Staples Management Discusses Q3 2013 Results - Earnings Call Transcript

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 |  About: Staples, Inc. (SPLS)
by: SA Transcripts

Staples (NASDAQ:SPLS)

Q3 2013 Earnings Call

November 20, 2013 8:00 am ET

Executives

Chris Powers

Ronald L. Sargent - Chairman, Chief Executive Officer and Chairman of Executive Committee

Christine T. Komola - Chief Financial Officer and Executive Vice President

Joseph G. Doody - President of North American Commercial

Demos Parneros - President of North American Stores & Online

Analysts

Daniel T. Binder - Jefferies LLC, Research Division

Michael Lasser - UBS Investment Bank, Research Division

Christopher Horvers - JP Morgan Chase & Co, Research Division

Gregory S. Melich - ISI Group Inc., Research Division

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

Aram Rubinson - Wolfe Research, LLC

Michael Baker - Deutsche Bank AG, Research Division

Gary Balter - Crédit Suisse AG, Research Division

Gregory Hessler - BofA Merrill Lynch, Research Division

Anthony C. Chukumba - BB&T Capital Markets, Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Q3 2013 Staples, Inc. Earnings Conference Call. My name is Michelle, and I will be your operator today. [Operator Instructions] As a reminder, this call is being recorded for replay purposes. I would now like to hand over to Mr. Chris Powers, Director of Investor Relations. Please proceed, sir.

Chris Powers

Thanks, Michelle. Good morning, everyone, and thank you for joining us for our third 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 www.staples.com 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' third 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

Thanks, Chris, and good morning, everybody. Thanks for joining us today. This morning, we reported our financial results for the third quarter of 2013.

Total company sales were $6.1 billion, which was a decrease of 4% versus Q3 of last year. If you exclude the negative impact of stores that we closed in the 12 months prior to Q3, as well as the stronger U.S. dollar, total company sales were down about 2% year-over-year.

During the third quarter, we grew sales in staples.com, quill.com and our North American contract business. This was offset by continued weakness in our International business and North American stores.

Taking a look at growth trends by category. Ink, toner, paper and core office supplies, which make up about 60% of our sales, was a little below the total company average. Categories beyond office supplies, which account for about 40% of sales, performed better than the house despite continued weakness in business machines, as well as computers.

During the third quarter, we took aggressive action to streamline our organization. This resulted in severance expense, which negatively impacted our third quarter earnings by about $0.08 a share. Excluding this charge, earnings per share from continuing operations were $0.42. On a GAAP basis, we reported earnings per share of $0.34 from continuing operations.

It's been about a year since we announced our plan to reinvent Staples. Our vision is to be the destination for every product that businesses need to succeed. While trends in core office supplies remained tough during the third quarter, we continued taking important steps to evolve our business and meet the changing needs of our customers. So let me take a few minutes to update you on our recent progress.

First, we continue to drive growth online. staples.com sales were up 3% versus Q3 of last year. During the third quarter, we launched the biggest refresh to staples.com and staples.ca since 2005. Our top priority was to improve the customer experience. We updated our online storefront. We made the site 40% faster and much simpler to navigate. We enhanced the search experience with improved speed and relevance of results, and we integrated Staples Rewards, which resulted in a much more simplified checkout process.

Today, Staples is the second-largest retailer in the world. While our foundation is solid, we need to continue improving our capabilities to better serve our customers. During the third quarter, we added data sciences expertise and a Silicon Valley presence with the acquisition of Runa. The team at Runa will help drive increased customer engagement by delivering personalized offers in real time.

We've already started to integrate some of these capabilities with the launch of our new staples.com website, and we're confident that will help accelerate sales growth going forward.

In addition to Runa, we're adding new talent to the organization to support our digital initiatives. During the third quarter, we opened a Seattle Development Center to tap into the wide range of talented engineers, e-commerce and creative professionals in that market. We also added new leadership to our global IT organization during the quarter. I'm excited to have Tom Conophy join our team as Staples' Chief Information Officer. Prior to Staples, Tom served as CIO for InterContinental Hotels, and he has a broad range of experience in the hospitality and airline industries. His technical expertise and history of success driving online transformations and customer engagement will be extremely valuable as we reinvent Staples.

In terms of expanding our assortment in categories beyond office supplies, during the third quarter, we added another 70,000 new products on staples.com in areas like furniture, office decor and education. We continue to add assortment to quill.com and staples.ca as well.

During Q3, we also took a big step toward becoming the technology destination for business customers as we expanded our relationship with Apple. We're very excited to now offer the latest assortment of iPads on staples.com, quill.com and staplesadvantage.com.

Our business customers have told us that they trust Staples to provide them with many more categories beyond office supplies. So we're aggressively pursuing this opportunity by adding a wide assortment of products that are tailored to specific industries.

Our offering of 20,000 retail store supplies is gaining momentum. And over the coming weeks, we'll launch a broad assortment of 20,000 restaurant supplies. We're in the early innings of our vertical strategy and have plans to expand our offering to serve many more industries in the coming months.

At the end of Q3, the expanded assortment on staples.com, staples.ca and quill.com was driving over $3 million in incremental sales per week. With over 200,000 products online today, we're right on track to surpass 300,000 SKUs by year end.

Turning to the reinvention of our contract sales force. Our goal here is to become the #1 commercial player in categories beyond core office supplies. Earlier this year, we developed a new selling approach, which is much more unified and collaborative. It focuses on growing our share in adjacent categories like facilities and breakroom supplies, furniture, technology, print, promotional products.

To accelerate growth, we replaced some of our office product sales reps with specialists in these adjacent categories. We also moved some administrative tasks offshore to provide our strategic account leaders with an extra day of selling per week. Based on the success of our pilot, we're in the process of rolling out this new team selling model across the organization. We're on track to grow sales in these adjacent categories by about $200 million in North American Commercial this year.

We also continue to drive growth in our services business. Copy and print sales in North American Stores & Online were up mid-single-digits during the third quarter. This growth was supported by additional services in stores, as well as solid growth online. Our retail copy and print sales force continues to drive strong double-digit growth. And to unlock even more potential, we're aligning our retail copy and print account managers with our contract sales force. This should help win rates and also drive more print volume to our stores.

In terms of cost-out initiatives, we took significant steps to streamline our organization and reduce costs during Q3. We eliminated more than 1,400 positions across the company. This included about 15% of vice presidents and directors in North America.

At the beginning of the year, we committed to driving $150 million in gross savings in 2013. In addition to overhead costs, we've had good success reducing cost of goods sold, streamlining our retail and contract organizations, reducing nonproduct-related costs and outsourcing lower complexity tasks. And as a result, we achieved our 2013 cost reduction goal ahead of schedule.

Demand for core office supplies has been weaker than we expected this year, and we remain committed to invest to drive growth beyond office supplies. As a result, we're taking a much harder look at additional opportunities to reduce costs and drive a new approach to the way we do business going forward.

We've appointed Mike Patriarca, a 20-year Staples veteran, to lead this effort. Prior to his new role, Mike was the head of our quill.com business, and he has a deep understanding of our existing business practices, as well as our reinvention priorities. We've got a lot of work to do as we build our long-range plan and look forward to providing more details when we announce our Q4 results in early March.

We remain focused on driving retail productivity by rationalizing our North American store network and improving our omnichannel offering. During the third quarter, we closed 7 stores. We downsized and relocated 3 stores. We now have 11 of our new 12,000 square-foot stores open, and we continue to retain more than 95% of our sales in those stores.

We also continue to drive double-digit growth sales in our in-store staples.com kiosk, which is supported by our expanded assortment, as well as improved customer service. For the full year, we remain on track to close 40 stores, and downsize and relocate about 45 [ph] of our new 12,000 square-foot stores by year end.

In Europe, the team continues working hard to improve profitability. We're taking cost out of the business by reducing headcount, consolidating operations, streamlining our pan-European assortment and reducing nonproduct-related costs.

Over the past year, we've eliminated more than 1,000 positions in Europe, and we're taking out more than 600 positions as part of our Q3 headcount reduction. All in, these actions will reduce our European workforce by about 20% over a 2-year period.

We're also narrowing our focus on core businesses where we have scale. And during the third quarter, we completed the sale of our noncore European Printing Systems division.

We got a lot done in the first year of our reinvention. We expanded our assortment beyond office supplies. We built a stronger foundation for growth online. We've closed over 100 unproductive stores. We added new talent to our leadership team and on our board. We made some difficult decisions to reduce headcount and cut expenses. And in the coming months, we'll relaunch our brand to let customers know that Staples offers every product their businesses need to succeed.

While we've accomplished many of our early reinvention goals, we've got a lot of work to do. We're holding ourselves accountable for getting back to growing sales and earnings, and our progress over the past year puts us in a much better position to accomplish this goal.

Now let's take a quick look at our Q3 results for each of our business units, and I'm going to start with North American Stores & Online. Sales for the third quarter were $3 billion. It was down 5% compared to Q3 of last year. In the 12 months prior to Q3 of this year, we closed 59 stores in North America, and this negatively impacted our Q3 sales growth by approximately 1%.

Third quarter same-store sales, which exclude staples.com sales, declined 3%. Customer traffic declined 3%, and average order size was flat. staples.com sales grew 3% versus the prior year, and this growth was supported by increased customer traffic and stable customer conversion, partially offset by lower average order size.

During the third quarter, growth in tablets, facilities and breakroom supplies and copy and print services was more than offset by weakness in office supplies, business machines and technology accessories, as well as computers.

North American Stores & Online operating margin decreased 88 basis points versus last year's third quarter to 9.5%. This was driven by increased cost relating to growth initiatives in staples.com and the negative impact of fixed expenses on lower sales, partially offset by reduced store labor expense and marketing expense.

The holiday selling season kicks off next week, and we've got big plans to drive traffic in our stores and on our websites. This year, we'll have some great deals the week of Black Friday through Cyber Monday, and our retail stores will be open on Thanksgiving for the first time in our history. We have a new Price Match Guarantee that matches prices in store and online with Amazon, as well as omnichannel retailers. And as always, we're helping Staples reward members save all season long with free shipping on all orders and 5% back in rewards. We're also launching New Daily Deals on staples.com and flash sales through our new and improved mobile app.

Moving to North American Commercial. Sales for the third quarter were $2.1 billion. That was an increase of 1% compared to last year. Sales in both contract and quill.com grew in the low-single digits during the quarter.

Growth remained strong in adjacent categories like facilities and breakroom supplies. We also saw solid growth in tablets and furniture. This momentum was partially offset by weakness in office supplies, paper and ink and toner.

North American Commercial operating margin for Q3 decreased 126 basis points versus last year to 7.6%. This reflects investments in sales force and marketing costs as we strengthen our team-based selling model and build awareness in categories beyond office supplies.

In International Operations, sales for the third quarter were $1 billion, a decline of 8% in U.S. dollars, as well as local currency versus Q3 of last year. The sales decline reflects ongoing weakness in European delivery, store closures in Europe and weakness in Australia. In the 12 months before Q3 of this year, we closed 48 stores in Europe, and this negatively impacted our Q3 sales growth for International by about 2%.

In Europe retail, same-store sales were down 2% during the second quarter -- I'm sorry, the third quarter, with sales per square foot up about 5%. Customer traffic, average order size each declined about 1%. Our European delivery businesses remained under pressure as the difficult macro trends in Europe and re-tender pressures from enterprise customers weighed on our results.

Across Europe, we continued to experience weak demand for ink and toner, core office supplies and business machines and technology accessories. During Q3, International operating margin improved 31 basis points versus last year to 0.2% of sales. But if you exclude $16 million of accelerated Australia tradename amortization during Q3 of last year, total International operating margin declined 111 basis points during the third quarter. This was driven by the negative impact of fixed expenses on lower sales, as well as lower product margins in Australia and European delivery. And that was partially offset by reduced marketing and rent expense.

And with that, I'll turn it over to Christine to review our financials.

Christine T. Komola

Thanks, Ron. Good morning, everyone. During the third quarter, total company sales were $6.1 billion, a decrease of 4% versus the third quarter of last year. In the 12 months preceding Q3 of 2013, we closed 107 stores in North America and Europe, which negatively impacted total company sales growth for the third quarter by about 1%. Excluding these closures, as well as the negative impact of the stronger U.S. dollar, total company sales were down about 2% during Q3.

Our third quarter GAAP earnings per share from continuing operations on a fully diluted basis was $0.34 versus a loss of $0.85 during the third quarter of 2012. Excluding $64 million of pretax charges related to employee severance and other associated restructuring activities during the third quarter of 2013, we achieved non-GAAP income from continuing operations of $274 million or $0.42 per diluted share. This compares to third quarter 2012 non-GAAP net income of $310 million or $0.46 per diluted share.

Gross profit margin for the third quarter decreased 50 basis points to 27.1% of sales. This decline reflects lower product margin. Additionally, we experienced rate headwind in core categories, as well as unfavorable mix due to sales growth in lower-margin categories like tablets. We also had a modest de-leverage of fixed expenses on lower sales in North American Stores & Online.

During the third quarter, we continued to aggressively manage expenses and reduced total company SG&A by $27 million. This reflects savings in lower stock-based compensation related to headcount reductions, changes in management incentive compensation and reduced marketing expense.

As a result of weak sales trends, SG&A, as a percentage of sales, did increase 33 basis points versus last year's third quarter to 19.8%. Year-to-date, we did have significant progress reducing our cost base. SG&A is down $92 million, net of investments we've made in our growth priorities. We've also hit our targets with vendor negotiations, indirect procurement and other cost-out efforts this year.

As Ron mentioned, we did achieve our goal of $150 million in growth savings ahead of schedule, and we're continuing to aggressively pursue additional cost-saving opportunities. Excluding the impact of the charges we took during the third quarter of this year and last year, non-GAAP operating income rate declined 82 basis points to 7% compared to the third quarter of 2012.

On a non-GAAP basis, our effective tax rate for the quarter was 32.5%, which excludes severance and other associated restructuring costs. Year-to-date capital expenditures were flat versus the prior year at $204 million with operating cash flow of about $875 million.

We did generate free cash flow of $671 million, and we remain on track to generate more than $900 million in free cash flow for the year. During the third quarter, we repurchased 6.8 million shares for $104 million, bringing our year-to-date repurchase to 18.2 million shares or $269 million. We plan to continue repurchasing common stock through open market purchases during Q4, and we also remain on track to repay with cash $867 million of debt, which matures during the fourth quarter.

At the end of Q3, 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.

Now turning to guidance. Consistent with last quarter, we expect full year 2013 sales to decrease in the low-single digits compared to 2012 sales on a 52-week basis of $23.9 billion. And we expect full year 2013 non-GAAP diluted earnings per share from continuing operations to be in the range of $1.21 to $1.25. Our 2013 EPS guidance excludes the charges we took during the third quarter related to severance expense and other associated restructuring activities.

Thanks for your time this morning. I'll now turn it back over to our conference call moderator for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] First question we have comes from the line of Dan Binder, and he's from Jefferies.

Daniel T. Binder - Jefferies LLC, Research Division

So I had a couple of questions for you. First, on the expanded assortments online. I think you mentioned it was driving about $3 million of incremental sales per week. I realize that's ramping, but can you give a rough idea, give us a rough idea of what that should look like if it ends up hitting your expectations. Is this potentially a $20 million, $30 million, $50 million type per week driver at some point?

Ronald L. Sargent

Well, the answer is certainly yes. I mean, obviously, the reason we are making these changes and expanding our assortment is because I think we've learned that customers will buy a lot of things from us besides paper-based office supplies. So yes, we see this as kind of a big growth driver for the company. It also is going to be a big growth driver for online business. And frankly, I'm looking forward to getting back to the point where the beyond-office-supplies growth crosses the line of the shrinkage of the core. We need to get back to positive sales growth, and we expect to do that in the next few quarters.

Daniel T. Binder - Jefferies LLC, Research Division

And my second question was related to the headcount reduction that you mentioned. You guys have historically run a pretty lean organization. So I don't imagine headcount reduction was a necessarily easy decision. But my question, really, is around kind of what kind of reductions they were, given that you've got your competitors probably getting underway with integration efforts soon. I would think you'd want to really keep your organization in a place where you can really capitalize on all of the potential share opportunities. And obviously, with headcount reduction, there's change in the organization and, potentially, can be disruptive shorter term. So just trying to understand what type of -- what kind of changes were made.

Ronald L. Sargent

Yes, I guess our strategy, in general, was to get ready for the online world. The folks that we're competing with in the online space have lower G&A structures than we do. So I think most of the changes that we've made on our own G&A structure was one, to obviously take cost out. But I felt like given there were a lot of people at the director and vice president level, which requires -- everybody requires a staff, everybody feels like they have a chance to weigh in on decisions. It's really about speed. And we've got to get a lot quicker and faster in our overhead structure. But a lot of this is basically pretty straightforward stuff. We had separate HR organizations, for example, in each business unit. We had separate finance organizations in each business unit. We had separate marketing organizations. Given that we're all in -- at least the bulk of the company is in North America, similar product line, similar vendors, in some cases, similar customers, the idea was to consolidate a lot of that infrastructure to make us a lot quicker in decision making, as well as take out some unnecessary cost. But that was kind of the plan. But really, it wasn't geared toward kind of the industry consolidation. It was really geared toward getting leaner and meaner from the G&A standpoint as we compete more aggressively, particularly, in the online world.

Operator

The next question we have comes from the line of Michael Lasser, and he's from UBS.

Michael Lasser - UBS Investment Bank, Research Division

So my question, Ron, is how are you thinking about the potential dislocation of market share on the heels of the Office Depot-OfficeMax merger? And along those lines, what is Staples doing right now to capitalize on that opportunity?

Ronald L. Sargent

Well, first of all, let me say congratulations to OfficeMax, their shareholders, for getting the transaction completed. And we said that this was the right thing for customers, and we said it's the right thing for our industry, and we still feel that way. Obviously, the hard part begins now for Office Depot, which is consolidating and integrating the acquisition. Our focus is really back to executing on our plan, but we feel that this disruption in the industry will create opportunities for Staples going forward. And our job is to realize those opportunities over the next several years. And we have a pretty strong, aggressive plan in place to really go after market share, not only in our retail business but also in our online business, as well as our contract business. So I think we're going to take advantage of every opportunity we see in front of us. But at the same time, it's not really going to change kind of our strategy going forward.

Michael Lasser - UBS Investment Bank, Research Division

You talked about -- well, 2 thoughts. You talked about the staffing increases on the Commercial side were -- was part of that decision to position you better to take advantage of some of the market share opportunities, and how quickly do you think those opportunities arise?

Ronald L. Sargent

I think the answer is obviously, the structure -- restructure and the additional sales people that we've hired are focused on taking market share wherever it might come from. In terms of how quickly, I think we're already starting to see that where we've tested the new selling model, and we expect that to continue and in fact, accelerate in the coming quarters. I don't know, Joe, you want to say any more about that?

Joseph G. Doody

Yes, just briefly, I think we've added people both focused on business development going after new business and new customers, but also significantly expanded our category specialists in the BOSS [ph] area to really drive BOSS [ph] growth because that's where our long-term growth is going to be. So adding more specialists there to go after that growth, as well as more business development to go after new business, and we're in a good position to take advantage of the opportunities over the next several years.

Michael Lasser - UBS Investment Bank, Research Division

Okay. And then last question for me is, Ron, you mentioned that part of the reason that you've reduced your cost structure is because some of your competitors have a lower SG&A base. Well, they also have a lower overall operating margin. Do you think that one of the outcomes of adding some of the new categories and expanding your online presence, Price Match, will be that Staples is just going to have a structurally lower operating margin that will look more commensurate with the peer group for which you're competing over the long term?

Ronald L. Sargent

Well, it depends on who you count as your competition. I don't know that we're ever going to have the same structural cost model as somebody whose purely online, given our retail business and our International business. I should note that half of the cost takeout in the restructuring was European-based. So it wasn't completely North America. In terms of your second question, Michael, I'm sorry I missed it.

Michael Lasser - UBS Investment Bank, Research Division

Well, it was -- you basically answered it, will your cost -- will your margin structure over the long term look like either the online-only peers or others, mass merchants who have an inherently lower cost.

Ronald L. Sargent

I think the only other point I'd make is our whole strategy is geared around margin dollars. It's really not geared around margin rate. Obviously, when you do a lot more incremental sales through the marketplace vehicle, we are going to get those sales in a lower margin rate than we -- our core business would engender. So the goal is margin dollars, and I'd be happy if our margin rate went down, if our margin dollars goes up dramatically in the coming years.

Operator

The next question we have comes from the line of Chris Horvers from JPMorgan.

Christopher Horvers - JP Morgan Chase & Co, Research Division

I wanted to focus a bit on the cost side. So can you talk about how much of the cost cuts didn't flow through? So far you did the headcount reduction, another headcount reduction in 3Q. You mentioned that $92 million in SG&A savings year-to-date versus the $150 million target. Is that gap actually the investment that you made or is there going to be more cost cuts that flow through in light of the recent overhead reduction that you made in the third quarter?

Christine T. Komola

In terms of the flow-through, so we did, we took out $90 million -- $92 million of cost this year. It's actually higher. There -- that doesn't actually include things that have -- the merchants have actively worked on in, for example, product costs. But we have also been actively investing in areas. So we continue to expect cost takeout into the back half -- into the Q4 quarter. So we'll plan further in 2014, as well as balancing the investment strategy that we've got. So it is a balance, but I think we feel very good about the work that our organizations have done across all areas of the business to continue to actively push this cost take-out process and really think about our business differently.

Christopher Horvers - JP Morgan Chase & Co, Research Division

So can you refresh the number of -- what were the numbers, in totality, that you took out, the headcount that was reduced during the third quarter?

Christine T. Komola

During the third quarter, we took out over 1,400 heads. That was -- about half in International businesses, and half in the North America businesses. Most of that in North America was more of the overhead, not fields -- not as much fields related. The examples that Ron gave around kind of consolidating some of those HR, backroom, finance operation, working on BPO, as well as ITO. So that was the headcount in North America primarily. In Europe and Australia, it was also a significant headcount, and that was actually probably 3/4 of the dollars just because of the structure and severance compensation packages that the International businesses have. And that was a lot of overhead. It was a lot of consolidating warehouses and people, a lot of the work around merchandising, marketing, streamlining that organization that John's been driving.

Christopher Horvers - JP Morgan Chase & Co, Research Division

And presumably, these were generally very few sort of open seats that were included in that 1,400 number and...

Christine T. Komola

These are actually field people, and they're existing people.

Christopher Horvers - JP Morgan Chase & Co, Research Division

Yes, and that should flow through going forward. In terms of the 80 basis points EBIT margin deterioration in North American contract, was any of that onetime in nature due to some of the hiring that you're doing in terms of the sales force?

Christine T. Komola

I think the hiring that we have on the sales force is part of that incremental investment that we just talked about, and Joe can talk a little bit further about it. But I do want to clarify that on the flow-through of these headcount reductions, obviously in North America, you get the payback quicker where in Europe, which is 3/4 of the savings, that's going to happen during -- throughout 2014, and mostly in the back half of that.

Joseph G. Doody

Yes, just to comment, Chris, on the de-leveraging in North American Commercial. As we said, it was heavily driven by our investment in both contract specialists, as well as new business development people in contract, as well as marketing investment in Quill, both of which are geared to drive additional growth as we look forward. And then finally, as far as an element of that, our gross margin in both contract and Quill were basically flat on a year-over-year basis in the quarter.

Christopher Horvers - JP Morgan Chase & Co, Research Division

So it's not necessarily price. It's investing for future top line growth.

Joseph G. Doody

Correct, correct. Our team has done a great job of protecting our price in spite of the fact that it's become more competitive in the marketplace more recently than we've seen in a long time.

Christopher Horvers - JP Morgan Chase & Co, Research Division

Do you -- the last one from me. Do you feel the need that given where your prices are, both in contract as well in retail, do you think you need to close the gap further versus online competition. I think, Ron, you've talked about previously being, I guess, close enough and people willing to pay for the convenience factor. Has your thought process changed at all?

Joseph G. Doody

On the contract -- I'll speak to the contract point, Chris. We've just seen I would say, most recently, a more unsustainable level from one of our competitors that, quite honestly, is evident in their results. So I think that's not sustainable and not something that would be continued going forward. So we're competitive from a contract standpoint, but our pricing approach has not changed. We are very, very controlled, very, very measured in what we do within the contract business from a pricing standpoint.

Ronald L. Sargent

And Chris, on the second part of your question, I think we'll continue to make investments in price. Again, not sure you have to be exactly the same, but you certainly have to be in the ballpark.

Operator

The next question we have comes from the line of Greg Melich from the ISI Group.

Gregory S. Melich - ISI Group Inc., Research Division

I just wanted to get a little deeper into the Commercial business, given we've got some growth there. It sounds like gross margin's flat. So starting to get some top line improvement with the investments. Is that coming from broadening out the assortment and getting more sales from the customers you have or how is the customer count going? Have you been able to pick up any of those?

Joseph G. Doody

Yes, okay, Greg. In Quill, first of all, it's clearly through 2 things. One, new customer acquisition. So our customer file is growing, as well as sales to existing customers are up on a year-over-year basis. So that is because of the marketplace and the expansion of SKUs [ph] significantly within Quill. So that's what's driving their growth, which was almost 3% during the quarter. At contract, sales to existing customers were actually down slightly, but it was more than offset by a strong customer acquisition, as well as strong retention rates. So those were the drivers. Our goal is clearly to focus on the BOSS [ph] categories and drive those sales to existing customers up in contract, and that's what I would expect to be changing as we look out over the next several quarters.

Gregory S. Melich - ISI Group Inc., Research Division

Got it, and then if I could follow-up on gross margins, you mentioned that in contract, again, flat. Could you help us understand on the retail side where the real margin pressure was, I think, by category and also, how International influenced that?

Christine T. Komola

In terms of the gross margin, we did decline, and it was primarily driven by investments in some of the pricing. With -- also, in North American Stores & Online, it was really driven by the fact that our sales growth in technology and tablets and some of the computers was more than offset by the slower decline in supply. So that mix was definitely a good chunk of the loss. Another part was the international decline. So that was driven by -- primarily by the contract businesses, both in Europe and in Australia. To the point of pricing pressures, we're seeing that all over the business units. Not unusual, but it definitely was part of our degradation [ph].

Gregory S. Melich - ISI Group Inc., Research Division

And how is mobile? I know that's been an initiative on the retail side. How has that rollout gone? How has that influenced top line and margin?

Ronald L. Sargent

Demos?

Demos Parneros

It's actually having a sort of impact on top line. So mobile, for us, would be tablets and mobile phones, essentially. So on the mobile phones side, we've had, up to this point, about a 500-store set out there. And by the beginning of -- probably the beginning of the month, we'll have close to 1,000 stores up and running. So the good news there is bigger exposure, ability to market a little bit more effectively, and we should see continued strength there. On the tablet side, again, good news, we have a top line assortment. And as we mentioned earlier, having Apple online gives us a huge advantage with a lot of customers who've been asking for that product. So obviously, a little bit challenged on the margin side, but our attachment selling and accessory selling has been quite good. So I'd say, on balance, very positive.

Gregory S. Melich - ISI Group Inc., Research Division

If you include tablets and mobile phones, is the margin there above the retail average or below now? Knowing that the 2 might be very different.

Demos Parneros

Yes, that would definitely be below the average. And another way that we look at it is the margin, is the total margin dollar bucket greater than that of, say, older technology like PCs, and the decline in PC is still a little bit of a lag. But I think the shifts are happening, so it's just a matter of time.

Operator

The next question we have come from the line of Matthew Fassler from Goldman Sachs.

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

I'd like to follow up on a couple of the points that I think have already been touched on today. The first relates to competition in the contract arena. Joe, you alluded to one of your competitors being extremely aggressive. Before OfficeMax was folded into Office Depot and they reported their third quarter, they alluded to a very aggressive competition, and their contract margins took a hit. And I think there is some expectation that there will be a bit of grab for A accounts that could get caught in limbo as a result of this deal. To the extent you could talk about what you are doing or what you are seeing and how the competitive dynamic in the industry, broadly, is being impacted by the merger and the process surrounding it, it would be very helpful.

Joseph G. Doody

Yes, I can't say too much more, Matt. To be honest, I think our -- as I said, our approach has not changed. It's very measured. It's very controlled. We have -- my involvement and others on my team for large opportunities, and we are very careful in terms of how we go after that business. I think competitively, that may be falling through the cracks today. So we just got to wait it out over the long term, and I think our value proposition to our customers is extremely strong. We have finished our integration. We now have the opportunity to really manage difficulties that are going to take place over the next several years in integration. So we're ready, and we're set to really focus on growing this business regardless of the integration but feel that there will be some positive benefits with it.

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

And my follow-up relates to gross margin. If we look at operating margin across the enterprise, about half of the decline year-to-date, maybe slightly more than that, relates to gross margin erosion. If you think about the price adjustments that you have to make across the company, and I know you face different competitive sets, but also the fact that the mix of the products that you seem to be ramping in, probably, is favorable to gross margin. Is this the year where you would expect that gross margin erosion to peak or do you feel like the adjustment process netted out with the mix continues to weigh on you as you look into '14 and beyond?

Christine T. Komola

Matt, it's Christine. In terms of the gross margin, we would -- this year, I think it'll kind of continue to be in this kind of slow margin rate decline. As Ron said, we're definitely focused on gross margin dollar growth. And as we put together our plan for '14, we'll come back and talk to you a little bit further about it. But I think pricing pressure is everyday in this environment. I don't think it changes. I don't think it's changed over time. I think our job is to be able to price it, to get it at the lowest cost possible, and our merchants are all over that strategy and have done a good job. And then it's to right-size kind of how we manage the rest of the P&L to continue to make the bottom line goals and plans and generate the cash that we expect to. So I think it's the whole package, and we'll come back to you with how we expect it to play out in '14 in Q4.

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

And just to get closure on that point, the products that you're adding in new categories, what is their impact, typically, on margin rate?

Christine T. Komola

It really varies. So I think if you'll look at technology, where we're gaining share in some of those new categories online, obviously, that's a lower rate. And then if you look at other categories, facilities and breakroom, typically, is higher than the house. One thing that I would say is that on the products that were added through our marketplace, a lot of those products are actually a little bit lower than the house, but that includes a drop-ship component. So kind of net-net, when you get it to the bottom line, it does -- it is more profitable. So it really does vary. And at any one quarter, it's kind of interesting to see depending on where we're focusing our SKU expansion opportunities, it'll be higher than the house or it could be lower than the house.

Operator

The next question we have comes from the line of Aram Rubinson from Wolfe Research.

Aram Rubinson - Wolfe Research, LLC

There's been a lot of talk about some of the products that you're adding to the stores and to the online business. Can you talk about what you're editing? I mean, you can't just net add. Wondering kind of on what metrics you're cutting or calling products from the assortment, and if you're using online to kind of move products out of the stores and into an online-only world? And then I had a follow-up.

Ronald L. Sargent

Yes, I mean, sure. We do that in every part of our business every day, whether it's looking at our retail stores, 4 foot by 4 foot, to see where's the -- what's the direct product profitability of a potential SKU. And if it doesn't meet where we need it to be, we would eliminate it and kind of reallocate out of that SKU. Same story on our delivery warehouse. If it's a productive SKU, we want to stock it. If it's an unproductive SKU, we want to send it out to the wholesaler. And I'm sure, and we're already starting to see some SKUs that we're now selling on marketplace that we haven't sold before that we will be bringing in-house because they're very, very productive. But much like you see in kind of the Amazon model, if it's a good SKU, you want to stock it. If it's a slower moving SKU, you want to outsource it. And the good news is many of these categories are things that we've never sold before in the history of our company. And you can be very, very aggressive on the pricing side because it is all incremental.

Aram Rubinson - Wolfe Research, LLC

And then the follow-up is on the delivery side, specifically, on the contract side. Can you remind us your mix of kind of mid-market versus large customer and how that compares to the industry and what kind of trends we're seeing there? I'm assuming the mid-market is still a better growth business to be competing in, and I just wonder if you're seeing the same?

Ronald L. Sargent

Yes, Joe?

Joseph G. Doody

Yes. You're right. The mid-market is a better growth opportunity given the higher margins that it has. It's a market that we've been investing in, in over 10 years, Aram, and a very solid business there. Mid-market alone would make up a good 1/3 of our business, another 1/3 of our business in contract is these regional companies out there that would be medium- to large-sized regionals, and then the remaining 1/3 in the contract business, roughly, is our Enterprise business. So that's how it breaks out. Clearly, we're focused heavily from a business development standpoint, customer acquisition standpoint on that mid-market given the great opportunity that lies there, given our market share position is low, and the margin opportunity per account is higher.

Aram Rubinson - Wolfe Research, LLC

And the last thing, just a clarification. You mentioned I think of the 150, half of that came international and half domestic. So just checking the math. That's about 2% of sales that you've kind of taken out in international, but only about 50 basis points kind of in the North American business. Is that -- is my math about right?

Ronald L. Sargent

Christine? I'm not...

Christine T. Komola

Is that the...

Ronald L. Sargent

The 150 is what number, Aram?

Aram Rubinson - Wolfe Research, LLC

The cost takeout, I'm sorry.

Christine T. Komola

The cost takeout was $92 million in -- oh, the 150 -- how we achieved our goal.

Ronald L. Sargent

Yes.

Christine T. Komola

It was primarily driven by North America. The cost takeout in Europe has been, net-net, they funded things themselves. So but this -- the $150 million is a North America number.

Operator

The next question we have comes from the line of Michael Baker from Deutsche Bank.

Michael Baker - Deutsche Bank AG, Research Division

So fully appreciate the idea of going after gross profit dollars rather than rate, but in order to make that work, you need -- what kind of sales growth do you need to make that work such that the higher gross profit dollars leverage the SG&A and ultimately, grow the earnings?

Ronald L. Sargent

I'm not sure I'm going to give you a 30-second answer to that one. But obviously, what we've said along is we need our core business growing, and we expect it to grow. We've done a lot of change over the past year. We've invested heavily in the growth side of our business, whether that's beyond office supplies, whether that's online, whether that's in our contract sales force. So obviously, we need our base to grow, and then we look at the additional sales from incremental sales relating to the marketplace or the online kiosk or some of the other new categories that we're in. Obviously, we think that's the added sales and profit that we're going to need to get the business back on track, from my perspective. In terms of 2014, we're not ready yet to kind of nail down our budget. So we should do that shortly, and we'll be sharing that with you when we have that.

Michael Baker - Deutsche Bank AG, Research Division

Okay. Fair enough. A couple other follow-ups. You talked about the win rate and delivery, so growing your customer base. Can you compare that to the trends in some of the recent quarters? Are you gaining more customers, and really what I'm getting at is are we seeing yet any benefit from the merger? Have you been able to pick up incremental accounts as some customers might be concerned about what's going on with Depot and Max?

Ronald L. Sargent

Joe?

Joseph G. Doody

Yes, Michael, I think it's premature for customers to typically make a change based on what may happen as far as disruption. So I wouldn't say that there's any pickup in customers due to merger integration opportunities that will take place over the next several years. But we do feel good about our trends in our customer base, both from a contract standpoint, as well as from a Quill standpoint. And that has trended slightly upward throughout this year.

Michael Baker - Deutsche Bank AG, Research Division

Okay, okay. Interesting. One more -- if I could slide one more in the -- just on the balance sheet. I think you have some debt due, coming up soon, so I think you pay that down. And does that free up more cash to buy back stock next year? And how does that impact your interest expense for next year?

Christine T. Komola

We do pay down about $867 million in January. So next year, we'll be much lower in our actual cash balance. So as we kind of refill the cash, particularly in the U.S., we'll be giving out further guidance on where our restructuring -- where our repurchase program will be next year, but we will need to kind of refill the coffers on that. And in terms of the actual interest takeout we haven't, once again, figured out exactly how much will drop with that piece. But you'll see a decline of about $50 million or $60 million in interest expense next year.

Operator

The next question we have comes from Gary Balter from Credit Suisse.

Gary Balter - Crédit Suisse AG, Research Division

A couple of follow-ups on the retail side. You talked about how successful a 12,000 square-foot store is. Could you talk about your transition into that, like, how many do you envision doing over the next few years? And could you -- how quickly could you move to those?

Ronald L. Sargent

Demos?

Demos Parneros

We're excited about the 12k. We've got 11 that are set exactly like our prototype, and there are another 10 or so that are 12,000, but don't have our full complement of the different elements. We're going to convert those to the go-forward model. In terms of how many and how fast, we're tackling that issue a couple of different ways. One is, each year with our renewal program, to the extent that we can continue our downsize program, we'll continue to do that. So it's been around the 35 to 40 range each year, and so we'll continue to do that. Relocations, about the same number. Probably, though, the best way to get the benefit of what we've learned from the 12k is to apply as much of the 12k into the balance of the chain, and that's what we're working on right now as we continue to weed out categories that are no longer effective or need less space and bring in some of the new fresh categories that we've added into the 12k that are far more productive for us. We'll be bringing those to the balance of the chain on a rolling basis. So I'm excited about not only the 12ks but also the impact to the rest of the chain.

Ronald L. Sargent

The only other factoid I just had here is that we, today, have about 200 stores in the chain that are 14,000 square feet or smaller. So those would be kind of quick-and-easy converts. Some of the 225 stores that come up for renewal every year, some of those are easy and some of those are, frankly, hard because they're great profitable stores.

Demos Parneros

And if I can add one other point here, I think that one of things that we're excited about is that we went into this with a set of economics for the 12k, and one of them was to retain roughly 95% of sales. We've achieved that in very short order. So the good news, I think -- it's a twofold issue, actually, it's sort of good news, bad news. Good news is, we've got the number and we know how to do it. The bad news is, it just -- well, [indiscernible] to reinforce this, but there were quite a few dead categories. And as we eliminated those quickly, the faster we move on to the growth of these new BOSS [ph] categories both in stores and online.

Gary Balter - Crédit Suisse AG, Research Division

You talked -- just following up on that, you talked about having Apple online and the benefits of that, but I was waiting for Demos to say and -- we're about to have it in the stores for Christmas. Could you update us on the Apple discussions?

Demos Parneros

Sure. I mean, we're very excited about Apple. As you know, we started with a small number of stores in our accessories program, and now most of the chain. We went full online: Quill, commercial with iPad and iPods. And I'd say so far, so good. Apple is pleased. Staples is pleased. We're both happy with each other. Relationship's moving along just fine. We've got a little more work to do and continue to evolve the relationship. So ultimately, our goal is to do what you asked about. We're just not quite there yet.

Gary Balter - Crédit Suisse AG, Research Division

Okay. And then one last question just on the contract side. We heard a bunch of discussions, Joe, from one of your competitors being very aggressive on pricing, bringing down the market a little bit, yet your margins were fine on pricing. Based on the comments you made, it sounded like your investments were different. As you look out, are these investments expected to drive margins back up or are they expected to drive sales? Like, how should we be thinking about the steady-state operating margin potential of the contract business because obviously, in the last 2 quarters we've seen declines, but it hasn't really been on the price side.

Joseph G. Doody

Yes, I would say, Gary, the investments we're making are clearly to be driving top line growth and most heavily in BOSS categories, because that's where the growth opportunity is the biggest for us. But also we're continuing to invest in that mid-market, driving new customers at the higher margin. So I would expect the margin improvement that we would get over time would be by better leveraging our sales growth.

Gary Balter - Crédit Suisse AG, Research Division

But does the -- the changing competitive pricing pressure change any of that?

Joseph G. Doody

I don't think the pricing pressure that we've seen recently is sustainable by our competitor.

Gary Balter - Crédit Suisse AG, Research Division

Okay. And Ron, you're not planning to climb any mountains and plant flags in the future?

Ronald L. Sargent

I've got plenty to do right here in Framingham.

Operator

The next question we have comes from Greg Hessler from Bank of America.

Gregory Hessler - BofA Merrill Lynch, Research Division

I had a question on the PSD business that you ultimately sold this quarter. It looks like there was maybe an $85 million loss from that, and you said in the filing that most of that was noncash. Can you tell us what the actual cash component of that sale was?

Christine T. Komola

It was very de minimis. It was less than $10 million, very de minimis. And that was mostly related to working capital true-up.

Gregory Hessler - BofA Merrill Lynch, Research Division

Okay. Is that the, call it, $12 million or so that's on the cash flow statement?

Christine T. Komola

It's interrelated to that transaction, yes. [indiscernible] on the closure of it.

Gregory Hessler - BofA Merrill Lynch, Research Division

Okay. And then the other question I had was just on the overall credit rating and the strategy there. Fitch has a negative outlook. I know that historically, you guys have strived to be mid-BBB. Once you pay down the maturity in January, in your discussions with Fitch and some of the other agencies, do you feel like you'll kind of be affirmed at that mid-BBB level at that point?

Christine T. Komola

You never can exactly tell how they'll -- how Fitch will -- what they will do. In terms of all of our conversations, very productive. Moody's, S&P, we expect to maintain our continued BBB rating across the agencies, and they've been very supportive. I think similar to kind of the questions that you all, and we're driving towards, it's EBITDA growth and driving in that direction. And I think as we continue to manage our capital structure and communicate openly with them, they're very supportive.

Operator

The final question we have comes from the line of Anthony Chukumba from BB&T Capital Markets.

Anthony C. Chukumba - BB&T Capital Markets, Research Division

Yes. So I had a question on the Price Match Guarantee. I know it's sort of early days, but I was just interested just even directionally like, I mean, what percentage of your customers in-store and maybe online are actually asking you to price match? And what has been the gross margin implication of the Price Match, if any?

Ronald L. Sargent

Yes. Demos?

Demos Parneros

So far, it's been very well received by customers and our associates. So very excited about the Price Match policy. It gives our team the confidence that we not only have great prices, but on the odd occasion that we're not the lowest priced, they can take care of the customer and never have a customer leave empty-handed. We've had a little bit of activity so far. I can't express it in a percent of sales, it's actually small, and it's only been 2 weeks. I'd say comparing it to our last year's policy, it's slightly higher but not to a level that's either alarming or concerning to us at this point. I'd say that it's a very well-received program. It's right on our plan, and again just too small to express the numbers yet, in percentages.

Anthony C. Chukumba - BB&T Capital Markets, Research Division

Okay. And just one quick follow-up. You mentioned compared to your last year policy, what was the policy last year?

Demos Parneros

Well, the policy that we've had -- we've always had a price match policy, and the difference now versus last year is that in the past it's been stores compared to stores and online comparing match to online. And now we've said in store, we'll price match either stores or online, basically anyone. So long as it's a reputable competitor, we'll match. And so that policy -- a little bit more of an activity -- a little higher activity from some of the pure online players.

Ronald L. Sargent

And I think as a retailer, you really have to do that. I mean, it's not a big number but it's more sizzle than it is steak, but it's sizzle I think you have to have.

Operator

Thank you. I'd now like to hand over to Ron Sargent for closing remarks.

Ronald L. Sargent

Well, thanks, everybody, for joining us on the call this morning. We look forward to speaking with all of you again very soon.

Operator

Thank you for your participation in today's conference. This concludes your presentation. You may now disconnect. Thank you for joining, and enjoy the rest of your day.

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