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SPLS > SEC Filings for SPLS > Form 10-Q on 15-Aug-2012All Recent SEC Filings

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Form 10-Q for STAPLES INC


15-Aug-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward Looking Statements

This Quarterly Report on Form 10-Q and, in particular, this management's discussion and analysis contain or incorporate a number of forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934 (the "Exchange Act"). Any statements contained in or incorporated by reference into this report that are not statements of historical fact should be considered forward-looking statements. You can identify these forward-looking statements by the use of the words "believes", "expects", "anticipates", "plans", "may", "will", "would", "intends", "estimates" and other similar expressions, whether in the negative or affirmative. These forward-looking statements are based on current expectations, estimates, forecasts and projections about the industry and markets in which we operate and management's beliefs and assumptions, and should be read in conjunction with our condensed consolidated financial statements and notes to condensed consolidated financial statements included in this report. Staples, Inc. and its subsidiaries ("we", "our" or "us") cannot guarantee that we actually will achieve the plans, intentions or expectations disclosed in the forward-looking statements made. There are a number of important risks and uncertainties that could cause our actual results to differ materially from those indicated by such forward-looking statements. These risks and uncertainties include, without limitation, those set forth under the heading "Risk Factors" of this Quarterly Report on Form 10-Q. We do not intend to update publicly any forward-looking statements whether as a result of new information, future events or otherwise.

Results of Operations

Major contributors to our second quarter of 2012 results, as compared to the results for the second quarter of 2011, are reviewed in detail in the Consolidated Performance and Segment Performance discussions and are summarized below:

On a consolidated basis, we generated $5.5 billion in sales, a decline of 5.5%;

North American Delivery's sales decreased 0.8%, and business unit income rate decreased to 7.7% from 8.4%;

North American Retail's sales decreased 2.7%, comparable store sales decreased 2%, and business unit income rate decreased to 4.4% from 5.0%;

International Operations' sales decreased 18.2%, including the unfavorable impact of foreign exchange rates, and business unit (loss) income rate decreased to (2.0)% from 1.2%;

Net income attributed to Staples, Inc. for the second quarter of 2012 was $120.4 million or $0.18 per diluted share compared to $176.4 million or $0.25 per diluted share for the second quarter of 2011; and

Our quarterly income tax rate was 32.5% compared to 25.7% in the prior year.

Outlook

Our results for the second quarter were weaker than expected. As a result, we are adopting a more conservative sales and earnings outlook. Current expectations for 2012 assume slower growth in the U.S. economy, continued weakness in the demand environment in Europe and an unfavorable impact from foreign exchange rates. Including the impact of the 53rd week in 2012, we now expect full year sales to be flat compared to 2011 and earnings per diluted share to grow in the low single-digits compared to non-GAAP earnings per diluted share in 2011. In 2011, earnings per diluted share was $1.40 on a U.S. GAAP basis and $1.37 on a non-GAAP basis, which excludes the $0.03 per share impact of a $20.8 million tax refund received from the Italian government.

Non-GAAP Measures

In our analysis of the results of operations below, we have referred to non-GAAP financial measures related to net income and earnings per share, which reflect adjustments to exclude the impact of a non-recurring tax refund received in the second quarter of 2011. We believe these non-GAAP financial measures better enable management and investors to understand and analyze our performance by providing meaningful information relevant to events of a non-recurring nature that impact the comparability of


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underlying business results from period to period. However, these supplemental measures should be considered in addition to, and not as a substitute for or superior to, the related measures that are determined in accordance with GAAP. Reconciliations of the non-GAAP measures to their corresponding GAAP measures are included in the analysis of our consolidated performance below.

Net income attributed to Staples, Inc. for the second quarter of 2012 was $120.4 million or $0.18 per diluted share compared to $176.4 million or $0.25 per diluted share for the second quarter of 2011. Net income attributed to Staples, Inc. for the first half of 2012 was $307.5 million or $0.45 per diluted share compared to $374.7 million or $0.53 per diluted share for the first half of 2011. Our results for the second quarter and first half of 2011 include the receipt of a $20.8 million refund from the Italian government related to an overpayment of income taxes in previous years. A reconciliation of net income adjusted to remove the 2011 tax refund is shown below (amounts in thousands, except for share data):

                                                      13 Weeks Ended                                                      26 Weeks Ended
                                       July 28, 2012                     July 30, 2011                     July 28, 2012                     July 30, 2011
                                                Per  Diluted                     Per  Diluted                       Per  Diluted                     Per  Diluted
                               Net income          Share          Net income        Share          Net income          Share          Net income        Share
Net income as reported       $    120,429     $         0.18     $  176,438     $      0.25      $    307,488     $         0.45     $  374,683     $      0.53
Adjustments, net of taxes:
Tax refund                              -                  -        (20,800 )         (0.03 )               -                  -        (20,800 )         (0.03 )
Non-GAAP adjusted net income $    120,429     $         0.18     $  155,638     $      0.22      $    307,488     $         0.45     $  353,883     $      0.50

Consolidated Performance

Second Quarter of 2012 Compared to the Second Quarter of 2011

Sales: Sales for the second quarter of 2012 were $5.50 billion, a $321.1 million or 5.5% decrease from the second quarter of 2011. The sales decline reflected a $142.6 million unfavorable impact from foreign exchange rates, decreased volumes in International Operations and a 2% decline in comparable store sales in North American Retail. Ongoing weakness in the sales environment and reduced consumption in core categories were the primary factors contributing to our sales decline.

Gross Profit: Gross profit as a percentage of sales was 26.0% for the second quarter of 2012 compared to 26.5% for the second quarter of 2011. The decrease in gross profit rate for the second quarter of 2012 was primarily driven by lower product margins in North American Delivery and International Operations and by deleverage of fixed costs in International Operations and North American Retail due to a decline in sales. The lower product margins in North American Delivery and International Operations reflected inflationary pressures on core office supplies and investments to drive sales and customer loyalty, and, with respect to International Operations, adverse customer and product mix in Europe. These unfavorable drivers were partially offset by improvements in North American Retail product margins driven by a favorable shift in sales mix.

Selling, General and Administrative Expenses: Selling, general and administrative expenses decreased by $53.6 million from the second quarter of 2011 to the second quarter of 2012, reflecting a reduction in marketing expense and a $13.3 million decrease in stock-based compensation expense due to a change in the structure of management compensation. These reductions were partially offset by increased costs associated with legal settlements. As a percentage of sales, selling, general and administrative expenses were 21.7% for the second quarter of 2012 compared to 21.4% for the second quarter of 2011, reflecting deleverage of labor costs on lower sales.

Amortization of Intangibles: Amortization of intangibles was $14.8 million for the second quarter of 2012 compared to $16.2 million for the second quarter of 2011, primarily reflecting the amortization of trade names, customer relationships and noncompetition agreements related to Corporate Express. Amortization of intangibles resulting from our acquisition of Corporate Express was $12.3 million for the second quarter of 2012 and $13.2 million for the second quarter of 2011.

Interest Income: Interest income was $1.5 million for both the second quarter of 2012 and the second quarter of 2011. An unfavorable impact from lower interest rates was offset by a favorable impact from higher international cash balances for the second quarter of 2012.

Interest Expense: Interest expense decreased slightly to $41.8 million for the second quarter of 2012 from $41.9 million for the second quarter of 2011. Our interest rate swap agreements reduced interest expense by $6.0 million for the second quarter


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of 2012 compared to a reduction of $7.0 million for the second quarter of 2011.

Other Expense: Other expense was $1.4 million for the second quarter of 2012 compared to $0.4 million for the second quarter of 2011. The increased expense was primarily due to foreign exchange losses in the second quarter of 2012.

Income Taxes: Our tax rate was 32.5% for the second quarter of 2012 compared to 25.7% for the second quarter of 2011. The increase in the tax rate was primarily due to a tax benefit of $20.8 million in the second quarter of 2011 related to a refund due to Corporate Express from the Italian government that was previously deemed uncollectible, which was recorded as a discrete item in the second quarter of 2011.

Our effective tax rate in any year is impacted by the geographic mix of earnings. Additionally, certain foreign operations are subject to both U.S. and foreign income tax regulations, and as a result, income before tax by location and the components of income tax expense by taxing jurisdiction are not directly related. The earnings generated primarily by our entities in Australia, Canada, Hong Kong and the Netherlands contributed to the foreign tax rate differential impacting the effective tax rate.

First Half of 2012 Compared to the First Half of 2011

Sales: Sales for the first half of 2012 were $11.60 billion, a $389.2 million or 3.2% decrease from the first half of 2011. The decline reflects decreased sales in International Operations, a $198.9 million unfavorable impact from foreign exchange rates and a 1% decline in comparable store sales in North American Retail, partially offset by growth in our North American Delivery business.

Gross Profit: Gross profit as a percentage of sales was 26.2% for the first half of 2012 compared to 26.5% for the first half of 2011. The decrease in gross profit rate was primarily driven by lower product margins in North American Delivery and International Operations and by deleverage of fixed costs in International Operations and North American Retail due to a decline in sales. The lower product margins in North American Delivery and International Operations reflected inflationary pressures on core office supplies, investments to drive sales and customer loyalty and, with respect to International Operations, adverse customer and product mix in Europe. These unfavorable drivers were partially offset by improvements in North American Retail product margins driven by a favorable shift in sales mix.

Selling, General and Administrative Expenses: Selling, general and administrative expenses decreased by $48.0 million from the first half of 2011 to the first half of 2012, reflecting a reduction in marketing expense and a $17.6 million decrease in stock-based compensation expense due to a change in the structure of management compensation. These reductions were partially offset by severance-related expenses and increased costs associated with legal settlements. As a percentage of sales, selling, general and administrative expenses were 21.3% for the first half of 2012 compared to 21.0% for the first half of 2011, reflecting deleverage of labor costs on lower sales.

Amortization of Intangibles: Amortization of intangibles was $30.1 million for the first half of 2012 compared to $33.5 million for the first half of 2011, primarily reflecting the amortization of trade names, customer relationships and noncompetition agreements related to Corporate Express. Amortization of intangibles resulting from our acquisition of Corporate Express was $24.9 million for the first half of 2012 and $27.5 million for the first half of 2011.

Interest Income: Interest income was $3.1 million for the first half of 2012 compared to $4.0 million for the first half of 2011. The decrease was due to a decline in interest rates, partially offset by higher international cash balances.

Interest Expense: Interest expense decreased to $84.1 million for the first half of 2012 from $90.7 million for the first half of 2011. This decrease was primarily due to a reduction in debt balances resulting from the payoff of the $500 million, 7.75% notes (the "April 2011 Notes") and the pay-down and refinancing of certain debt and liquidity facilities. Our interest rate swap agreements reduced interest expense by $12.1 million for the first half of 2012 compared to $14.2 million for the first half of 2011.

Other Expense: Other expense was $1.7 million for the first half of 2012 compared to $0.6 million for the first half of 2011. The increased expense was primarily due to foreign exchange losses in the first half of 2012.

Income Taxes: Our tax rate was 32.5% for the first half of 2012 compared to 30.6% for the first half of 2011. The increase in the tax rate was due to a tax benefit of $20.8 million realized in the first half of 2011 related to a refund due to Corporate Express from the Italian government that was previously deemed uncollectible, which was recorded as a discrete item.

Our effective tax rate in any year is impacted by the geographic mix of earnings. Additionally, certain foreign operations are subject to both U.S. and foreign income tax regulations, and as a result, income before tax by location and the components of


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income tax expense by taxing jurisdiction are not directly related. The earnings generated primarily by our entities in Australia, Canada, Hong Kong and the Netherlands contributed to the foreign tax rate differential impacting the effective tax rate.

Segment Performance

We have three reportable segments: North American Delivery, North American Retail and International Operations. Our North American Delivery segment consists of the U.S. and Canadian businesses that sell and deliver office products and services directly to consumers and businesses and includes Staples Advantage, Staples.com and Quill.com. Our North American Retail segment consists of the U.S. and Canadian businesses that operate stores that sell office products and services. Our International Operations segment consists of businesses that operate stores and that sell and deliver office products and services directly to consumers and businesses in 24 countries in Europe, Australia, South America and Asia.

Business unit income excludes stock-based compensation, interest and other expense, non-recurring items and the impact of changes in accounting principles (see reconciliation of total business unit income to consolidated income before taxes in Note K in the Notes to the Condensed Consolidated Financial Statements).

Second Quarter of 2012 Compared to the Second Quarter of 2011

The following tables provide a summary of our sales and business unit income by
reportable segment for the second quarter of 2012 and 2011:
                                                                              July 28, 2012     July 30, 2011
                                            (Amounts in thousands)
                                                13 Weeks Ended                  Decrease          Increase
                                                                                  From              From
                                       July 28, 2012       July 30, 2011       Prior Year        Prior Year
Sales:
North American Delivery              $     2,412,755     $     2,433,217           (0.8 )%             3.1 %
North American Retail                      1,989,139           2,045,143           (2.7 )%             1.7 %
International Operations                   1,096,602           1,341,252          (18.2 )%            15.2 %
Total segment sales                  $     5,498,496     $     5,819,612           (5.5 )%             5.2 %



                                           (Amounts in thousands)
                                               13 Weeks Ended               July 28, 2012     July 30, 2011
                                      July 28, 2012      July 30, 2011       % of Sales        % of Sales
Business Unit Income (Loss):
North American Delivery              $    185,767      $       204,765           7.7  %             8.4 %
North American Retail                      88,413              102,872           4.4  %             5.0 %
International Operations                  (22,081 )             16,576          (2.0 )%             1.2 %
Business unit income                 $    252,099      $       324,213           4.6  %             5.6 %

North American Delivery: Sales decreased by $20.5 million or 0.8% for the second quarter of 2012. This decrease was driven by the decision late in the prior year to not renew two large customer contracts, which did not deliver adequate returns, as well as an unfavorable impact from foreign exchange rates of $10.2 million. These declines were partially offset by increased sales of facilities and breakroom supplies and promotional products.

Business unit income as a percentage of sales decreased to 7.7% for the second quarter of 2012 from 8.4% for the second quarter of 2011. The decrease was driven by inflationary pressures on core office supplies, investments to drive growth and loyalty in our on-line businesses and increased costs associated with legal settlements, partially offset by a reduction in marketing expense.

North American Retail: Sales decreased by $56.0 million or 2.7% for the second quarter of 2012. This decrease was primarily the result of a 2% comparable store sales decline and a $22.3 million unfavorable impact from foreign exchange rates, partially offset by non-comparable sales for new stores opened in the last twelve months. The decline in comparable store sales reflects a decrease in customer traffic and significant declines in sales of computers, software, and computer accessories. These sales decreases were partially offset by positive performance in copy and print services, mobile phones and accessories and facilities and breakroom supplies.

Business unit income as a percentage of sales decreased to 4.4% for the second quarter of 2012 from 5.0% for the second


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quarter of 2011. The decrease was driven by deleverage of rent and occupancy and labor expenses, as well as by costs associated with legal settlements. These unfavorable drivers were partially offset by improved product margins resulting from favorable sales mix and by a reduction in marketing expense.

International Operations: Sales decreased by $244.7 million or 18.2% for the second quarter of 2012, primarily as a result of weakness in our European and Australian businesses. Ongoing weakness in the sales environment drove a 9% decline in comparable store sales in Europe, as well as declines in the company's European delivery businesses. In addition, foreign exchange rates negatively impacted sales by $110.1 million.

Business unit (loss) income as a percentage of sales decreased to (2.0)% for the second quarter of 2012 from 1.2% for the second quarter of 2011. This decline reflects deleverage of fixed costs on lower sales in our European and Australian businesses, and declines in European product margins due to a combination of adverse customer and product mix as well as an increase in investments to drive sales.

First Half of 2012 Compared to the First Half of 2011

The following tables provide a summary of our sales and business unit income by
reportable segment for the first half of 2012 and 2011:
                                                                             July 28, 2012        July 30, 2011
                                        (Amounts in thousands)
                                            26 Weeks Ended                Increase (Decrease)        Increase
                                                                                 From                  From
                                   July 28, 2012       July 30, 2011          Prior Year            Prior Year
Sales:
North American Delivery          $     4,967,826     $     4,944,863                0.5  %               2.5 %
North American Retail                  4,312,970           4,373,228               (1.4 )%               1.2 %
International Operations               2,322,525           2,674,459              (13.2 )%               9.3 %
Total segment sales              $    11,603,321     $    11,992,550               (3.2 )%               3.5 %



                                       (Amounts in thousands)
                                           26 Weeks Ended               July 28, 2012      July 30, 2011
                                  July 28, 2012      July 30, 2011        % of Sales        % of Sales
Business Unit Income (loss):
North American Delivery          $    386,726      $       401,615            7.8  %             8.1 %
North American Retail                 255,368              280,221            5.9  %             6.4 %
International Operations              (40,851 )             26,100           (1.8 )%             1.0 %
Business unit income             $    601,243      $       707,936            5.2  %             5.9 %

North American Delivery: Sales increased by $23.0 million or 0.5% for the first half of 2012, reflecting increased sales of facilities and breakroom supplies, promotional products and copy and print services. These favorable drivers were partially offset by the impact of the decision late in the prior year to not renew two large customer contracts which did not deliver adequate returns and by an unfavorable impact of foreign exchange rates of $14.9 million.

Business unit income as a percentage of sales decreased to 7.8% for the first half of 2012 from 8.1% for the first half of 2011. The decrease was driven by inflationary pressures on core office supplies, investments to drive growth and loyalty in our on-line businesses and increased costs associated with legal settlements, partially offset by a reduction in marketing expense and increased supply chain efficiencies.

North American Retail: Sales decreased by $60.3 million or 1.4% for the first half of 2012. The decrease was primarily the result of a 1% comparable store sales decline and a $33.2 million unfavorable impact from foreign exchange rates, partially offset by non-comparable sales for new stores opened in the past twelve months. The decline in comparative store sales reflects a decrease in customer traffic. Declines in software, computers, and paper were partially offset by positive performance in copy and print services, mobile phones and accessories, e-readers and facilities and breakroom supplies.

Business unit income as a percentage of sales was 5.9% in the first half of 2012 compared to 6.4% in the first half of 2011, The decrease was driven primarily by deleverage of rent and occupancy costs and labor expenses, as well as legal settlements and related costs. These expenses were partially offset by a reduction in marketing expenses and improved product margins resulting


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from favorable sales mix.

International Operations: Revenue decreased by $351.9 million or 13.2% for the first half of 2012 as a result of decreased sales in our European and Australian businesses. Broad-based weakness in the sales environment drove a 7% decrease in comparable store sales in Europe, as well as declines in the company's European delivery businesses. In addition, foreign exchange rates negatively impacted revenue by $150.8 million.

Business unit (loss) income as a percentage of sales decreased to (1.8)% for the first half of 2012 from 1.0% for the first half of 2011. The decrease reflects deleverage of fixed costs on lower sales in our European and Australian businesses, an increase in severance-related costs across our International businesses, and declines in European product margins resulting from adverse customer and product mix and an increase in investments to drive sales.

Critical Accounting Policies and Significant Estimates

Our condensed consolidated financial statements have been prepared in accordance with U.S. GAAP. Preparation of these statements requires management to make significant judgments and estimates. Some of our accounting policies require estimates which may have a significant impact on amounts reported in these financial statements. A summary of our critical accounting policies and significant estimates may be found in our 2011 Annual Report on Form 10-K, filed on February 29, 2012 ("Annual Report") in the Critical Accounting Policies and Significant Estimates section of Management's Discussion and Analysis of Financial Condition and Results of Operations. There have been no material changes to our critical accounting policies as disclosed in that report. Since the filing of our Annual Report, the political and economic environment in Europe has not improved, the operating results for our European businesses have not met our expectations, and the short-term outlook for these businesses remains challenging to predict. Despite this short-term instability and uncertainty, our long-term outlook for these businesses has not yet changed and we remain confident in our ability to return to or exceed the levels of operating performance which these businesses experienced in the past. However, because of the long-term nature of our sales and profit projections and the increased uncertainty in the short-term, we continue to closely monitor events and trends in Europe to assess whether any factors indicate that it is more likely than not that any of our reporting units' fair values have declined below their carrying values. Given the ongoing instability and uncertainty in the region, we think it is reasonably possible that an interim goodwill impairment test may be required in our third quarter.

Liquidity and Capital Resources

Cash Flows

Cash provided by operations was $256.8 million for the first half of 2012 compared to $302.2 million for the first half of 2011, a decrease of $45.4 million. The decrease was primarily due to a year-over-year decline in net income adjusted for non-cash expenses and the timing of income tax payments, . . .

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