy office products and I think our customers are giving us permission to be the place to buy a lot of things for their business and it's not just office products, it's safety equipment, it's retail supplies, it's many of the categories, even technology, we thought a kind of more curated assortment of technology probably made sense for our customers, but our customers are saying, you know, we want choice. So I think the assortment expansion, products that we're not stocking but we're partnering with others who stock it has been a really pleasant surprise. I think it's early days on the omni-channel area. I think we're lapping some of the larger contract losses that we had talk about in the past. So I think that's kind of behind us. We're seeing strong double-digit growth in facilities and breakroom. I think the new rewards program has been well received by customers and the sign-ups are heading beyond what we expect. So I think we've got lots of kind of growth areas in many parts of our business. I think when you look at the second half, frankly, I think our comparisons are a little easier. We got the Hurricane Sandy, remember, impacted our sales in the second half; Black Friday was just so-so for our business; we expected a lot out of the Windows 8 launch in the fourth quarter. So you I think that compares are a bit easier as well. So, yeah, I guess I am kind of encouraged about sales accelerating and momentum accelerating continuing through the year.

David Gober - Morgan Stanley: So, Ron, in that response, you mentioned technology and obviously, you've had some progress on a lot of different categories and technology has been one where you've had – for a number of quarters now, you've had a drag on results. It sounds like you're definitely more encouraged there. Is that new product category? Do you think that you're seeing – you'll see more progress in talents or other kind of adjacent areas? I guess what gives you confidence that the weak results in technology stabilizer actually turned positive at some point?

Ronald L. Sargent - Chairman and CEO: Demos is probably the best expert to talk about technology, but when you look at the computer business, I mean it was very disappointing, it's been very disappointing for the last year. I am not sure that the traditional PC business is going to recover, but Demos has got a lot of great things that we all compensate for that.

Demos Parneros - President, North American Stores & Online: This is sort of (indiscernible). When it's working, everybody is happy, unfortunately we're in this decline stage with a lot of the old tech, you know old business machines and some of the deterioration and things like (bulk) software related copier (stacks), digital cameras, GPS, all that continues to erode and essentially it's slowly going away. We had very good success with our tablet expansion. Our assortment is second to none. Obviously, everything but Apple hardware in our stores, but the Apple accessory business has been good pleasant surprise in the U.S. so far. Our mobile phones business which has been in 500 stores has been a good lift for us and we are preparing to continue to add another 500 stores to that business. So, I think it's a little bit of a work-in-progress. We have been told although I am reluctant to be overconfident on new product introductions based on the comments from earlier, that there is a good strong pipeline of products for holiday. I think tablet prices will continue to be more and more competitive as that business heats up and it's really transitioning very quickly away from laptops to become – to a more stable level and away from the reader category and really on to the tablet and mobile phone platform. So, we're participating in that. Our team has done a really good job in getting the right assortment in store and our associates in the store prepare to sell it. So, we're in the midst of it.

David Gober - Morgan Stanley: Demos, maybe as I have you here, maybe if I could just sneak one quick follow-up on the Staples Rewards relaunch. Are you seeing any significant uplift there since you relaunched with the 5% Back?

Demos Parneros - President, North American Stores & Online: 5% Back has been very encouraging for us. Number one, it is simple for customers. They really get it. It includes the entire store. 5% Back on anything services, products. Our goal was to increase our sign-up significantly with new customers. In a short couple of months, we are very encouraged by the level of sign-ups and enthusiasm in stores. We are starting to see repeat shopping activity. So I'd say all systems go on Rewards so far. The FREE Shipping with no minimum (fee) rewards customer is a big differentiator for us and customer feedback on that has been very strong.

Operator: Greg Melich, ISI.

Greg Melich - ISI: I want to start with the gross margin. (I guess it delves) on what Gary was asking, if we sit back and we see it was down almost 60 basis points and I guess the dollars were down around 6%, how should we think of that decline in either rate or dollars in terms of product margin, investment, mix and deleverage?

Christine T. Komola - CFO: Greg, it is Christine. So in terms of our gross margin, we deleveraged about the 60 basis points and it really varied by segments. So, North America Stores & Online was about 40 basis points. Commercial was about 50 basis points. International was about a little over 100 basis points. So as we think about the segments, that was a big conscious decision in terms of where we were going to put the investments to grow. So you could see that the online businesses in North American stores as well as the online business in Quill really did grow based on the investments that we made in there. Now part of that investment we did start to fund that investment with our cost initiative to get product savings. International was a heavy deleverage because of the fixed cost that they have and that as you take out the infrastructure with the 200 basis points around stores for that business that over time that's going to take time to cycle through as people actually leave and we actually do physically close our consolidated warehouses. So it is a conscious decision on where we're investing and how we're investing it and that's really the thought around our growth combined with the deleverage that you saw.

Greg Melich - ISI: So sort of following on to that strategically, where you're getting the traction (in either) the product margin investment particular, do you expect to delve that up in those categories or do you think the balance is sort of where you wanted to be?

Christine T. Komola - CFO: I think it's going to vary, but I think in general it's about where it's going to be. I mean you'll see continued investment around that amount in those businesses and I think it will be pretty consistent.

Greg Melich - ISI: I think it was in the retail area. There was a SG&A charge that was related to some severance. I think I got that in the original comment. How much was that and if we think about the SG&A deleverage, how much of it was ongoing in retail and how much of it is sort of just a one-off?

Christine T. Komola - CFO: That was more of a one-off, as we start to really right size our store labor model in stores that was about, I don't know, $9 million or $10 million. So it wasn't a significant amount, but it does impact this quarter and we do expect that's part of our cost (down) plan that will – as we reshaped the store labor model. Demos has done a great job of taking labor, reallocating it, out of our management team into a more normalized hourly activity and really streamlined that process, so you'll see the benefit throughout the rest of the year.

Greg Melich - ISI: Lastly, Christine, you could start this, but (Demos) also wants to chime in. The free cash flow of $900 million for the year, I just want to make sure that's before any cash restructuring cost, is that right?

Christine T. Komola - CFO: That would actually include any restructuring activity.

Greg Melich - ISI: As a reminder that was like what $250 million this year, something like that?

Christine T. Komola - CFO: About $150 million.

Greg Melich - ISI: About 150 this year, and then I guess longer term, I mean (this one is) to Ron, do you think that's a – if this strategy continues to work, you're right-sizing the business, getting productivity stabilized and growing again, are you comfortable with that sort of cash investment each year to kind of keep improving the other parts of the business?

Christine T. Komola - CFO: I think as we look at our investment, I think you will continue to leverage the investment over time, so I think that we will – sales grow, we will continue to give back to the business as well as give back to shareholders through the buyback program and through the dividend program, so I think it's hard to predict over the next – beyond the three years, but out intension is…

Greg Melich - ISI: I guess that wasn't my question. Is the $150 million of cash restructuring cost every year; is that sort of a good sort of run rate?

Christine T. Komola - CFO: No, I think as we continue to look at our investments, $150 million is more around the restructuring of last year's expenses, so we don't expect to have a significant portion like that every year going forward.

Ronald L. Sargent - Chairman and CEO: We have no plans for kind of annual restructuring charge, so I would assume no.

Operator: Aram Rubinson, Nomura Securities International.

Aram Rubinson - Nomura Securities International: Question about international and North America retail, not suggesting that there is an analog between the two, but I guess what I'm trying to figure out is, you want to make sure that there is not an analog between the two. So what are we doing you know – the North American retails kind of falling off, I don't know if there are kind of similarities to the way international did when it first began to underperform and what you're doing to kind of learn, from what seems to be stabilization in international margins, now of course at a low level. How you might kind of leapfrog the issue in the U.S. and kind of take which you're currently doing in international, which is aggressive and apply it to the U.S. before you do become an analog?

Ronald L. Sargent - Chairman and CEO: I think we're talking about an apple and an orange. Our retail business in Europe is kind of breakeven due to a lot of reasons. Obviously, execution over the years, a lousy economy, lack of scale and I don't think that relates to anything at all to kind of our North American retail business which is kind of an 8% profit business that is doing just fine. So I'm not sure there are lessons that we can take from international to the U.S. We are trying to obviously employ best practices from things we're doing in the U.S. to our international business, but I mean it's a null set, I mean they did not relate at all.

Aram Rubinson - Nomura Securities International: I thought there maybe since you were kind of really taking very aggressive actions international that it might be, hey, you know let's kind of do that ahead of time in the U.S. just in case, but you really see them as different I understand?

Ronald L. Sargent - Chairman and CEO: I think we took that action with our U.S. retail business and North American retail business last year.

Christine T. Komola - CFO: I think our (indiscernible) for the U.S. retail business is really focused on the store remodel program as well as the omni-channel. So, I think that the actions are equally urgent, but just different actions.

Aram Rubinson - Nomura Securities International: Also, I'm not sure if this was asked, but can you comment on the attrition rate inside of your contract business, whether that has been, let's say, benefited by the (looming) acquisition or just kind of curious whether that's begun to be a benefit for you?

Ronald L. Sargent - Chairman and CEO: I wouldn't say that it was a big factor, Aram, in the quarter, but clearly I think it is – I do see it as a potential benefit as the year unfolds, certainly the uncertainty of whether it's going to be emerged up a player out there or not, and it helps to – helps with our retention of our existing customers, so that uncertainty, but it was not a major factor in Q1's performance.

Operator: Michael Baker, Deutsche Bank.

Michael Baker - Deutsche Bank: Couple questions. First, just curious, what did the margins look like on these new expanded categories, particularly if they are sourced through third parties, is that one of the factors leading to the lower gross margins or is it more just being more aggressive on price?

Ronald L. Sargent - Chairman and CEO: The answer is, yes. I mean the good news is that we don't handle any of this product, it's being – mitigation is combined and sent, but the goal here is really generate the incremental margin dollars, and since this all incremental sales and you are competing with some pretty aggressive online players. You are going to have to have a lower margin rate and we do.

Michael Baker - Deutsche Bank: Two more if I could, one, Europe comps best of the three years, but the economy is still pretty bad there and maybe even getting worse. Why (is it) the comps have gotten a little bit better i.e., down less? Is it just simply easy compassions or is it some of the changes that you guys are making over there on the retail side?

Ronald L. Sargent - Chairman and CEO: Well, we closed our worst stores, but John Wilson is on the phone and maybe I should let John to kind of weigh in.

John Wilson - President of Staples Europe: Sure, Ron, thanks. If closing the stores did help a bit, but I think it's more a function of some aggressive actions we're taking in Europe, particularly in the more difficult markets we've had some pretty aggressive promotion but smart promotional activity and really focusing on some of the basics, I would say, getting back to promotional planning, aggressive promotional planning, synchronizing their promotional activities with our in-store stock positions and buy. So I'd say it's more about better execution and more integrated planning in the environments that we're in. They are very tough environments. The retail expectations going forward are continued difficulties and challenges, but the closures combined with better execution is really what I would say is the biggest factor.

Michael Baker - Deutsche Bank: One more, if I could. I'm just curious, I just wanted to talk about the merger real quick, the pending merger. I understand that you don't think you've picked up any additional share, but just wondering, theoretically, how do you try to take advantage of any disruptions? Do you reach out to customers of your competitors and actively try to win business more aggressively than you would otherwise? Or do you just sort of let it come to you? Just curious as to how that process works.

Ronald L. Sargent - Chairman and CEO: I don't think we're necessarily doing anything we wouldn't otherwise. I mean we aggressively go after our competitors' customers all the time and have been doing that for 26 years. So I don't know that anything has really changed. I think, obviously, our customers read the newspaper and when we get questions we answer. But at this point, it's really premature to even know if the merger is going to happen

Operator: Colin McGranahan, Bernstein.

Colin McGranahan - Sanford Bernstein: First question on the Reward and FREE Shipping program, was there any impact or what was the impact to that on gross margins in the quarter? Then, I guess, bigger picture. How do you think about the required lift from that and what kind of an ROI you get on that program?

Christine T. Komola - CFO: I can do the first one Colin. It's Christine. In terms of the pre-shipping, there is – we do have pre-shipping for most of our customers almost 98%. But if there was a slight impact because delivery in the Quill business and in the business is slightly more expensive than, for example, our contract business. So it did impact margins slightly.

Colin McGranahan - Sanford Bernstein: The 5% reward?

Christine T. Komola - CFO: The 5% reward, no, that's basically we took from the previous program and reallocated the dollar. So, as of right now that hasn't had a big incremental expense to us at all.

Demos Parneros - President, North American Stores & Online: In fact, (Chris for a second), the 5% Back serves as a good trip generator back to the store. In terms of covering the cost and what return is needed, that's calculated into our expected lift for new enrollment and we are right on track, if not slightly ahead, to deliver on that. So, it's only two months in, but we are right on track with it. So we feel good about the program, the customer reaction and the financials as well.

Colin McGranahan - Sanford Bernstein: Secondly, on pricing. Ron, I know in the past you had said, you thought you were still a couple of percent away from where you wanted to be. How do you feel you are today relative to your most competitive online competitors?

Ronald L. Sargent - Chairman and CEO: I think we're going to continue to invest in price. I think we have over the last 12 months and I think we will continue to do that, to look at individual SKUs and the elasticity of product line. We made pricing a bit differently in the online world than we would in the retail world. Having said all that, I mean on the contract side, we've got 3,000 sales reps out there and I would guess that our pricing is much better than you'll see in any online competitors. So, I think our challenge on pricing and we are continuing to invest is really on the and I think with price matching as needed in the stores, we're going to continue to look and spending a lot energy understanding pricing in every segment of our business, we are looking at more dynamic pricing, but, yeah, I think pricing is going to be one of those few things, but I don't think that's the only reason customers choose to shop our online business or even our retail business, even more importantly.

Colin McGranahan - Sanford Bernstein: Then on the new categories. Ron you said you are pleasantly surprised that some of the pickup as you've added assortment. Any particular areas or categories that have been surprisingly positive? It is a pretty broad swath of stuff out there from one educational product to large-screen TVs to feeding tubes. So I'm wondering what really is starting to resonate as you added that assortment.

Ronald L. Sargent - Chairman and CEO: I don't want to get into kind of what's selling, because I don't want to invent competitor strategies for them on our conference calls, but the one we've focused on most of all and we have talked most about is facilities and breakroom. That's been a home run, but I think there's going to be some other home runs on the online world as we expand the assortment as well. But I just don't want to get into which categories are doing well and which are doing poorly.

Colin McGranahan - Sanford Bernstein: Final quickie. Demos, how would you handicap the odds of getting Apple hardware by back-to-school?

Demos Parneros - President, North American Stores & Online: Obviously, we are working with Apple very closely. The relationship has been very good. We have a great relationship in Canada. The U.S. program has been very good so far. Don't have a definitive answer, but we are moving in that direction and that's our hope.

Colin McGranahan - Sanford Bernstein: Sounds better than 50-50 to me.

Operator: Katherine McShane, Citigroup.

Katherine McShane - Citigroup: I was wondering if you could talk to us a little bit about I know you've just made the hire for your new digital officer and was it being such a big part of your contract business and you were one of the early movers to the dotcom business. What capabilities are you hoping to improve upon and what can we expect to see from that over the next 12 months?

Ronald L. Sargent - Chairman and CEO: I think in some respects I think we're pretty good in the online world and some we're not. I think when you look at the fact that we do next day delivery to 98% of North America and we do it free. I think that's pretty good logistics. I think tying into the marketplace wholesalers and super sellers, I think we're well on our way there, but in terms of investments, we got a lot to do to improve the frontend of our business. I don't think our website is nearly as good as some of the online competitors and I think we got to get a lot better at that. I think dynamic pricing is something we need to play catch up with some of our online competitors. I think there is a little difference in that. We're more of a business-to-business play versus lot of online competitors are really going after consumer. So the needs of businesses are a little more unique, and the fact that we have thousands of sales rep who actually negotiate individual pricing with millions of customers. I think that makes is a little different as well, but in terms of where I would place the energy in the investment it would be to improve the shopping experience on our website and I think it would probably be – to be a little more nimble in the area of pricing. Those would probably be the areas where I would place my emphasis, I don't know, Demos?

Demos Parneros - President, North American Stores & Online: That's right on. I think the only other thing I'd add to that is on the pricing, it's not really the pricing and the dynamic pricing that Ron described, but also the sequencing and the coordination with our store pricing. I am really encouraged by the omni-channel activity in stores. Customers are very receptive to walking into a store and really interacting with our sales people on the floor and finding what they need and often pleasantly surprised. The only other area I'd add is just the continuing aggressive customer acquisition that we're doing to build our file, so that's kind of the workload going forward and the momentum is building.

Ronald L. Sargent - Chairman and CEO: You've got a – you think about what we're trying to do here. I mean at some point you've got to aggressively go out and tell customers either digitally or in more traditional marketing vehicles that Staples, you can buy a lot more than just office supplies at Staples and we're much broader than we have been in the past in terms of what we can do for you.

Joseph G. Doody - President, North American Commercial: Ron, sorry, this is Joe. I'll comment just one step further. I think with the expanded assortment, I think our website has to become much better at being able to sell that expanded assortment to a customer without confusing them, but also all of our websites have to take advantage of all the knowledge and information that we have. We know what they bought, we also know what they haven't bought, so how do we best present to them those opportunities and areas that they haven't bought, but they probably are buying from somebody else and become really single source of provider to them with our broader assortment. So I think that's a real opportunity from a website standpoint.

Katherine McShane - Citigroup: Then just my second question, with your Quill results which seemed very encouraging. Is there any kind of macro read through from the improvement there? Obviously, the expanded assortment is helping, but from that particular customer, do you see that customer getting healthier?

Joseph G. Doody - President, North American Commercial: Well, I think it's – really, Kate, it's in terms of Quill, they did invest in marketing, so we had a marketing investment that we made during the quarter and they help drive a mid-single-digit growth in new customers for them. Then on top of the expanded assortment that we've added as well as our continued growth in facilities and breakroom with existing customers helped us to get a bigger share of wallet of those existing customers, as well as add on some new customers. So they've got a good strong solid base of customers, very loyal base of customers and we just were able to acquire some more than we have been in the past due to our marketing investment in the quarter, as well as just do a better job of selling the expanded assortment into the existing customer base.

Katherine McShane - Citigroup: Is that higher level of marketing investments going to continue throughout the year? Will we see it accelerate?

Joseph G. Doody - President, North American Commercial: Yeah, I wouldn't say we see it accelerate, but we'll see it certainly continue to make that investment, especially if we see the results that we've seen through the first quarter.

Operator: Matthew Fassler, Goldman Sachs.

Matthew Fassler - Goldman Sachs: A question that I think perhaps ties together so many other questions my peers have asked this morning. You're clearly investing in the business to reinforce your competitive standing, most notably versus the online channel. How do you know when you're done? What are the markers of, I wouldn't say satisfaction but if you think about your end game, is it pricing parity? Is it – can it be reflected market share trends, just as we think about this as an investment year, which is basically baked into your guidance and into consensus and we start to think about what 2014 or 2015 might look like, how should we think about what you guys will see as a management team that will establish that the investment has essentially achieved its goal? Is it impossible to think about what that end game is or is it premature to think about what that end game is or is it premature to think about what those milestones might be?

Ronald L. Sargent - Chairman and CEO: We are probably not – ever going to be done, to tell you the truth. I mean we are kind of a Company that feels like there's always more to do and on this one we do as well. We're not trying to be kind of an online consumer or kind of a consumer play. I think we kind of said what's unique about our Company and your whether that's the fact we do have stores, which I think are really important. Our customer base is B2B, I mean service in terms of not only free next day delivery, but we can put it where you want when you want it. Whether it's negotiated pricing, whether it's the handholding of the sales force or the fact that our deliveries go on 1,400 Staples trucks or we've got 25 million rewards members, we've got relationships with 10 million SMB customers and so we're trying to find the right balance between kind of the fact that we are historically a retail player, but we have increasingly focused on the online and the delivery side of our business. So I think the model is going to continue to evolve to make us more competitive every year and every quarter and whether that's more assortment or whether it's more investments in online or more investments in omni-channel, that's kind of a plan. I mean obviously I'm going to determine success by one of the things I said earlier, we got to grow the top line and we want to aggressively grow the top line and we've certainly got to demonstrate that we can operate a business in Europe and I am not sure we've done that over the last couple of years. So obviously growing sales, growing profits, creating shareholder value, I mean that's kind of what I'm all about and if I feel like I'm doing then I feel like we are making progress.

Katherine McShane - Citigroup: I appreciate the complexity and kind of the challenge. Just one follow-up. If you think about some of the basic objective benchmarks; your pricing, your delivery policies, the kind of membership program you aspire to, is all of that essentially done by yearend. If you think about what it takes you to get to what you view those market parity understanding that there might be other changes in investments, but are you sort of caught up with where you're thinking it to be in the marketplace by yearend '13?

Ronald L. Sargent - Chairman and CEO: I mean I think we're going to make a huge amount of progress. We said this was going to be kind of one of those reset years where we're going to have flat earnings per share because we need to reposition and restructure and kind of reinvent the Company. I think we're going to make a lot of progress by yearend. Do I think we're going to be as good as some of our online players in the area of IT or website functionality or search engine optimization? I think we're probably still going to have – kind of have to get a lot better there to really be a big, big time player in the Online world of future.

Operator: (Greg Hessler, Bank of America).

Greg Hessler - Bank of America: So you're cash flow from operations ended up coming in pretty strong in the first quarter. I think it was like $348 million versus about $1.50 million last year. What were the key drivers of that and did you expect that heading into the quarter?

Christine T. Komola - CFO: Sure, Greg. Yes. The biggest driver was AP. The timing of our accounts payable on a 53-week last year was unusual. So we did expect it. We expect it will even out throughout the year. That was the main point of it.

Greg Hessler - Bank of America: Okay. So we shouldn't take this quarter and sort of extrapolate it. I'm just trying to figure out if there is upside to your $900 million free cash flow guidance.

Christine T. Komola - CFO: We will be over $900 million. So how much upside, we're not going to – ready to predict, but we will be over the $900 million.

Ronald L. Sargent - Chairman and CEO: We should note that we've got a big debt to payback in January of next year which – I think $867 million that we will be paying back out of cash next January.

Operator: Thank you very much indeed for your questions. Ladies and gentlemen, I would now like to turn the call over to Ron Sargent for the closing remarks.

Ronald L. Sargent - Chairman and CEO: My closing remarks are brief. Thanks for joining us on the call this morning. We look forward to speaking to all of you again very soon.

Operator: Thank you for joining today's conference. Ladies and gentlemen, this concludes the presentation. You may now disconnect. Have a very good day.