Staples Inc. F4Q09 (Qtr End 01/30/10) Earnings Call Transcript

Mar. 2.10 | About: Staples, Inc. (SPLS)

Staples Inc. (NASDAQ:SPLS)

F4Q09 Earnings Call

March 2, 2010 8:00 am ET

Executives

Laurel Lefebvre - Vice President Investor Relations

Ron Sargent - Chairman and Chief Executive Officer

Mike Miles - President and Chief Operating Officer

John Mahoney - Vice Chairman and Chief Financial Officer

Demos Parneros - President US Stores

Joe Doody - President North American Delivery

Analysts

Chris Horvers – JP Morgan

Stephen Chick - FBR

Colin McGranahan – Sanford Bernstein

Mike Baker – Deutsche Bank

Matthew Fassler – Goldman Sachs

Brad Thomas – Kebanc Capital Markets

Dan Binder – Jefferies

Kate McShane – Citi Investment Research

Oliver Wintermantel – Morgan Stanley

Gary Balter – Credit Suisse

Alan Rifkin – Bank of America

Operator

Welcome to the fourth quarter and full-year 2009 Staples, Inc. earnings conference call. (Operator Instructions) I would now like to turn the call over to Ms. Laurel Lefebvre, Vice President of Investor Relations. Please proceed.

Laurel Lefebvre

Good morning everyone and thanks for joining us for our fourth quarter and fiscal 2009 earnings announcement. During today’s call, we will discuss some 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 Staples.com for an explanation and reconciliation of such measures and other calculations of financial measures that we use to analyze our business.

I would 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 latest 10-K filed this morning.

Here to discuss Staples’ Q4 and full 2009 performance and business outlook are Ron Sargent, Chairman and Chief Executive Officer, Mike Miles, President and Chief Operating Officer, and John Mahoney, Vice Chairman and Chief Financial Officer. Also joining us are Demos Parneros, President of US Stores and Joe Doody, President of North American Delivery.

Ron?

Ron Sargent

Thanks Laurel. Good morning everybody. Thanks for joining us today. I am pleased to report strong fourth quarter results this morning and I am very happy that we are getting back to growing the business again.

During Q4 sales trends were encouraging particularly in North America where our retail business got back to positive comps. Staples Business Delivery grew sales for the first time in six quarters and our contract business showed nice signs of recovery. Both SBD and contract improved their top lines by more than 10 percentage points compared to last quarter. We are gaining traction in our international business and saw strength in European catalog and contract as well as in South America.

In terms of the Q4 headlines, total sales were up 4% versus last year to $6.4 billion. North American retail comps were positive for the first time in 10 quarters. Adjusted earnings per share increased 6% to $0.38 and we ended the year with record free cash flow of $1.8 billion.

By sticking to our recession plan of providing great service, managing expenses and investing in growth ideas we got a lot done in 2009. Our team made great progress on the integration of Corporate Express in North America and Europe. We took big steps towards building one global Staples brand. We laid a solid foundation for growth in tech services and copy and print businesses and we strengthened the leadership of our international business.

As we look to the year ahead we are pretty excited about our opportunities in 2010. While we are not planning for a big economic recovery this year we do plan to getting back to growing both the top and bottom lines. What are the biggest drivers of this growth? We will be investing in growing adjacent categories like facilities and break room supplies, business technology and copy and print, all while continuing to grow sales in core office supplies.

We will accomplish major milestones on the CE integration. We will continue to open a new store every week and we will dramatically improve the profitability of our international business. All the work we have done to respond to our customer’s needs positions us well to drive growth in our core offering while taking the business in new directions. I have never been more confident that we have the right people and the right plans to take full advantage of the opportunities we have in front of us.

Now turning to our business units starting with North American delivery. Sales for the fourth quarter were $2.4 billion, down about 1% and while we are not quite back to growth in delivery we are encouraged by the improving trends we saw throughout the quarter as the top line in each of our delivery businesses improved sequentially. In Staples Business Delivery we grew the top line in the mid single digits. In contract sales declined in the low single digits and in Quill the top line declined in the mid single digits.

NAD operating margin improved 24 basis points to 9.2% compared to the same period last year. Synergies from better buying, combining two sales forces, closing warehouses and reducing marketing expense all helped operating margin. On the other hand, higher incentive compensation weighed on profitability. Contract customers also remained cautious with discretionary purchases. The mix shift to on-contract, lower margin products continued to moderate during the fourth quarter and was only a modest drag of about 10 basis points on NAD product margin.

During the fourth quarter we signed several new government accounts, continuing the trend we have seen throughout 2009. Our government business grew about 11% in Q4. We are right on track with the integration of Corporate Express in North America. During the fourth quarter we integrated key finance systems and consolidated accounts payable activities to our shared services center in South Carolina. We completed the consolidation of our office products assortment and we are currently rationalizing the assortment of facility supplies, furniture and our other lines of business.

We have wrapped up our brand transition in North America and we also made great progress with the integration of our distribution network. A few weeks ago we went live with our first distribution center that will serve both Staples and legacy Corporate Express customers.

Looking back at the past year I am extremely proud of our how our team has worked and the progress we have made with the integration. During 2009 we hit our targets for direct and indirect buying synergies. We reduced small orders, increased average order size and improved account profitability. We finalized our assortment and combined the Corporate Express and Staples brands paving the way for our 2010 full line catalog which features one common product assortment.

We combined our sales force and got all of our sales associates on the same compensation and benefits plans. We consolidated human resource and finance systems. We rationalized our transportation network and began using the re-branded Corporate Express fleet to deliver Staples products and we leveraged our new lines of business to win more than $200 million of new business in adjacent categories like furniture, printing and technology solutions.

At the same time, we managed working capital extremely well. Our shared services team dramatically improved DSO and our supply chain team increased inventory turns resulting in strong free cash flow for NAD. Despite how far we have come in the 21 months since we acquired Corporate Express we still have a lot of work to do. During 2010 we will complete the majority of our supply chain network integration and consolidate a handful of fulfillment centers. We will also be heavily focused on the design and testing of our single, common e-commerce ordering platform which will be a big improvement over our legacy systems.

During 2009 we made great progress developing our lines of business and in 2010 we are going to make an even bigger push into these adjacent categories where our existing customers want us to provide the most solutions. We recently launched Staples Technology Solutions to provide business customers with a one-stop shop for data center and desktop technology products as well as network services.

We will also invest in growing facilities and break room supplies where our capabilities have improved with the acquisition of Corporate Express. We are confident we can grow this category to become a much more meaningful piece of our business over the next coming years.

Moving on to North American retail. Sales for the fourth quarter were $2.6 billion, an increase of 8% or 4% in local currency versus Q4 2008. Fourth quarter same store sales rose 3%. Customer count comps increased 4% compared to Q4 2008 and that is the strongest increase in traffic we have seen in more than three years. Average order size continues to improve sequentially but remained negative compared to last year. Average order size was down about 1%.

We saw double digit top line growth in categories where we have made big investments like computers and ink. We also saw relative strength in multi-function devices, tech peripherals and core office supplies. Our services business also performed well during the fourth quarter. The copy and print center achieved high single digit top line growth while improving the bottom line and our Easy Tech business doubled versus the fourth quarter of 2008.

We continued to improve our price impression with customers in the fourth quarter with strong performance during both the holiday and back to business seasons. Price and value remain top of mind and many of our traffic driving initiatives like great deals on laptops and other tech products, 50% back in rewards, double rewards on ink and strong paper offers really struck a chord with our customers. While we are seeing increased traffic in our stores we haven’t taken our eye off the ball with customer service and I am happy to report that our customer satisfaction scores hit all-time highs during the fourth quarter.

North American retail operating margin increased 21 basis points to 9.5% for the quarter. Gross profit continues to benefit from purchasing synergies and we have leveraged rent and distribution expenses during the quarter. These improvements were somewhat offset by an increased mix of lower margin technology products. We did a good job with operating and selling expenses particularly in marketing where we continue to reduce costs by moving more of our marketing online. These improvements were somewhat offset by increased incentive compensation as the team drove better results in North American retail.

We also worked hard managing working capital in North American retail, reducing inventory per store by 5% and driving a 34 basis point improvement in inventory turns compared to last year’s levels, all while improving customer service and in-stock levels and driving the top line.

During the fourth quarter we opened four stores and we closed five. For the full-year we opened 48 stores and closed 12 stores in North America. We ended the year with a total of 1,871 stores in North America, 1,555 in the United States and 316 in Canada. The commercial real estate market remains very attractive and in 2010 we will continue being very selective of the locations of our new store openings. We expect to open about 40 new stores in North America for the full-year, around 35 in the United States and 5 in Canada.

In addition to investing in new stores we are also going to drive growth by making investments in attractive categories where we have very low market share like business technology and copy and print. We have made great strides in improving the quality of our offering and broadening our assortment but to succeed in these categories we are going to need to think differently about how we serve our customers. This year we will invest in people, training and store remodels to become a much more credible player here.

With that I will turn it over to Mike to talk about international.

Mike Miles

Thanks Ron. Good morning everybody. Sales for the fourth quarter in international were $1.4 billion, an increase of about 7% in U.S. dollars and a decrease of about 6% in local currency compared to the same period last year.

Operating margin was 4.1% of sales a decrease of 38 basis points from Q4 2008. Our office products business in Europe which makes up a little more than 70% of our total international sales showed relative strength. Profit improvement initiatives we have put in place are gaining traction and the operating margin of that business improved by almost 100 basis points during the fourth quarter with operating margin expansion across all channels; retail, catalog and contract.

However, the progress we are making there was offset by losses in the print systems division in Europe and our business in China. Together these two units lost $20 million in the fourth quarter compared to a small profit a year ago. Print systems division has done a good job right sizing for continued soft sales in 2010, reducing headcount by 11%. We expect PSD to post better results in the coming year.

In China although the top line trend showed some moderation during the fourth quarter we continued to face double digit sales declines and steep losses. Jeff Jin, the former Chairman of Staples China has left the business and we have a strong team on the ground including a new CFO and Head of Human Resource working with our COO to get that business back on track.

In Europe catalog sales grew in the low single digits in local currency versus Q4 of last year with particular strength in our French business. Catalog operating margin improved as a result of better product mix and purchasing synergies. Contract sales were flat in local currency versus last year although the Nordics region had a very strong performance. Contract margins improved nicely due to strength in our office supplies and cost saving measures.

In-store sales in European retail declined 8% during the fourth quarter. The decline was driven entirely by durables, especially technology with positive comps for consumables [paced] by double digit growth for ink. As a result, our gross margin comp was flat in spite of the soft sales. Overall profitability for the retail segment remained strong with operating margin increasing.

Turning to the Corporate Express integration in Europe we completed the majority of our direct and indirect vendor negotiations during the fourth quarter and made progress with the rationalization of our warehouse network across Europe completing the consolidation of contract and catalog warehouses in Spain and transitioning our German catalog operations from Brussels to Stuttgart. We are in the midst of the rebranding of all contract facilities in Europe and over the last month have resigned our retail stores in Scandinavia and Corporate Express brands to Staples.

Outside of Europe Corporate Express Australia did a good job driving profit improvement despite soft sales during the fourth quarter. Our business in South America drove top line growth and significantly improved its profitability year-over-year and our joint venture in India continues to grow quickly on pace with our expectations.

Last quarter I outlined three priorities for international; people, profitability and portfolio. On the people front we recently named John Barton, Executive Vice President of International Development with direct responsibility for our high growth markets and an overall charter for implementing Staples’ best practices around the world. John just celebrated his 20th anniversary at Staples and has led our real estate functions for the last six. That experience will be invaluable to ramp up new store growth in Europe with ten new stores in our 2010 plan.

On profitability the progress we are making with the integration of Corporate Express will be a key contributor to improving profitability. The integration in Europe got started about a year after North America and a large portion of the buying, G&A and supply chain efficiencies we focused on throughout 2009 will start to show up in our 2010 results. I mentioned the improved profitability of the Print Systems Division and we expect continued progress towards better profitability in our high growth markets.

I remain confident we will take a significant step forward on international profitability in 2010. Our international portfolio strategy is all about focusing on a relatively small number of markets where we can build a strong, profitable and multi-channel business, maximizing scale and minimizing G&A. We won’t hesitate to pull back from unprofitable markets. During the fourth quarter we closed our two office center stores in Germany and exited our catalog businesses in Hungary and the Czech Republic bringing our total countries with operations outside of North America down to 23 from 25.

At the same time we are moving forward with investments in some of our priority markets. New store growth and investment in building a mid-market contract sales force. The more I learn about our international business the more bullish I am about our opportunities.

Now I would like to turn it over to John to review our financials.

John Mahoney

Thanks Mike. In the fourth quarter total company sales were up 4% versus last year to $6.4 billion. The foreign exchange impact from the weaker U.S. dollar helped the top line by about 450 basis points during Q4 with about 40% of the benefit coming from Canada.

For the full-year total company sales were up 5% to $24.3 billion if you adjust our 2008 sales to include $3.4 billion of Corporate Express sales prior to the acquisition our top line declined about 8% versus last year. Our fourth quarter GAAP earnings per share on a fully diluted basis decreased 20% to $0.32 per share versus the fourth quarter of 2008.

A few weeks ago we announced a settlement to several retail wage and hour class-action lawsuits for which we recorded a $42 million pre-tax expense. We also incurred $20 million of pre-tax integration and restructuring expenses in Q4. Excluding those two items adjusted earnings per share increased 6% to $0.38 per share versus the fourth quarter of 2008.

Q4 2008 adjusted earnings per share excluded pre-tax integration and restructuring expense of $41 million and a $57 million tax gain. Favorable foreign currency exchange rates benefited EPS this quarter by about $0.02. For the full-year adjusted earnings per share declined 12% to $1.14 compared to last year’s $1.29.

Gross profit margin improved by 55 basis points to 27.4% during the fourth quarter. This reflects stronger product margins driven by purchasing synergies, efficiencies in delivery and distribution expense and leverage from rent expense partially offset by a higher mix of lower margin technology sales particularly in North American retail. On an adjusted basis SG&A de-leveraged 38 basis points versus last year’s fourth quarter to 19.5% of sales. This was driven by increased incentive compensation offset by leverage on the labor line, integration synergies and marketing efficiencies. Adjusted operating margin increased 17 basis points during the fourth quarter to 7.6%.

2009 capital expenditures came in at $313 million, down from the $378 million we spent during 2008. With operating cash flow of about $2.1 billion we generated a record $1.8 billion in free cash flow for the year versus $1.3 billion in 2008. In 2010 we are planning to increase our capital expenditures to $450 million as we invest in growth initiatives, new stores, remodels, systems and the integration of our distribution networks in North America and Europe. We expect that cash flow will remain strong during 2010. However, we don’t have the same degree of integration related working capital or tax opportunities we had in 2009.

We also may invest in inventory to support improving sales trends throughout the year. We plan to spend about $140 million more in capital this year and are expecting to generate more than $1 billion of free cash flow in 2010.

Looking ahead to the first quarter we expect total company sales to increase in the mid single digits versus Q1 2009. We expect adjusted earnings per share excluding integration and restructuring expense in a range of $0.25 to $0.27 for the first quarter of 2010. We expect total company sales for the full-year to increase in the low single digits versus 2009. We expect to achieve adjusted earnings per share excluding integration and restructuring expense in a range of $1.23 to $1.33.

This EPS guidance assumes a modest economic recovery throughout 2010 and increased investment in our growth ideas like business technology, copy and print, new stores, launching a mid-market contract offering in Europe and adjacent categories such as facilities and break room supplies.

Let me give you some more detail on our expectations for the P&L. We expect depreciation expense to be $115-125 million in the first quarter and $470-490 million for the full-year. We anticipate amortization expense to be $15-20 million for the first quarter and $65-75 million for the full-year. Integration and restructuring expense is expected to be front-end loaded during 2010 with $25-30 million in the first quarter and $50-60 million for the full-year. Net interest expense is expected to be $55-60 million in the first quarter and $225-235 million for the full-year.

In terms of share count you should expect about 735-740 million shares for the first quarter and 740-745 million for the full-year.

Thanks for your time this morning. Now I will turn the call back over to our conference moderator for Q&A.

Question and Answer Session

Operator

(Operator Instructions) The first question comes from the line of Chris Horvers – JP Morgan.

Chris Horvers – JP Morgan

Could you quantify how much incentive comp impacted earnings in the fourth quarter and perhaps was that a reversal you were going against in the prior year and how should we think about that cascading into next year particularly in the fourth quarter?

John Mahoney

Obviously we paid no bonus at all in 2009 and therefore it would have been an immaterial reversal in the fourth quarter. In total the impact would have resulted in SG&A leveraging this year had it not been for the incentive compensation.

Ron Sargent

In 2008 we paid no bonus. In 2009 we did pay bonus and in the fourth quarter basis points and in the [70 range]?

John Mahoney

I meant to say we did not pay a bonus for last year. This year we will expect to pay a bonus and the impact of that would have resulted in leveraging SG&A.

Chris Horvers – JP Morgan

Right because you de-leveraged 70 basis points and you would have leveraged slightly X that?

John Mahoney

No, SG&A de-leveraged by 38 basis points and if it hadn’t been for the incentive comp we would have leveraged.

Chris Horvers – JP Morgan

So as we think about next year you will have more of a regular accrual rate so there should be some pressure in the early part of the year and then a benefit in the fourth quarter?

John Mahoney

I expect that to be true. Our bonus levels would be expected to be about the same as they are this year next year.

Chris Horvers – JP Morgan

I think that the big surprise for us as we think about your 2010 guidance isn’t the sales because the sales are basically in line. Is the amount of leverage in the model, clearly a lot of investment going on with stores and technology and distribution domestically and internationally. Could you talk about or put some numbers around how much that is in terms of dollars? How that cascades through the year and how we should think about just your leverage point as the year progresses?

John Mahoney

I think there are really two factors there. One is we expect as the year goes on unless we see a pick up in the economy the compares are going to be more difficult. Therefore, we are expecting to see higher growth rates in sales at the beginning of the year than at the back half of the year. So that is one element of what you can expect to see on leverage. The other is obviously as we think about investments in some of our growth categories some of those are capital items which will occur at the beginning of the year.

Some of the store remodels, for example, and we will also invest in training associates to support that and that will put pressure on our profitability throughout the year particularly as we try and scale that so at the beginning of the year our training will be smaller numbers of people and to the extent we see results from the training and staffing we plan to invest in we will continue to invest in that throughout the year. I would say the significance of those will depend on the success we see with the initiatives themselves.

Chris Horvers – JP Morgan

So is it fair to characterize that EPS growth isn’t necessarily, it is relatively consistent throughout the year?

John Mahoney

We have given guidance for the first quarter and the full-year and I would expect that as we get into the year we will manage our results based on our usual practice of trying to maintain reasonable operating profit rates and at the same time investing in the things that if proven successful will drive our growth longer term.

Operator

The next question comes from the line of Stephen Chick – FBR.

Stephen Chick - FBR

Ron I was hoping could you just describe how the North American delivery sales trended during the quarter and how much the January kind of back to business period drove it? I was hoping maybe John could give us a little bit of granular sense on your sales guidance, a little direction of what you are thinking about the three components of the business if you could?

Ron Sargent

You are asking about North American delivery or North American retail?

Stephen Chick - FBR

North American delivery, the down 2.5% is a good improvement sequentially versus what you did last quarter. I was hoping to kind of get a sense of how it trended during the quarter.

Ron Sargent

I think North American delivery trended up throughout the quarter. Not dramatically up any particular month. If you look at North American retail we were pretty flat. The comps were pretty flat throughout the quarter at 3%. North American delivery is minus one.

John Mahoney

Minus one.

Stephen Chick - FBR

Well I was kind of talking about I think local currency. Have you seen now that we have kind of a month into the next quarter here and you are moving away from the back to business period, have you seen a change in the trend?

Ron Sargent

We aren’t going to talk about the quarter we are in other than the guidance we gave. I think it is safe to say we feel good about our existing customers buying more. We are continuing to kind of gain customers at about the current rate we had been gaining customers. There is some kind of optimism maybe the economy is helping us a little bit with existing customers. Joe do you want to add anything?

Joe Doody

All the difference you saw and the improvement you saw sequentially in Q3 and Q4 was existing customers strengthening in terms of their buys as you indicated Ron, our acquisition of new customers continues to outpace lost customers but the sequential improvement we saw of about 1,000 basis points from Q3 to Q4 was driven most heavily by sales from existing customers strengthening.

Stephen Chick - FBR

Ron the synergies of $300 million I think formerly you had said I think the other 40% of it or call it cumulatively 80% in what would be 2010 here is that within your earnings guidance for 2010 is that the number you have baked in, about 80% of $300 million?

Ron Sargent

That is the number we have assumed. The $300 million with 40% coming year one. Another 40% coming year two and then the last 20% coming in [Q3]. We feel pretty comfortable with that number.

Operator

The next question comes from the line of Colin McGranahan – Sanford Bernstein.

Colin McGranahan – Sanford Bernstein

On the share count obviously a pretty big increase here sequentially from the fourth quarter to the first quarter and then through the year. It sounds like you are guidance implies you will not be buying back any stock or is your guidance just guidance absent whatever stock repurchase you do?

Ron Sargent

There are really two elements to what drives our share count. One is the shares that we issued for our employee stock plans. The other is shares we buy back. We don’t really have, I think we have said if we were to buy back shares it wouldn’t begin until the middle of the year. Therefore we wouldn’t expect it to have a really significant impact on the total number of shares. Obviously we don’t really have a handle on how many associates will exercise options and impact the share count in that fashion. So I would say that our guidance is pretty down the middle. It assumes that we won’t see any major change from either our employee purchases or our employee shares plans or a share buyback. Based on what we have said before about share buybacks not beginning to the middle of the year.

Colin McGranahan – Sanford Bernstein

Using your share count it implies your EPS guidance range of operating margin for fiscal 2010 in the 6.45% range to 6.9% to maybe 25 to maybe 65 basis points of margin expansion. I am just trying to square that against I think Ron called it a dramatic improvement in international. Mike said a significant step in profitability in international. If you have that it would suggest either retail was positive comps leveraging rent and labor or delivery with positive top line growth is really going to see any margin improvement at all or there is any incremental synergies to the business at all. I am just really trying to square that and I guess I am having trouble understanding why there isn’t leverage in the model given the top line growth and the international improvement.

Mike Miles

I think as we face all of the opportunities and the challenges we have in 2010 we have the two sides of it; we don’t really know what the economy is going to do. As I mentioned we aren’t planning for a dramatic improvement in the economy. At the same time we have had pretty good success with some of the growth initiatives that we think are going to position us well for the longer term. I think that the investments we make against a relatively low single digit sales gain will result in what we think are in the base business you will see dramatic improvement. You will see the base improve but you will see investments in the growth areas offsetting a substantial portion of that and the aggregate effect of that is we will have what we think is decent operating margin expansion and we will manage that throughout the year.

Colin McGranahan – Sanford Bernstein

So you said the incentive comp in the fourth quarter was 70 basis point impact?

Ron Sargent

Yes it was.

Operator

The next question comes from the line of Mike Baker – Deutsche Bank.

Mike Baker – Deutsche Bank

Can you characterize the promotional environment both in retail as well as in the delivery business? Are you seeing people aggressively go after new contracts?

Demos Parneros

I would say the environment is essentially the same as it has been. Obviously everybody was working through the worst, previous quarter so in Q4 we really didn’t see anything particularly aggressive come through. I think towards the end of the quarter there was a little bit more activity as we headed into January but nothing too noteworthy.

Joe Doody

On the delivery side, I think you can say it continues to be competitive but rational. So we don’t see anything out of the ordinary out there.

Mike Baker – Deutsche Bank

So based on those comments and what I think you can infer from your guidance it sounds like you expect that to continue and then gross profit margins to be favorable in 2010?

Joe Doody

Correct.

Operator

The next question comes from the line of Matthew Fassler – Goldman Sachs.

Matthew Fassler – Goldman Sachs

First of all if you could shed just a little strategically on the technology effort you talked about in North American delivery I know you had a press release a week or so ago discussing the launch of that effort, what kind of size you anticipate from that business over the next year or two? I was wondering if you were going to steer clear from technology or at least [computer] technology in delivery?

Ron Sargent

Let me start and I will turn it over to Joe Doody. I think we are really talking about two initiatives but really one initiative, both related to technology. I think on the retail side we think there is an opportunity to sell a lot more technology to our retail customers and our catalog customers which I think is about assortment. It is about service. It is about building relationships. It is easy tech. Then the announcement we made a few weeks ago was on Staples Technology Solutions which is a combination of a business that we purchased a few years ago plus one of the lines of business that we acquired with Corporate Express. We put those two together and called them Staples Technology Solutions. Joe you might want to give some color commentary on that.

Joe Doody

I think just to go back to your first point I think we feel there is certainly opportunity throughout all of North America delivery for technology sales and getting a fair share of technology business out there among our existing customers. So it is clearly an area we can leverage our customer relationships with leverage, our vendor relationships and leverage our supply chain to bring more technology solutions to our customer base. As Ron said with the acquisition of Corporate Express we certainly picked up some additional capabilities. We really wanted to rebrand those under the Staples name and that is the announcement that you saw recently bundling some capabilities together. It is not a significant business today but certainly has significant growth opportunities for us.

Matthew Fassler – Goldman Sachs

Related to your currency assumptions and tax rate assumptions and also just clarifying on amortization perhaps it is common knowledge but it looks like you are guiding amortization down year-over-year from 2009. I just want to make sure that I got the math right on that.

John Mahoney

Amortization is an easy one starting off. There were a number of items that related to the brands that we had in Europe that we accelerated the amortization on as we plan to phase them into the Staples brand. That is the reason the amortization for those goes down. We had higher rates over the shorter life that we used based on the transition plan.

From a currency perspective obviously currency has been pretty volatile. We have assumed essentially what a consensus forward rate would indicate for currency for 2010. So it will be a little bit volatile but generally speaking it will hurt us during the year we expect. On the tax rate, we expect the tax rate will be similar to this year.

Operator

The next question comes from the line of Brad Thomas – Kebanc Capital Markets.

Brad Thomas – Kebanc Capital Markets

I wanted to follow up on the increased investments for this year specifically CapEx. Can you talk a little bit more about the areas of investment and the time frame you might hope to get a return?

John Mahoney

I think we have made it clear that integration continues to require some CapEx. Some of that is in the systems area. Some of that will be in facilities. We also have made planned investments to support the tech initiatives and the copy and print initiatives in our retail business. All of those we would expect to get returns in our normal time frame. In stores we see returns generally within the first couple of years. With the expenses for integration or the CapEx for integration that will be part of what has been able to drive our operating margin rate in NAD. Finally in Europe we have seen some investments both in distribution and delivery as well as systems as we implemented SAP throughout Europe. All of those would show a return in the very near-term.

Brad Thomas – Kebanc Capital Markets

I wanted to follow-up on the retail comp performance. When you look at it on a two year rate it looks like perhaps a little bit of a slowdown. It sounds like also the technology category a big driver, often perhaps maybe a little bit more of a consumer related category rather than a business related category. Can you talk a little bit more about what you are seeing in terms of the small business spending trends?

Demos Parneros

Overall I think the customer counts showing the best improvement we have seen in quite some time. I don’t have a strict breakout of the consumer traffic count at the moment. The trends are encouraging. Also the tech focus for us is really on business tech. As business hopefully get [inaudible] opportunity for us to really go after that which obviously is an area we feel is not fully served right now. So it is an exciting opportunity. Obviously it is a lower margin business and we will have to do a much better job at filling out the sale and really getting customers what they need and selling them a complete solution. That is going to take a stronger focus on how we actually set our stores, train our associates and how we really fulfill the customer’s needs.

Operator

The next question comes from the line of Dan Binder – Jefferies.

Dan Binder – Jefferies

On the $20 million hit you are taking between the print business and China I am curious what you would anticipate the direction of that to look like over the coming quarters? Is this sort of a trough on that and it is going to get better from here or do you expect it to run at that level for a couple of quarters before new management can impact China in particular? The second question is on the impact that technology had on gross margin if you have the breakdown in terms of was it 10 basis points? 20 basis points?

Mike Miles

On the print systems in China the vast majority of that was on China as opposed to last quarter when we had about the same sort of issue but the majority was print systems. I expect print systems will look a lot better in 2010 than it did for us in 2009 largely as a result of the steps we took in 2009. I don’t think the business is going to improve a whole lot but we have right-sized the cost structure there. China is a little bit more of a longer term project for us. As I mentioned we have had some management changes there and although I think the long-term prospects for us there are very bright I think we may have a little more pain to go through there before things really look a lot better.

John Mahoney

I don’t have the exact number, but I think overall we saw 55 basis points of improvement in our gross margin rate and that was driven by integration synergies but offset slightly by the change in mix in technology in the retail stores. That is not a really huge impact on the whole but it did moderate the improvement we saw.

Operator

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

Kate McShane – Citi Investment Research

Now that you have a few months in Europe under your belt can you talk a little bit about what you have learned that maybe you didn’t know before both on the positive side and the negative side? Can you go into a little bit more detail on your new mid-market contract strategy in Europe?

Mike Miles

I think in general the European business is one that has a number of very strong operations in it. If you look around up in the Nordics and southern Europe in our catalog business we have some strong operations. We have also really improved our retail business there over the years. I think 3-4 years ago we were struggling to break even in Germany at retail. That business is now approaching U.S. levels of profitability and on a nice trend. So I think there are some places in Europe where I think we are ready to invest today even though the overall operating profit level there is still below where we want it to be.

With respect to mid-market I think particularly in Germany and the U.K. there is a nice opportunity for us to leverage the contract infrastructure we have in place there and add the mid-market sales force model that has worked so well for Joe and the NAD team here in North America. You won’t be surprised to learn that we are exporting people from Joe’s team who are experts on that model to Europe to help lead that effort. We have already got the first people on the ground and are beginning to add sales people in that space as we speak. Obviously it is something that needs to build over time because you need to ramp the sales force to really drive the business but we are optimistic we can do the same over there that we have with SBA here in the U.S.

Kate McShane – Citi Investment Research

Of the 40 stores you are opening in North America in 2010 did you say how many were copy and print stand alone stores?

Ron Sargent

We didn’t. It is a handful.

Joe Doody

4-5.

Operator

The next question comes from the line of Oliver Wintermantel – Morgan Stanley.

Oliver Wintermantel – Morgan Stanley

Regarding the back to business season if you compare January 2010 to a more normalized January or January 2009 how was January 2010 in terms of sales volume and sales mix comparing consumables and more durables?

Ron Sargent

I don’t know that I have looked at it that way but off the top of my head I would say that probably 2010 looked a lot more like 2007 or 2008 kind of month in terms of mix of product. Maybe slightly more skewed towards technology as our business has evolved more towards technology but certainly 2010 is much better than 2009. Kind of your typical January. There have been some product mix shifts but nothing dramatic.

Operator

The next question comes from the line of Gary Balter – Credit Suisse.

Gary Balter – Credit Suisse

There has been discussions about possibly you giving up market share in contract based on as you bring Corporate Express in and customers you felt didn’t fit in with your longer-term goals. Yet your results were still stronger than the other two. Could you describe to us what your plans are and are you kind of done with reviewing all the contracts?

Ron Sargent

I will make a summary comment and turn it over to Joe. I am kind of an analytical guy. The numbers are the numbers. You can just kind of look to see we are obviously not losing share. Joe?

Joe Doody

The numbers are the numbers. Sequentially as I said we had 1,000 point improvement from Q3 to Q4. Our major two competitors at least had dramatically less sequential improvement or at least one of them did. But we are continually looking at contract whether they be CE contracts or Staples contracts to ensure we are driving a level of account profitability and we do that obviously through our lowest cost deliver model and we work with the customers to really drive savings for them, drive savings for us and drive some of the key metrics that you know helps that profitability like average order size, number of small orders, electronic penetration, etc. So it is never-ending whether it be the CE base or not. We have done most of what we need to do there. It is really fully integrated into the business and we are treating those customers the same as we treat our Staples customers.

Gary Balter – Credit Suisse

The follow-up is longer-term. You gave us guidance of 9%. I believe it is pre-tax but may be operating margin. Do you expect, we are projecting you will be at 6.2 now for 2010 which is up nicely from this past year. Do you think you will see that 9% before Canada defends her gold medal?

John Mahoney

The Canadians certainly did own the podium this time. That is all I can say.

Ron Sargent

I think it all depends on the economy. I think we are starting to see some nice recovery. I think that bodes well for 2010. I think it bodes even better for 2011. So given they won’t have a chance to defend their gold medal until 2014 yes.

Operator

The next question comes from the line of Alan Rifkin – Bank of America.

Alan Rifkin – Bank of America

On the North American delivery side I believe you said contract was down low single and Quill down mid singles. How much of a function of the lower marketing expenses do you believe those two businesses exhibited? Going forward in 2010 will we see an increase in the marketing side to hopefully boost those two sides of the business?

Ron Sargent

I guess I would argue we are spending marketing wisely and adequately. I think the big benefit from marketing is moving it from catalog and many of the things we have done historically to more of an online and direct sales force type marketing. I don’t think our lack of marketing expense impacted our sales. I think it was really just a function of the economy and our contract business. If you don’t have people working you don’t have people consuming office supplies. I think the early indications are that maybe the job situation has stabilized and we are hoping to see some improvement from here. Joe do you have anything to add?

Joe Doody

No. I think I agree with what you said and I have nothing further on that.

Alan Rifkin – Bank of America

Mike with respect to the international profitability significantly improving in 2010 after being own in Q4 can you shed a little bit more color on that? Is that more a function of a significant increase in productivity and where is the breakeven point with respect to expense leverage on the international side from a comp standpoint?

Mike Miles

It is really more driven by the expense reductions many of which we have implemented already in 2009 and the expenses we incurred associated with some of that not being around in 2010. It is not driven so much by sales leverage although obviously that helps. If we were to have a significant leg down that would obviously hurt. I think given a reasonable economic prospect and picture in 2010 we expect to get significant leverage from the better buying that we are doing and as I said those negotiations have all been completed and so we really know what that is going to be.

From the headcount reduction we achieved through the Works Council negotiations in 2009 and again not all of that has been implemented, it has all been negotiated and so we all know what that is going to be. Through the supply chain consolidation that we are still in the midst of we are going from roughly 37 warehouses in Europe down to something like half that. We are already half way there so those savings are kicking in as well. So I think we are not done. There is other stuff we want to get done. A lot of the reasons you hear some confidence in my voice when I talk about improved profitability it is because we have implemented a lot of the measures that will deliver that.

Operator

At this time there are no further questions. I would now like to turn the call back over to Ron Sargent for closing remarks.

Ron Sargent

Thanks everybody for joining us this morning. We look forward to speaking to all of you again very soon. Thanks everybody.

Operator

Ladies and gentlemen this concludes the presentation. You may now disconnect. Thank you for your participation.

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