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Staples Inc. (NASDAQ:SPLS)

Q3 2010 Earnings Call Transcript

November 18, 2010 8:00 am ET

Executives

Laurel Lefebvre - VP, IR

Ron Sargent - Chairman and CEO

Mike Miles - President and COO

John Mahoney - Vice Chairman and CFO

Demos Parneros - President of U.S. Stores

Joe Doody - President of North American Delivery

Analysts

Mathew Fassler - Goldman Sachs

Brad Thomas - KeyBanc Capital Markets

Kate McShane - Citi Investment Research

Chris Horvers - JPMorgan

Michael Lasser - Barclays Capital

Mike Baker - Deutsche Bank

Colin McGranahan - Sanford Bernstein

Stephen Chick - FBR

Oliver Wintermantel - ISI

Joscelyn MacKay - Morningstar

Mitch Kaiser - Piper Jaffray

Joe Feldman - Telsey Advisory Group

Brian Nagel - Oppenheimer

Anthony Chukumba - BB&T Capital Markets

Dan Binder - Jefferies

Operator

Good day, ladies and gentlemen, and welcome to the third quarter 2010 Staples Incorporated earnings conference call. (Operator Instructions) I would now like to turn the presentation over to Laurel Lefebvre, Vice President Investor Relations.

Laurel Lefebvre

Good morning and thanks for joining us for our third quarter 2010 earnings announcement. During today's call, we'll 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'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' latest 10-Q filed today.

Here to discuss Staples Q2 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 with us are Demos Parneros, President of U.S. Stores; and Joe Doody, President of North American Delivery.

During today's Q&A session to allow everyone to participate on the call, we ask that you please limit your questions to one per caller. If there's time remaining before we end the call at 9:00, we'll take additional question before us. Thanks. Ron?

Ron Sargent

Thanks, Laurel, and good morning, everybody. Thanks for joining us today. This morning I'm pleased to announce Staples third quarter results and I'll start with the headlines. Total company sales were $6.5 billion for the quarter, up slightly compared to Q3 of last year. And we adjusted earnings per share of $0.41 at the high-end of our guidance, and cash flows were very strong.

Last month at our investor conference we outlined our strategies to drive grown in North America and also our plans to profitably grow our international business. And during the third quarter, we made good progress against those plans. Gaining traction in our growth initiatives, growing core office supplies and significantly improving our international profitability.

In North American Retail we achieved strong comps in copy and print and double-digit growth in our EasyTech business. In North American delivery, we continue to see momentum on the top-line with 3% growth. And in our international segment, we drove solid profit growth with operating margins up 150 basis points, compared to last year's third quarter.

With all the work that we've done in 2009 and 2010, we're poised for better top-line trends going forward. For 2011, we're planning for sales growth in the low-to-mid-single digits and strong double-digit earnings growth. Although, we're not expecting a rapid improvement in the economic environment, we do assume a slow steady recovery throughout the year. We'll hit our sales targets by focusing on the four parts of our profitable growth strategy that we discussed at our Investor Day.

We'll continue to grow our share of core office supplies, including growth in Staples brand products. We'll take a big step forward in categories beyond office supplies like facilities and breakroom products. We'll increase our mix in services like copy and print and EasyTech. And we'll continue to make progress to a certain goal of 7.5% operating margin in international. Doing all this, we'll generate a lot of cash that we will use to invest in our business and return to shareholders through dividends and share buybacks.

Turning to our business units, and I'll start with the North American Delivery. Sales for the third quarter were $2.5 billion an increase of 3% in U.S. dollars or 2% in local currency compared to Q3 of 2009. We grew the top-line in the low-single digits in both Contract and Staples with Business Delivery. And Quill's top-line trend continued to improve as we got back to flat sales after nine quarters of declines.

Core office supplies and computers and accessories were strong during the third quarter. Office Paper grew faster than the House, while Ink was about flat for the quarter. Our facilities in breakroom initiative gained traction as we won several new multi-million dollar contracts during the third quarter. This year we put a lot of effort into building a foundation to accelerate growth and facility supplies.

We've expanded our assortment; we're offering sharper prices and improved our systems to handle the unique requirements of this business. We have high expectations for growth in this category going forward.

NAD operating margin was flat, compared to Q3 of 2009 at 8.9% with nice leverage in Contract. Our contract business continues to benefit from Property Express synergies, while also investing in our growth initiatives. Strong margins in Contract were offset by lower margins in Staples Business Delivery and Quill, as we invested in marketing and pricing to drive traffic and key categories like paper and facility supplies.

During the third quarter, we also made strong progress with the physical integration of our supply chain. And we upgraded 12 warehouses with the capability to serve both Staples and Legacy Corporate Express customers. And service levels of these facilities are at all time highs. The scope of our integration also includes our last mile delivery hubs. And so far this year, we've integrated over 45 locations with about 15 more in process.

And while we still have a lot of work to do in terms of integrating the supply chain network, launching a common front-end and moving all our customers to the new system we expect to get significant savings from this consolidation over the next several years.

Moving on to North-American retail, sales for the third quarter were $2.6 billion and increase of 1% in U.S. dollars compared to Q3 of 2009. Third quarter same store sales declined 1% with strength in core office supplies, EasyTech and copy and print offset by softness in business machines and computers. Computers were slightly negative as we cycled last year's launch of Windows 7 late in the quarter. This added a lot of point to our Q3 comp last year, consumables like ink and paper were in-line with the house.

We are pleased with our back to school season, which was highlighted by strong customer demand for core supplies. This year customers were required to hit a $5 minimum purchase threshold to be able to take advantage of our best offers, which drove up average order size and improved our margins.

North-American retail operating margin increased 47 basis points to 10.6% for the third quarter as we improved product margins and recorded lower depreciation expense, we also saw strong growth in our high margin services businesses like copy and print and EasyTech.

During the third quarter copy and print achieved mid single-digit comps and we're seeing a great response from mid-market customers who were serving in retail through our outside sales force and we continue to invest in copy center remodels as well as marketing to drive awareness.

Our EasyTech business is also gaining momentum with the strong double-digit growth during the third quarter we remain on track to exceed $100 million in EasyTech sales for the year in North-America. We've seen a great response to our traffic driving deals like our free PC tune-up and 50% off of tech service offers.

We've also seen good results from our remodeling activities we've now remodeled more than 550 stores with new EasyTech counters and we'll complete another 200 in Q4.

With Black Friday about a week away we've got big plans to drive traffic this holiday season for most of the year we have a strong focus on the needs of our small business customers but during the holidays we also work on driving consumer traffic. This year we're offering the latest tech products like the Kindle, web printers and Flip video cameras.

During the third quarter we opened 10 stores, we closed 1 store ending Q3 with 1897 stores in North-America. We remain on track to open about 40 new stores in North-America for the full year. And looking out to next year, we are planning to open about the same number of stores as this year.

And with that I'll turn it over to Mike Miles to talk about international.

Mike Miles

Thanks Ron, good morning everybody.

Sales for the third quarter in international were $1.4 billion, a decrease of about 4% in U.S. dollars or a decrease of about 1% in local currency, compared to the same period last year. We're seeing steady quarter-by-quarter improvement in local currency sales trend with 300 basis points of sequential improvement on a two-year basis during Q3.

Operating margin for the international business was 4.3%, an increase of 150 basis points from the same period in 2009. Almost a 50% increase in profit dollars versus last year. This was driven by strong margin improvement in both our European Delivery and Australian businesses, reduced losses in the printing systems division as well as lower amortization. It was somewhat offset by a de-leverage of fixed expense on lower sales in European Retail.

We had flat year-over-year sales performance in local currency in our European Delivery business and the team did an outstanding job managing expenses, driving almost 200 basis points of operating margin improvement. As we discussed on last quarter's call, we weren't satisfied with the minus 9 comp and European retail during Q2. And we didn't quite get back to positive comps for Europe as a whole during the third quarter. The minus 2 comp was a nice sequential improvement on both the one year and two-year basis.

Improving trend of retail was led by Germany and Portugal, which both had positive comps during the third quarter. A highlight is our German Retail business. We've taken a much more disciplined approach to our marketing programs. We've pulled back on using low margin tech to drive traffic and instead have focused on driving sales of core office supply. I feel confident that the German Retail business in on the right track. We're profitable in every single store in Germany and are making plans to ramp up new store growth there in 2011.

During the third quarter we completed our acquisition of the remaining shares of Corporate Express Australia. Despite a slight decline on the top-line in local currency, operating income increased 90 basis points. A few weeks ago, we launched staples.com.au, serving small business customers in both New South Wales and the Australian Capital Territory.

Staples name is new to the Australian market and our global experience will help us deliver a differentiated offer to small businesses there. We're using the European web platform for Australia and for China, as we leverage our global strength to give customers an easy e-commerce experience.

In the printing systems division, we achieved top-line growth in low-single digits in local currency. Over the last two years, PSD has reduced its cost structure by 25%. It will breakeven during the second half of 2010, providing a nice upside as we wrap the operating losses and restructuring charges of 2009.

At our Investor Conference in October, I'll walk you through our plans to improve international operating margins from 2.3% last year to 7.5% over the coming years. We have a big opportunity to get our cost structure more in line with our North American businesses and we put the right team in place to take us there.

During the first three quarters of this year, we've taken a big step forward. With year-to-date operating margin of more than 120 basis points, I'm confident that we'll end 2010 with international operating margins above 3.5%. And over the next few years, we expect to bridge the gap between, where we stand at year-end and our 7.5% goal by focusing on a few key areas.

First, we plan to achieve about 150 basis points of improvement through G&A savings. Second, we will get 100 basis points from merchandising initiatives like better buying and increased penetration of Staples brand products. Finally, I expect about 50 basis points each from supply chain turning around or exiting unprofitable business units, and improving business mix, like mid-market contract and retail services. Sales growth would provide additional leverage and accelerate our achievement, that the 7.5% margin target is based on the size of the business we have today.

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

John Mahoney

Thank you, Mike. Good morning, everybody. The third quarter total company sales were up slightly versus last year at $6.5 billion. The foreign exchange impact from the stronger U.S. dollar had a modest negative impact on the top-line, with sales growth rounding up to 1% in local currency for the quarter. Our third quarter GAAP earnings per share on a fully diluted basis increased 8% to $0.40 versus the third quarter of 2009.

During Q3, the company recorded pretax integration and restructuring expense of $9 million or $0.01 per diluted share, excluding these costs as well as the $16 million of pretax integration and restructuring expense that we incurred during the third quarter of 2009, adjusted diluted earnings per share increased 5% to $0.41 versus $0.39 during Q3 of last year.

Gross profit margin improved by 49 basis points to 27.6% during Q3. This reflects improved product margins as well as increased supply chain efficiencies. SG&A deleveraged 7 basis points versus last year's third quarter to 19.3% of sales. This is driven by lower depreciation expense and expense management, offset by our investments in training, labor and marketing to support the growth initiatives.

Adjusted operating margins, excluding integration and restructuring expense increased 60 basis points during the third quarter to 8.0% compared to Q3 of 2009.

As we've discussed on previous calls, our effective tax rate this year is 37.5% compared to 34.5% last year. In the third quarter, this drove approximately $14 million of additional tax expense. We expect our tax rate to return to about 34.5% in 2011, assuming no other changes in the tax laws.

Year-to-date capital expenditures came in at $246 million compared to $191 million that we spent on capital during the same period last year.

With year-to-date operating cash flow of more than $1 billion, we generated $750 million in free cash flow. We expect our capital expenditures for the year to be closer to $400 million versus our previous guidance of $450 million, and we are on track to generate more than $1 billion of free cash flow for the full year.

During the third quarter, we repurchased 8 million shares for $156 million. With $1.4 billion of cash and cash equivalents on our balance sheet and available lines of credit of more than $1.2 billion, our balance sheet remains strong.

Turning to guidance for the fourth quarter, we expect total company sales to increase in the low single-digits versus 2009. We expect adjusted earnings per share to be in the range of $0.39 to $0.41 for the fourth quarter and $1.27 to $1.29 for the full year. This excludes integration and restructuring expense of approximately 8 million in the fourth quarter and about $60 million for the full year.

Looking out to 2011, we expect top-line growth in the low to mid single-digits, as our growth initiatives continue to gain traction, and earnings per share in the range of $1.50 to $1.60. And we expect to generate more than $1 billion in free cash flow next year after spending about $500 million in capital expenditures as we invest in the supply teams, systems, new stores, as well as our growth initiatives.

Thanks for listening this morning.

And now I will turn the call back over to Ann to moderate the Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from the line of Mathew Fassler with Goldman Sachs.

Mathew Fassler - Goldman Sachs

I have got one question and one follow up. On the first one, if you could talk about your ability to generate operating leverage in retail, particularly as it relates to gross margin, given the mix shift towards technology. I understand that you cycled Windows 7; so maybe the tech mix shift was most pronounced as it has been. And this is the biggest retail leverage that I think you've shown in something like four years. So any insights there about drivers and sustainability would be great.

Demos Parneros

I'd just like to start with just the continued focus on what goes along with tech, which is the services and really our selling initiatives that we've put in place. We've worked hard to train associates throughout the entire country, and its really starting to pay off. So that along with the remodel initiatives, we'll have our over 700 stores remodeled by the end of the year for our EasyTech initiative, and that's beginning to take hold. And then finally, the work that we have done with our copy and print business, both in-store, the remodels, and the counter out on the street, are beginning take hold as well. So actually, those are the main drivers.

Mathew Fassler - Goldman Sachs

And I guess my follow up relates to your investments, your new business investments in particular. Can you help quantify perhaps the dollars that you are putting against these investments on the SG&A line and perhaps the revenue that they are driving today, just to understand how mature they are to results here in the third quarter?

John Mahoney

Of course, we aren't going to disclose all the details of exactly how this business runs. The big combination of capital is, you heard about the number of projects we have done in remodeling stores. And so you can imagine that we have got a substantial investment in G&A, both in terms of the people managing those activities as well as the people developing the marketing and training capabilities that we have. So it does have an effect.

And I think you've heard, all of the growth initiatives, particularly in the retail business with the services have been growing substantially faster than the rest of the businesses. So as Demos says, that helps gross margin but it also helps cover the G&A that we are adding in order to support those initiatives.

So as you'd expect, as we track these initiatives, we are trying to balance, maintaining good operating income margin and pushing the capabilities we need to be able to accelerate the growth in all of those. It's a delicate balance, but obviously in retail in the quarter, Pete did a great job.

Ron Sargent

Matt, just to kind of reinforce that, I think Demos and John talk to strategy, but the Retail team in the U.S. and Canada did a terrific job just kind of managing the business very carefully, managing the mix of business. Back-to-school I think was a nice surprise for us this year in terms of how that rolled out. So I think you've got to give a lot of credit to Demos and Steve Matyas and their teams.

Operator

And our next question comes from the line of Brad Thomas with KeyBanc Capital Markets.

Brad Thomas - KeyBanc Capital Markets

One more to follow up on the margins in North American Delivery. This was I believe the lowest quarter of margin improvement for the year, despite the best top-line results that we've seen in the year. I was hoping if you could just talk a little bit more about the impact of the marketing and pricing on margins, and how we should think about margins in the category over the next few quarters and where that leverage point is with some pretty investments that you're making?

Joe Doody

Yes, Brad. Well, first as we said, there was a nice leverage in Contract. But that was offset by a de-leverage in both the Staples Business Delivery as well as Quill.

And we clearly made investments in both marketing and pricing, focused on customer acquisition, building in an awareness campaign in Quill as well as facilities in breakroom. So those are the key areas that we've really focused on. We realized that in the short term that most of these investments did not have a positive impact on margin, but they are really the right things for the long term growth of the business.

We did see some upside to our trend line on sales. We feel real good about our customer base and the development of the customer base with our customer acquisition activity. And we're committed to continuing to see to meet our long term margin goal. Within the short term I wouldn't expected that our short term trends for sales and margin growth will differ dramatically at least in Q4 from Q3.

Operator

And our next question comes from the line of Kate McShane with Citi Investment Research.

Kate McShane - Citi Investment Research

Ron, I think you quantified EasyTech as being a $100 million business by the end of this year. Can you quantify what Copy and Print is?

Ron Sargent

Not in dollars, but I can tell you that in terms of mix, as Demos was saying, about 6% of our retail sales. So I can do the math, but that's rough and tough of what it is and it's been growing nicely. A few years ago it was 5%, now it's 6%.

Kate McShane - Citi Investment Research

And then my other question is about the independent dealers. And with some of these independent dealers winning some of the consortium contracts, I wondered if you could comment on any other changes you are seeing in the competitive environment as a result of these players getting more aggressive.

Ron Sargent

Yes, Joe and his team have been very successful in this arena. And I'm going to ask Joe Doody to answer that one.

Joe Doody

Yes, I think clearly they're trying to be able to band together to get some of other bigger contracts as you saw in the US Communities example. But they have been a strong competitor, and the strongest of the independents have survived. But we continue to gain share in that mid-market which is primarily where they are strongest. And we continue to invest heavily in customer acquisition in that area and continue to expect to gain further share in that market moving forward. So strong competition continues, but we continue to gain share in that market.

Mike Miles

And next quarter we'll be prepared I think to talk a little more specifically about how we are doing against the US Communities specifically, because that seems to be heating up.

Ron Sargent

Definitely heating up, and one where we are going after it aggressively as we do in all new business opportunities, but one that's a little too early to report specific success examples of although those are beginning as we speak.

Kate McShane - Citi Investment Research

And with the customer acquisition you've highlighted in your comments, was that more of the middle-market level or was it across the board?

Ron Sargent

It's really across the board, the investment we made and the customer acquisition is not just in the mid-market but also as I stated, it's in the Staples Business Delivery as well as Quill, so it also is in our small business area as well.

Operator

And our next question comes from the line of Chris Horvers with JPMorgan.

Chris Horvers - JPMorgan

One, a follow up on a topic that was started at the Investor Day. As you think about the wireless business and your push into adjacent categories, do you think that at some point in 2011 the Staples machine really gets behind the wireless tests? I know you have 100 stores right now, and you know maybe roll out a national, multi-carrier model because if you want to be successful in tablets, don't you really have to have some leadership in the smart phone business?

Ron Sargent

I think you are right. I think it is a growing category and its one that we are and we'll be getting behind, but Demos can talk specifically about it.

Demos Parneros

Chris, you are right, we have actually been testing the multi-carrier model as well as the single-carrier model. We do plan on doing more wireless in 2011. And you can actually do a lot of the tablet with or without these lighting up in the store. Obviously we prefer to light them up and get the wireless contract as well.

So we're working on it and its part of the overall tech initiatives that we are pushing forward with.

Chris Horvers - JPMorgan

Maybe want to give some color on the tablet plans.

Demos Parneros

The tablet, it's a really exciting plan. We're going to see the first of the tablets get into our assortment. There would be very little in Q4, but we'll have one nationally within a couple of weeks. We'll have also a piece that's only in our wireless stores which we're very excited about. But really gets much more fun in probably the first quarter, we expect anywhere between 5 and 10, all the major players really will have their offering and we are geared up and ready to go. Our team's ready, we have been really preparing for it and in tandem being a pretty important player in tablets overall.

So that should be a good opportunity for us for the majority of 2011.

Chris Horvers - JPMorgan

And just as a follow up on the PC side, is the Window 7 compare, is it really just that 2 week launch and that touch compare is behind us as we look at the fourth quarter?

Ron Sargent

No, we think it's behind us.

Operator

And our next question comes from the line of Michael Lasser with Barclays Capital.

Michael Lasser - Barclays Capital

We're seeing the kind of gradual narrowing in North-America retail of the comp between you and your leading competitors so do you think you are maintaining overall sharing and actually growing and do you think you are maintaining or growing share of the customers who are returning to the market now that the economy is getting better?

John Mahoney

Just briefly, I can answer that one. I mean comps are based on how you did the year before and when you look at our comp versus last year versus our competitors comps versus last year and you look at the two year trend I think its clear we are continuing to gain share. Do I think we are continuing to gain share at all parts of the business, Retail, Delivery, International? I think all of our internal data would indicate that we are.

Michael Lasser - Barclays Capital

And do you expect that to continue to be the case as the recovery of falls and do you think it's going to be as cost efficient as it has been throughout the downturn?

John Mahoney

Yes, I don't have a lot of experience with downturns because this is really only the second one we've had in the last 10 years. If anything, we've picked up a lot more share coming out of recovery last time because we invested heavily in the business during the downturn. This recession, unfortunately we've had more time to invest in the business during the downturn, but the recovery we have big expectations. And many of the things that we announced on our investor conference a couple of weeks ago, that stuff we've been working on, testing on and even rolling out over the last couple of years.

So we are feeling pretty good about kind of a recovering economy.

Operator

And our next question comes from the line of Mike Baker with Deutsche Bank.

Mike Baker - Deutsche Bank

So really I guess to follow up on that last point. Your sales guidance next year is better than this year and I think you said getting better throughout the year. So I guess what kind of economic outlook is that predicated on. And if you're not expecting an economic recovery, is it primarily based on the types of share gains that you just described.

Ron Sargent

Well, I think it's a little of both. But I think it's safe to say that we are seeing a slow steady improvement in all areas of the business. And recently, I think jobs growth would indicate things are getting a little better for the national economy as well as a lot of the other economic indicators. I think on top of that we are seeing really good progress in the areas where we are placing a lot of attention, whether that's the services business or facility supplies or technology or even kind of the core office supplies.

So I think it's a combination of investments we've made, continuing to execute against our competitors, so maybe there's some share gain there, and then third of all kind of in the backdrop of an improving economy. I don't think we are expecting a robust recovery next year, but I think we are expecting continued progress with the national economy.

Mike Baker - Deutsche Bank

And if I could ask one follow up. I just did want to ask about pricing in the retail business. So it sounds like you got a little aggressive in price in the Delivery business and that helped your gap between your competitors widen this quarter. Again, Retail, it did narrow and you did have tough comparison. That's fair, but I am wondering if your competitors were more aggressive in pricing in the back-to-school period than you were, and just general comment on what you are seeing promotionally there?

Demos Parneros

I would say, not at all. I think the back-to-school promotional climate was consistent. I would say it was pretty aggressive across not only in OSS but mass and other channels as well. But as Ron mentioned before, we had a good back-to-school season. We had particularly good strength in our core supplies back-to-school businesses. The weakness is really a little bit in computers as we mentioned.

So we are happy with back-to-school. And as far as just the overall pricing, I am sure Black Friday is going to be the normal you know crazy pricing that we see every year and we intend to have a good day, we've got a great offer for the day. But don't see really anything materially different.

Operator

Our next question comes from the line of Colin McGranahan with Sanford Bernstein.

Colin McGranahan - Sanford Bernstein

First question for Mike, just on the pacing of G&A reductions, I guess 150 basis points would equate to something like $75 million. How do you think that would be spread out over the course of 2011, and do you think it will extend beyond 2011?

Mike Miles

It will extend beyond 2011, Colin. And recognize, as I'm sure you do that the implementation costs on G&A reductions with principally people, come with some expense as well. So you'll probably see more of it in terms of actually hitting the P&L in 2012, because the gains we get in 2011 will be offset to a large extent by the costs to implement those G&A reductions.

Colin McGranahan - Sanford Bernstein

That's helpful. And then, Mike, just on Australia, launching Staples dotcom. You talk about catalog circulation plans there, and eventually try to build a larger business, maybe both on the catalog side and the retail side?

Mike Miles

Yeah, it's interesting Colin. This would be the first dotcom business that we've gotten into, where we really led with the dotcom as opposed to having a catalog business where dotcom kind of follows in behind it. We are going to see how far we can push this by using e-commerce and e-marketing techniques largely. All others, certainly a direct mail plan that goes with it, it's probably not as catalog-intense as the SBD business is here, and certainly not as catalog-intense as our direct businesses in Europe are.

We are on a soft launch at the moment; we are going to go much heavier in the first quarter of 2011 and then through a combination of the direct marketing that you described and also expanding the geographic spread. Today as I said, we are just in the Sydney/Canberra areas. We will expand across the country in 2012.

Operator

And our next question comes from the line of Stephen Chick with FBR.

Stephen Chick - FBR

I have two questions. I guess, first, I want to make sure I took this down right. In North American Retail, did you say that paper and ink was in line with House for the quarter?

Ron Sargent

Yes.

Stephen Chick - FBR

Yes; so take us down 1%. Do you know kind of what the markets did in that category at Retail and is that something that's consistent what you talked about at the Analyst Day with some of those categories maybe declining or decelerating a little bit in, I don't want to say relevance, but the Paper was kind of move or would you expect that to accelerate from where you are here?

Ron Sargent

When talked at Analyst Day, we were talking about kind of macro over 10, 15 years. We weren't talking about quarter-to-quarter change in paper consumption. When you look at ink, I think our trend in ink was reflected gaining share, because I think ink is down because of the economy. I think ink is down a little more than we delivered. So we are pretty pleased that we picked up some share in ink.

Paper, my guess is, we were kind of about average. I don't know that we gained share or lost share in paper for the quarter. But it's a little hard for us to kind of know what going on from a quarter-to-quarter basis on market share. I don't think this is part of the secular decline in going to the paperless office.

Stephen Chick - FBR

And then second, if I could. Quill, congratulations on the sequential improvement. I remember, you talked about reinvesting to increase the awareness of Quill. In SBD, the investments that you've made there, is that something that's kind of reacting to something you're seeing competitively. And then second to that, if I took a downright that the low-single digit growth rate in SBD, I think it was running mid-single digit growth rate before. Could you just speak to that a little bit?

John Mahoney

SBD have a very slight weakening in growth Q2 to Q3, maybe 100 basis points, so not significant. As far as the pricing in SBD, it was really around facilities and breakroom products to really get and be more of a destination category there than a convenience category. So we have to get our pricing in line and we've done that as a result of that. And we're seeing very good growth beginning in that category.

And as far as the marketing investment in SBD, whereas you said Steven it's awareness building for Quill. In the case of SBD, it's really a customer acquisition spend from a marketing standpoint that's driving that, and not due to any competitive activities in the marketplace.

Operator

And our next question comes from the line of Oliver Wintermantel with ISI.

Oliver Wintermantel - ISI

From a geographical standpoint, has the variance between your best and your worst market narrowed since last year or is just a less significant difference? And if you could comment on Retail and Delivery please?

Demos Parneros

Actually there was little gap in our case between best and worse; actually it was pretty consistent across the border. So I would say there's no real significant difference across the U.S.

Oliver Wintermantel - ISI

And Joe, on the Delivery side any geographic?

Joe Doody

Not really, Oliver. We have seen some improvement in states like Florida and California, which back a year or so ago were being hit more. But they're more in line with House today. The only time we see a state that might pop-up a lot from an NAD standpoint is, as we talked about at the Investor Day, some of our new state business. We've had good success in a particular state by picking on a state contract and that may pop the business in that particular state in the short term. But generally speaking, there's been no major movement there.

Oliver Wintermantel - ISI

And then just the follow-up here in the ticket versus traffic, could you please breakdown ticket versus traffic for us?

Ron Sargent

Ticket and traffic were fairly close. I think, all within zero to plus 1% of delay.

John Mahoney

And I think one of the challenges for this quarter is because of the change and the way we did our back-to-school marketing. We didn't have as many of the transactions that are very low, less than $1 transactions (not really) taking up the penny offers. So the day is a little bit muddier. But overall, as we try to estimate the impact to that, we will say that traffic was probably slightly better near flat and average ticket was down a little bit, driving the aggregate down one.

Ron Sargent

It's a reflection of fewer computer sales than maybe we expected.

Operator

And our next question comes from the line of Joscelyn MacKay with Morningstar.

Joscelyn MacKay - Morningstar

I'm just trying to get a little bit more color on your potential for the beyond office products mainly. At your Analyst Day we did talk quite a bit about the overall categories slowly declining. And we said that core office products is about half of Contract. And then I know, Demos mentioned that ink and toner is about a quarter of retail sales. I was kind of trying to kind of marry those two numbers maybe for the overall company or maybe a little bit more specific to get to an apples-to-apples.

John Mahoney

We tried to describe the size of the market, certainly in technology and copy and printing, some of you are well aware of those. So just try to think about the beyond office supplies categories like facilities and the prints business as well as promotional products. Obviously facility is the biggest, it's a multi-billion dollar opportunity for us. And it can certainly make a dent in the total companies sales growth overall.

And I think many of them aren't quite as big, a little bit more volatile like promotional products. But in the aggregate, each of them represents an opportunity to a take the good solid office supplies base, the relationship we have with those customers and to build on that by penetrating the account and selling more products, and drive the overall productivity.

Ron Sargent

And to be clear, we expect to continue to grow our sales and core office supplies, including things like ink and paper and basic supplies. I think once people go back to work, we are going to continue to sell them a lot of office supplies. So I think what we are trying to do is just kind of explain why we think the push in the services, and technology, and copy and print made sense for us long term. But I wouldn't be expecting continued declines in office supplies as we expect to be growing core office supplies going forward in all categories of business.

Operator

And our next question comes from the line of Mitch Kaiser with Piper Jaffray.

Mitch Kaiser - Piper Jaffray

Could you talk a little bit about the eReader and Tablet category? I know that you are going to have a couple offerings here, and it sounds like a lot more in Q1. Just in terms of thinking about comp and margin implications and then some of the eReader categories, is there opportunity to recognize recurring revenue stream with content downloads.

Demos Parneros

Just to talk a little bit about eReaders for us, I'm really excited about our launch of Kindle. It's in all our stores and has been received very well. We've had very good sales on Kindle. We currently don't participate in the downloads portion of that business. We are basically selling product, and we've got a very nice attach rate on some of the other items that you'd sell with Kindle, (accessories) and so forth.

We have one or two other off-brand products on the floor, but essentially that's the go-to-market brand for us. We've chosen to stay away from the other brands out there that some of the book shops have and others have. As far as the download portion, for the future, the answer is, don't know. Nothing at the moment.

We expect to have a really good season. Obviously, December is going to be a big month for the Reader category. There is also some good innovation in the category. There have been several new products, bigger products in terms of size, different form factors. So we expect our good relationship to continue and to build that business.

As you mentioned earlier with tablets, we are very excited about becoming an important player in the tablet business. We are ready in terms of floor space, the preparation for training of our associates. As soon as the product is available, we'll be ready to go. So I think at this point it's a matter of each of the major players who have announced their plans to come through with delivering the product. And we'll get it in our stores and get behind it. So we don't have a national forecast because we haven't sold any, but we have to get after it pretty aggressively.

John Mahoney

And our PC share is pretty low. So we are expecting and hoping the tablet business to be added into our current technology mix.

Mitch Kaiser - Piper Jaffray

So as you sign people up then on the tablets on a go-forward basis, are there opportunities to recognize bounties for lighting them up as you had talked about?

Ron Sargent

Yes. In those cases where there is a light up situation, the answer is, absolutely, yes.

Operator

(Operator Instructions) And our next question comes from the line of Joe Feldman with Telsey Advisory Group.

Joe Feldman - Telsey Advisory Group

A quick question, I was hoping you could maybe talk about the small business customer a little bit and drill down into that. I would like to ask you guys, that there just being increased confidence among those guys, and I know that the trends are all gradually improving, I am trying to determine how much is a real comeback or is it just easy comparisons compared to past couple of years, and is there more appetite for private label or branded, discretionary versus non-discretionary?

Ron Sargent

We read the same stuff you do. I guess my gut tells me that things are really getting better. I think they are getting better slowly. We have seen nice growth in Staples brand this year, but we are also seeing good growth in some of the more discretionary items. And I am not sure in real time whether that's because we are doing a better job, or investing or putting emphasis behind certain categories or in fact things are getting better.

But maybe one indicator might be furniture. Our furniture business, after being near death for many years is starting to kind of be alive and I have even seen some positive signs in front of some furniture numbers recently. So I think that you're right. It is easy comparisons, but I think people wouldn't be doing some of those discretionary buying if they didn't feel a little better about the state of the economy.

Joe Feldman - Telsey Advisory Group

That's helpful, thanks. And if I could just follow-up with one more, actually for Mike. You mentioned Germany and doing a little more expansion there. I was just wondering if you could talk about what exactly you are seeing, what gives you the confidence. Also, are you learning things you can take to other countries, maybe around Europe or the rest of the world that would help to drive the retail business?

Ron Sargent

Yes, Joe, as we look at Germany, it's a pretty attractive market for us on a number of dimensions. The economy there is probably the strongest in Europe right now. We've done a fair amount of market research that suggests that customers who are aware of the Staples experience and particularly those who have been in our stores accept the concept and really like what we offer in retail there. We've got 50 odd stores there, all of which are profitable, which is a pretty good sign that our concept works. And there is not really a pure play competitor in the market.

So given that there are only 57 stores there and we've got 81 million people in Germany, you do that math versus any of our North American markets and you can see that there is lot of upside to add stores.

So we're excited about the prospect and are looking to start opening stores again there over the next couple of years. I am sure as we do that there will be some things that we can learn for the other European markets. But it is true that the European markets are pretty different, one from the other. And the challenges that our business in the U.K. is facing for instance are quite different than what we see in Germany. But from a new store standpoint, if we can be successful in Germany anywhere near to the extent that we can, that could be several years worth of new store growth just in that market without us even having to look to other companies in Europe.

John Mahoney

And I'd just add that not only are all the stores profitable but the operating margin rate there is sufficient to be able to earn a return on investing further capital on the stores there.

Operator

And our next question comes from the line of Brian Nagel with Oppenheimer.

Brian Nagel - Oppenheimer

Just a couple of quick questions if I could. First, recognizing we had a very detailed update on your business in late October and we do have been in a quite fluid environment here, maybe some comments on sales thus far in the fourth quarter, particularly as we get close to the holiday and some of your more extensive offerings for the holiday season mature.

Ron Sargent

We don't like sort of giving guidance. We are basically two-and-a-half weeks into the quarter, and the quarter, we've got the holiday selling in December, we've got the big January push with everybody getting back to business. And I just think its way premature to give you any kind of direction other than the guidance we've already provided.

Brian Nagel - Oppenheimer

I understand, thanks. I thought I'll just try. The second question again, really a simple question, but you know just looking there, you did lift the low end of the EPS guidance in the release today versus what you had given in late October. Is that just simply a reflection of the results coming out a little bit better than you had guided to for the third quarter?

John Mahoney

Actually it's quite more to do with the way earnings per share is calculated. As you know, the earnings per share calculation is discrete for each quarter and then the annual calculation is the average for the quarters. So the rounding tends to get you there. The intention is to maintain the guidance that we had; it's really increasing.

Operator

And our next question comes from the line of Anthony Chukumba with BB&T Capital Markets.

Anthony Chukumba - BB&T Capital Markets

Just had a quick question in terms of I guess the stores of the new EasyTech counters. You mentioned a jump of 550 stores and you will remodel another 200 stores by year end. So I think it's pretty safe to assume that you're pretty happy with the performance of those stores. I was just wondering if you can give us any color, even just directionally in terms of the sales that you're getting in those stores for either just the EasyTech business and/or total technology product sales in those stores.

Ron Sargent

I don't think we are prepared to share kind of what the technology lift is, but I can tell you that we've been kind of growing the EasyTech business 50% or so quarter after quarter after quarter. And we've been doing that with the offering and with the promotions, but frankly we haven't been doing it very well from a facility standpoint. We've been trying to grow this business with a little counter that's like 3 or 4 feet wide. And once we do expand to a full blown EasyTech in our stores, the lift is pretty significant. Demos, you want to provide some color or commentary there?

Demos Parneros

The only thing I would add is that we actually are in the EasyTech business in every single store in the U.S. and Canada. And the un-remodeled stores I guess do have a small workspace. As Ron mentioned, these remodeled stores really provide us with the opportunity to a much better job at handling the work and really demonstrating to customers what a big commitment we've made to the business.

Just the last thing I would say is that we've actually been working on the people's side for the last two years or more and really feel good about the level of certification and training capability that we've built. And as we imagine, the physical build-out which is the easier part, having the people part done and our team having done a good job on this is going to pay off and we'll see a nice lift not only in the EasyTech sales, grocery market related hardware sales to go along with that.

Anthony Chukumba - BB&T Capital Markets

Okay, but just to clarify, you are seeing a lift when you put in the specific EasyTech counter as opposed to stores that just have the smaller desk?

John Mahoney

I don't think we'd be doing any, if weren't seeing the list; so absolutely.

Operator

And our final question today comes from the line of Dan Binder with Jefferies.

Dan Binder - Jefferies

Two questions, one on distribution. You mentioned both in your meeting in October as well as earlier about the substantial work still in front of you on integration. And I was just curious, as you look at your longer-term profit margin targets, maybe you could talk to a little bit on what that represents as you march towards those higher levels. In another words, what are the savings, what does the margin improvement ultimately look like as you get that distribution network to the level you wanted to add in. And maybe in that conversation, if you could talk a little bit about where the square footage is on the network today and where it's ultimately going?

Ron Sargent

We're going through along this planning process, and I'm not sure we want to share year-by-year what we think, we're going to get out of distribution and delivery. But I think it's pretty clear to us and we talked about this a few weeks ago, that we do expect NAD to get to that 12% operating profit in the next several years and North American Retail 10%, international we've talked about 7.5%. But I think there's plans and there is credibility behind each one of those of how we're going to get there.

I know, distribution specifically, Joe, you want to say anything about that.

Joe Doody

That'd be a part of it. Dan, as you could well imagine. But it's not going to be the majority of it by any means. But it is going to be an important part of that. We are leveraging today and in spite of the fact, even in this last quarter we leveraged, in spite of the fact that we've got some short-term cost that were incurring to undertake the most projects we've ever undertaken in our history at one time.

And we're in the midst to those, here in the third and the fourth quarter trying to get many of them done before we get into peak, which is the month of January. And then we'll still continue to finish up some of those throughout 2011 and have the best majority of them done in 2011. So it will be a contributing factor for sure in our March to 12%, but will not be the majority of the differential between where we are today and getting to that level.

Dan Binder - Jefferies

Can you give us a sense of what the capacity reduction will look like over that time, over the next two-and-a-half years?

John Mahoney

I think it's fair to say that we will go down in terms of number of buildings. But as far as overall capacity, we plan to grow into some of the excess that we have today and some of the excess that we have, we will consolidate into other buildings. And into market-by-market analysis, Dan, because in some markets where we do have duplicate buildings today, either of the two buildings that are there can handle to provide volume that we have in that market. So it's a step at a time, it's not going to happen over the next year or so, given now these obligations etcetera. But it's a very measured plan based on really the roller performance of the different options that we look at within that market.

Dan Binder - Jefferies

And then finally, any parts of your business where you're seeing or expect to see meaningful inflation/deflationary trends?

Ron Sargent

I can't think of a single one. There's a little inflation in Argentina. But you think about our business over time, I mean typically you'll see inflation in paper-based products and resin-based products, and obviously oil is a little more expensive. But overtime it tends to be balanced out by the fact that technology goes the other way.

The 2000 average ticket size for a computer five or six years ago is now $600 or something like that. So I think, in general, we're not planning on any kind of significant impact from inflation for next year.

Operator

Ladies and gentlemen, this concludes today's question-and-answer session. I would now like to turn the call back over to Mr. Ron Sargent for closing remarks.

Ron Sargent

My only closing remark is, thanks everybody for your time this morning and your continued interest in our company. And we look forward to speaking to you all again very soon.

Operator

Ladies and gentlemen, we thank you for your participation in today's conference. This concludes the presentation. And you may now disconnect. Have a good day.

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