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Staples, Inc. (NASDAQ:SPLS)

Q1 2007 Earnings Call

May 22, 2007 8:00 am ET

Executives

Laurel Lefebvre - VP, Investor Relations

Ron Sargent - Chairman and CEO

Mike Miles - President and COO

John Mahoney - Vice Chairman and CFO

Joe Doody - President, North American Delivery

Demos Parneros - President, U.S. Stores

Analysts

Matthew Fassler - Goldman Sachs

Brad Thomas - Lehman Brothers

Bill Sims - Citigroup

Danielle Fox - Merrill Lynch

Colin McGranahan - Stanford Bernstein

Gary Balter - Credit Suisse

Chris Horvers - Bear Stearns

Michael Baker - Deutsche Bank

Oliver Wintermantel - Morgan Stanley

Jack Murphy - William Blair & Company

Anthony Tacumbe - FTN Midwest Securities

Joe Feldman - Telsey Advisory Group

Ryan Renteria - Karsch Capital

Presentation

Operator

Good day, ladies and gentlemen and welcome to the First Quarter 2007 Staples Incorporated Earnings Call. My name is Lyon and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I'd now like to turn the call over to your host for today, Laurel Lefebvre, Vice President of Investor Relations.

Laurel Lefebvre

Good morning everyone and thanks for joining us for our first quarter 2007 earnings announcement. During today's call we'll discuss the non-GAAP metrics such as return on net assets to provide investors with useful information about our financial performance. Please see the Financial Measures section of Investor Information portion at 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 contained in 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 and referenced under the heading, Risk Factors and elsewhere in Staples' latest 10-Q filed this morning.

Here to discuss Staples Q1 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 U.S. Stores and Joe Doody, President of North American Delivery. Ron?

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Ron Sargent

Thanks, Laurel and good morning, everybody. This morning I am pleased to report another quarter of solid earnings growth for Staples. Our North American Delivery business had a terrific quarter with strong top line growth coupled with steady margin improvement. Our effort to build a profitable international business continues to pay off. And our North American retail business proved it can maintain strong operating margins in a pretty challenging sales environment.

During the quarter our earnings per share were up 16% to $0.29 and we saw continued growth on the top line with sales growth of 8%. Although our North American retail business experienced softer than expected sales during the quarter with same-store sales up only 1% and total sales up 2.5%. We still grew the bottom line with operating margins of 19 basis points from last year to 8%. Our North American Delivery business continued to gain market share with top line growth of 15%, bottom line of 17% and profit margins increasing 17 basis points.

And finally we're happy with the continued improvement we are seeing in our International business, where total sales were up 16% in U.S. dollars or 5% in local currency. Same-store sales grew 2% and operating margin jumped 52 basis points to 2.4%.

Now we understand that our choppy top line results in North American retail for Q1 are likely to cause concern about what we are seeing in the economy. We've often said it’s hard for us to know exactly what impact the economy is having on our business in the short run and that's certainly true today when we are seeing such mixed signals.

On one hand our delivery business is going strong showing no signs of deceleration. This leads us to believe our delivery business customers of all sizes are not feeling the need to cut back on office supply purchases.

On the other hand, we've experienced softer than expected trends in our North American retail business. We've seen that some of our competitor's recent results and comments weren't terribly encouraging. And we've read the headlines that reported weak April same-stores sales across a broad mix of retailers.

This leads us to believe that the consumer and the very small business customer who are important components of our retail business are feeling pressured. All this gives us reason to take a more cautious approach about the economic environment for the rest of the year.

Now Mike Miles is going to get into the specifics of our results and what we are doing to ensure we have a good year in just a moment. But before I turn it over to Mike, I'd like to quickly review our 2007 company wide objectives for you.

First of all; we remain committed to growing our business profitably through industry leading execution, building a differentiated brand and growing our market share around the world. Second; we'll continue to make investments to drive the top line in existing businesses as well as develop new growth platforms for the future.

In North American Retail, we believe that there is plenty of opportunity to grow the business profitably, and we are going to do this by investing in new markets like Denver by opening a 100 plus new stores this year, growing services such as Copy and Print center and Staples EasyTech, and developing new growth platforms like our standalone Copy and Print shops. As always, our retail team is committed to giving great customer service that will set us apart from our competitors.

In North American Delivery, we've been growing the business in the mid-teens annually and plan to achieve this again in 2007. We'll continue to gain share in this channel by acquiring new customers, and by getting more sales from existing customers through initiatives such as Copy & Print, (name stamp), Mail and Ship, and IT hardware and services. As we do this, we'll continue to build on our fulfillment, delivery and IT infrastructure to support our growth.

In Europe, our focus here is on making progress in both retail and delivery on our way to reaching our 7.5% operating margin goal in the next three to five years. In our retail business, we'll continue to refine the model to compete effectively in the UK and Germany. In our Delivery business we want to drive sales through marketing and loyalty programs.

Overall on our European business, we need to improve our supply chain, we need to buy better and we need to develop shared services functions. And finally, in Asia and South America we'll continue to build a strong foundation for market leadership.

Now I'll turn it over to Mike to talk about our first quarter results in North America. Mike?

Mike Miles

Thanks Ron, good morning. Let's start with the results for North American Retail. Sales for the quarter were $2.4 billion up 2.5% versus Q1 of 2006. As we pointed out in last quarter's call, our 2006 fiscal year ended a week later causing us to swap out a higher volumes February week for a lower volume May week this quarter. This shift in the calendar cost our North American retail business about 200 basis points in growth.

Same-store sales were up 1% for the quarter, as higher average order size was offset by slower traffic in line with the trends in the rest of the industry. Syndicated data and recent competitive announcements indicate that we continue to gain share on our destination categories of ink and toner, printers, Copy center and paper, both from our direct competitors and from retailers more broadly.

In addition, we had strong growth in computers and peripherals, business software's, storage and organization supplies and Copy Center. These gains were offset by flat performance in our supply categories and continuing weakness in furniture.

We did a pretty good job managing gross profit and finding ways to operate more efficiently and as a result North American retail operating income grew faster than sales to $190 million and operating margin was up 19 basis points to 8%.

Historically, we've done a good job flexing expenses to drive operating income growth in a wide range of sales environment summits and given the 1% comp in uncertain economic climate Ron described, we will continue to carefully manage our expenses. At the same time, we will still make investments in the business that will ensure our success in the long-term.

We've begun to direct more of our marketing spend toward traffic driving supplies oriented offers with an increase in direct mail and circulars. Additionally, our new rewards program launched in April gives customers 10% back on the purchases of ink and toner, paper and Copy Center the products our core customers purchased most frequently. Early results have been encouraging.

We are intensifying our efforts to bring new product to Staples that will drive own-brand penetration. We've just completed the rollout of a new furniture assortment with four exclusive, higher end collections. Earlier this year, we added two more SKUs of Dell compatible ink in the Staples brand and now have six SKUs, highlighting Staples, as the destination for ink no matter what make or model we use.

In April, we introduced our better binder, a higher end entry into a significant and profitable category. We've also debut two new printers from HP available exclusively at Staples, and our Copy Centers are introducing a new Business Cards platform this quarter, providing printer quality Business Cards in less than an hour.

We continue to invest in our store base. During Q1, we opened 24 office superstores versus five for the same period last year. We are on-track to open over a 100 stores in North America this year. We are infilling Chicago and Miami Fort Lauderdale, we've just started down in the Denver market, where we now have five stores opened and we are looking to some of the other major markets that we have yet to enter.

At the end of the quarter, we had 1644 stores open in North America. We also invested in the Staples EasyTech business in the first quarter. We now have over 1800 Staples EasyTech's and everyone of our stores in North America now has at least one resident Tech, capable of diagnosing and fixing problems with personal computers, as well as installing new software and hardware.

We are remodeling our service counters across the chain to establish a clear point of contact for our customers to learn about our Tech services offering and drop off their hardware.

Sales, albeit on a small base are ramping nicely in both the U.S. and Canada. Our other service priority, Copy Center continues to provide strong growth. During the quarter, customers responded to some of our newer offerings, such as the wide format color printing. We are also continuing the rollout of our new self-service payment system, which is more convenient for customers and provides better controls for our self-service machines. Sales at our three small format copy and print shops in the Boston market are ramping well and we plan to open several more in New York City later this year.

Overall, we fell short of our sales objectives in the quarter, but we demonstrated our ability to improve the bottom line even in a tough environment, and we are making the right moves to continue gaining share and enter a long-term profitable growth.

Moving on to North American Delivery, the NAD team delivered terrific top line results again this quarter. Sales grew 15% year-over-year to $1.6 billion in Q1. Our organic growth of 14% was driven by strong customer acquisition in all segments of the market, and, in particular, we are winning customers in the middle-market segment. North American Delivery achieved double-digit growth in many of our major product categories. Ink cartridges and janitorial and break room supplies showed particular strength.

Our contract business grew the fastest, again this quarter, through new account acquisition and increasing "share of wallet" with existing customers. We also continue to make acquisitions at either expand our geographic reach or broaden our product and service offerings.

Just this morning we announced our latest acquisition which will give us a new platform for increasing our shares spend with our customers. We have acquired American Identity, one of the largest distributors of logoed merchandise in the United States. This acquisition gives Staples a strong presence in the $18 billion promotional products market.

American Identity will be part of our NAD business unit, but we see applications for our retail business down the road as well. We expect this new business to add 1% to 2% to our top line growth in its first full year and be slightly accretive even after integration costs and investments in growth.

Our online and catalog business, Staples Business Delivery, benefited from its targeted marketing efforts, strong online promotions and high customer conversion rates on staples.com. Both sales growth and margin improvement were very strong.

Quill, our highest margin delivery business continue to grow sales at a steady rate as it benefited from strong own brand product sales as well as increased "share of wallet" within its existing customer base.

Medical Arts Press accelerated its top line performance this quarter from improved customer acquisition. Worldwide e-commerce sales in the first quarter were $1.4 billion, a 22% increase year-over-year. Electronic sales represent 92% of our total sales in our contract segment and 77% of sales from North American Delivery overall.

Staples was recently ranked as the second largest Internet retailer after Amazon.com in Internet Retailer Magazine's list of the top 500 retail websites. SBU income increased 17% to $152 million or 9.5% of sales, a 17 basis point increase from last year's first quarter. Our gross margins in North American Delivery were hurt by the negative impact of higher paper costs, but we were more than able to offset this through leverage in marketing and customer service.

We are making good progress with our supply chain improvement initiatives. Trips per order were an all time low. Customer service calls are decreasing. Vendor on time performance is improving and customer delivery metrics are at all-time highs. In addition to improved sales from higher customer satisfaction, these efforts have lowered our costs in our call centers as customer service contacts per order have reached to an all-time low.

The three new fulfillment centers opened last year are fully integrated and we are pleased we their operating performance. The new fulfillment centers are ramping up to capacity and that caused us to slightly deleverage our distribution expenses year-over-year, and we're continuing to build out our network and plan to open our next tri-channel fulfillment center in Denver this July.

As we entered the Denver market this year with retail stores, we expect to see a significant increase in our delivery business there. Our latest fulfillment center will ensure great service experience for those new customers.

In summary, we are pleased that our North American Delivery business continues its sales momentum and rapid market share gains. We also expect to continue to drive steady sales and margin improvements by delivering on our brand promise to make it easy for our customers.

With that I'll turn it back over to Ron to talk about International.

Ron Sargent

Thanks Mike. Sales for the first quarter were $633 million in our International business that's up 16.2% in US dollars, and 5% in local currencies versus Q1 of last year. SBU income increased 47% to $15 million or 2.4% of sales which was a 52 basis point improvement over last years Q1 results. We are pleased with the continued improvement we see in International as we build a strong foundation to support future growth.

In retail, we saw improved profits and comps up 2%. We continue to make progress in the UK, I know a number of you have visited our UK stores and have noted the improved stores standards as well as merchandised presentation. We've seen good improvement in a number of key metrics there including attachment sales, customer compliments, Copy Center sales and owned brand penetration.

We are continuing advertising in direct mail campaigns to build our small business customer base, and we are encouraged by the growing mix of small business customer traffic demonstrating that our marketing focus is working. Three new stores were added and one closed in Europe during the quarter and we ended Q1 with a total of 266 stores in Europe.

On the Delivery side the operating margin rate in Europe improved nicely year-over-year with strong top line growth. French Catalog business continues to reap the benefits of our investments in marketing programs and customer service. We are particularly pleased to see the progress in perfect orders and lower distribution and call center expense.

Additionally many of our other delivery businesses also showed good improvement, in particular I should note our Italian business had double-digit top line growth and contributed significantly to this quarter's increased operating income.

Turning to new markets, our Asia and South American businesses are on-track with China performing particularly well. During the quarter we closed our investment in Pei Pei adding 12 retail locations to our China operations. At the end of the quarter we operated a total of 17 stores ranging from 2000 square feet to 9000 square feet.

And only last week we opened our first flagship store in China. This is a 30,000 square foot store it's located in Beijing and offers a broad assortment of supplies in office technology and expanded offering of environmentally friendly furniture and a copy and print center on three floors.

We've also been selected as the exclusive provider of office furniture to the 2008 Beijing Olympic Games. And finally our joint venture with Future Group in India officially started operations just last month.

In summary, operating margin improvement is encouraging in Europe and we are confident that we can dramatically improve this business and achieve our operating margin goal of 7.5% in the next 3 to 5 years.

Now I'll turn it over to John Mahoney to review our financials.

John Mahoney

Thanks Ron. I'll review the financials and give you some additional color on what's driving our results and then provide some guidance on our expectations for the second quarter and the full year.

Turning to our Q1 results, total company sales of $4.6 billion were up 8.3% versus last year's first quarter. Excluding currency benefit in our Canadian and International businesses sales grew 7%. Gross profit margin decreased by 6 basis points to 28.0% during the quarter. We're pleased to see North American Retail gross profit leverage year-over-year despite a higher technology mix and furniture clearancing.

The increase in North American Retail was more than offset by a decline in North American Delivery primarily due to managing higher paper costs in the contract business and slight deleverage in distribution costs as we ramp up our new fulfillment centers.

Operating and selling expenses for Q1 were 35 basis points favorable versus last year's first quarter at 16.55% of sales. This reflects good cost control and increased marketing efficiency resulting in modest leverage across each of our business segments.

Turning to general and administrative expense, G&A as a rate of sales remain flat, year-over-year at 4.34% reflecting good cost control offset by increased investments in information systems as well as startup cost for our new shared services center.

Moving on to the balance sheet, total inventory turns were up 4 basis points versus last year to 5.84 turns. Higher liquidity and financial resources remain very strong, at the end of the first quarter, Staples had 2.1 billion in liquidity, including cash and short-term investments of $1.3 billion and available lines of credits about $800 million.

Return on net assets for the year improved to 14.4% up 140 basis points compared to the end of the first quarter a year ago.

During the first quarter, we repurchased 7.2 million shares for $188 million under our $1.5 billion stock buyback program. We've about $400 million remaining on our authorization. Our diluted weighted average shares outstanding declined by just over 15 million shares year-over-year for the quarter, as a result of our repurchase program, offset by stock option exercises.

Year-to-date CapEx came in at $64 million down from $115 million; we spent for the same period in 2006, primarily reflecting a smaller investment in fulfillment centers, probably offset by an increased investment in new stores.

With operating cash flow of $192 million, we generated $128 million in free cash flow year-to-date. For the year, we expect $550 million in capital expenditures and more than $700 million in free cash flow.

Looking ahead, while we've taken several steps to drive more customer traffic into our North American stores, we do not anticipate that the week sales growth we saw in Q1 will turn around significantly in the second quarter. We will, however, have a small benefit to the second quarter due to the 2006 fiscal year ending a week later, causing us to swap out a lower volume May week for a higher volume July week.

On the top line, we expect low double-digit growth in Q2. This implies a low single-digit comp and a high single-digit sales growth in our North American retail business, mid-teens growth in North American delivery and high single-digit sales in local currency and international. We can mitigate the impact of weaker sales to expense reductions and are maintaining our previous EPS guidance of 15% to 20% growth for the quarter. However, our EPS growth will likely be at the low end of that range. Given the softening we experienced in our North American Retail business during the first quarter, we also now expect to achieve the low end of our range of $1.43 to $1.49 full year EPS guidance we previously provided.

Adjusting for the extra week in last year's fourth quarter, we expect low double-digit sales growth for the total company. This reflects a positive low single-digit comp, with high single-digit top line growth in North American Retail, mid-teens sales growth in North American Delivery and low double-digit revenue growth in international and local currency.

Despite some softness in the market, our business remains fundamentally strong. We are maintaining our investments in projects and people that will enable us to continue to provide a differentiated customer experience and gain market share. Through consistent execution, we expect to be able to achieve sustainable, profitable growth.

Thanks for your time this morning, and now I'll turn the call back over to our conference call moderator for questions-and-answers.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Matthew Fassler with Goldman Sachs.

Matthew Fassler - Goldman Sachs

Thanks a lot and good morning.

Ron Sargent

Good morning Matt.

Matthew Fassler - Goldman Sachs

I've got two quick kind of related questions for you. As we look at your guidance, you didn't really change the stated sales guidance. So to the extent that you're sort of directing the numbers towards the low end of the range, does that mean that sort of within the low single-digit North American Retail comp guidance and a low double-digit overall revenue guidance sort of a low single-digits, or is that a manifestation in your view of perhaps having to push a little harder somewhere on the margin front in order to capture the sales?

Ron Sargent

I will ask John to answer that one.

Matthew Fassler - Goldman Sachs

Thanks.

John Mahoney

Matt, I guess there is a couple of issues there, one is the products that have sold have tended to be less margin rich things like some of our PC sales, our laptop sales. And so our margin dollars are growing a little bit slower than we would have expected them to grow. Additionally, we've continued to make investments in our EasyTech program and service in our copy centers and service in our stores. And as a result, those investments had been made expecting a higher rate of sales growth, so that will have some drag effect on our profitability overall. In NAD, we talked about the fact that our distribution centers are operating very effectively particularly the new ones compared to last year. However, we are still growing into the capacity that we created last year. So that will have a slight impact on our margins there, along with the continuing pressure that we felt from paper prices as the mills have constrained capacity and increased cost to us.

So, overall I think that the message is that our cautious approach is really oriented towards continuing to invest in the business, plus seeing the mix of sales not be as attractive as we have had in other years.

Matthew Fassler - Goldman Sachs

That's very helpful and just may be I have a quick follow-up. You talked about traffic seeming to be more of the issue than ticket. If you think about your business over the long run, when the economy has been an issue for you, has it typically been manifested in traffic slowing or in ticket coming under pressure? I am just trying to sort of connect the dots in terms of identifying our root causes here.

John Mahoney

Well, I think that isn't typically I guess I would say. Depends on the nature of the recession that we've seen, last time we saw average ticket go down dramatically as customers didn't buy the capital goods. We mentioned that furniture was weak so you would expect that that's a capital goods weakness, which would make the average ticket go down, but our traffic has been slower this time which we think we can do something about.

Mike mentioned that we have changed our mix of marketing towards more traffic driving activities. We also think that some of the excitement that will come in our store from some of the new products that Mike talked about will also help that traffic. So, we are hoping that some of the traffic driving activities are within our control and not just economy related.

Ron mentioned that we've seen pretty steady demand from our small business customers particularly in delivery. So we are anticipating that the weakness that we have seen really has come from the consumer and so if we can redouble our efforts to make sure that we address small business needs we expect that will help traffic as well in stores.

Matthew Fassler - Goldman Sachs.

Thank you very much.

Ron Sargent

Thanks Matt.

Operator

Your next question comes from the line of Bill Sims with Citigroup.

Ron Sargent

Good morning, Bill.

Mike Miles

Bill we can't hear you. May we move on and come back to Bill.

Operator

Okay. Your next question comes from the line of Brad Thomas with Lehman Brothers

Brad Thomas - Lehman Brothers

Good morning, thank you.

Ron Sargent

Good morning, Brad.

Brad Thomas - Lehman Brothers

Just wanted to talk about the International segment a little bit, it seems like the margins came in ahead of what your expectations had been but that the sales rate of growth may be slow just a little bit in terms of comps. Can you just talk about that a little bit more?

Ron Sargent

Sure, I think that was by design, as I mentioned I think we are making very good steady solid progress in both our retail and delivery businesses. You are right that profits came in a bit better than we expected, I think last quarter this call we thought we would be more flattish on the profit side, in fact they were much better than last year. But I think we've always set our priorities to get to that 7.5% profit rate and will do that even at the expense of the top line.

I think our European team is doing a very good job in kind of managing the business, as I said the focus is really on profits there and sales are what they are. We've made good progress in the UK and France, which are our two biggest markets and also are making good progress in some of the other countries, like Portugal and Italy, who have really come into their own.

Also in our international business, you had Asia and South America and in both cases we have a slight loss in Asia and South America, which is kind of pulling down profitability a bit. But I think the end result is we plan on making steady progress. Last quarter we were at a 5% comp rate, this quarter we are about 2% comp rate and I think that's pretty consistent across the board, I think virtually all expect may be one country we've positive comps.

But the really the focus is on building relationship and developing relationship with the small business customer in Europe, much like we have here and with that comes a much more profitable mix and a much more profitable business.

So, I think we are making steady progress towards 7.5% operating margin, but I got to tell you 2.5% was still a long way to go.

Brad Thomas - Lehman Brothers

Okay, great and just one more follow-up on the North American Delivery, if I could? As we think about the different segments and maybe sort of the ticket growth versus the traffic growth, the new account acquisition versus the share of wallet. I know, you don't usually like to quantify that, but you may be gave us a sense for what the trends have been within some of the different size customer groups?

Ron Sargent

I would also recon Delivery business continues to be terrific and Joe Doody is here says so, I will ask Joe to talk at that point.

Joe Doody

Yeah Brad across all segments, we're extremely satisfied with our growth, not only in terms of our existing customer growth but also our new account acquisition activity. So, our customer base is expanding quite rapidly across all three segments, small, medium and large businesses. There are very high retention rates going on in the business because we're achieving all time highs in terms of customer satisfaction and the service that we are providing to our customers. In our new acquisition activity is at record highs as well. So and that's true in all areas both small medium and large business activities. So, we're very confident not only in terms of what we're seeing in terms of our existing customer base but also bringing on high amount of new customer activities as well.

Brad Thomas - Lehman Brothers

Great, thanks so much.

Joe Doody

Thank you, Brad.

Operator

Your next question comes from the line of Bill Sims with Citigroup.

Bill Sims - Citigroup

Thank you and good morning.

Ron Sargent

Good morning, Bill, we got you back.

Bill Sims - Citigroup

Thank you, I apologize. Two questions; first, as the strong environment become more challenging. Are you seeing any signs that the competitive commercial environment is intensifying in either retail or delivery?

Ron Sargent

Frankly I don't, the Demos Parneros is here, I will let him comment, but I don't really see any significant change.

Demos Parneros

Yeah, I don't see a lot of change either, in fact even in some of our new market openings where we have done without trend opening there, haven't been much of our promotional response. So, I would say simply straight forward at this point.

Bill Sims - Citigroup

And pricing has been very rational, I think really across both the delivery and retail.

Mike Miles

Yeah Bill it's a competitive market out there, but it remains rational and we continue to be very disciplined in our approach, especially in the contract space, where we really have a value proposition of delivering the total lowest delivery cost to our customers. So, we're nothing really has changed there at all in the recent time.

Bill Sims - Citigroup

And then it is just a follow-up to an earlier question. When you look at the drivers of your delivery growth, just tell me share of wallet and market taking have been some of the key drivers. When you look at the share of wallet initiatives, how far along are we and therefore the implementation of product categories? And then, can you give us an idea of maturity cycle of these new categories, how long should we expect them to contribute to the growth of the business?

Mike Miles

Well there are several new categories that were going after and we just announced another one today with our acquisition of American Identity. So, that one is just going to begin, as we look at taking their capabilities and bringing them to our many, many customers within NAD and then as well further down the road to retail customers as well.

So, that's one that is just beginning with the introduction of that new category, but there are many other categories as well that we're fairly early on in the process. Our copy and print initiative with closed door print facilities is still very early on, we're building that network throughout the U.S. So, that's again in the very early stages. Other ones like our [Jensen] and our furniture a little bit further along but still our penetration rates in terms of the percentage of our customers that are buying those products from us on a regular basis is still fairly low.

So, we're again there is still quite a bit of runway left on those. And then, technology products, technology services with our recent acquisition of Thrive, again very early on in the process for that one as well.

So, I guess, the bottom line is, I see a lot of runway left there in terms of many and most all of these key share of wallet in new category activities that we're bringing into the business.

Bill Sims - Citigroup

Thank you very much.

Mike Miles

Thank you, Bill.

Operator

Your next question comes from the line of Danielle Fox with Merrill Lynch.

Danielle Fox - Merrill Lynch

Thanks, good morning.

Ron Sargent

Good morning, Danielle.

Danielle Fox - Merrill Lynch

I have two questions; one, I was wondering if you could talk a little bit about new store productivity, it's a little bit tougher for us to calculate it with the calendar shift. Where did it come in relative to history and to your expectation, because I'm wondering if any of the softness that you are seeing in supplies and furniture is affecting the way new store is opened?

Ron Sargent

Yeah, Demos is here, I'll ask Demos to answer that one.

Demos Parneros

Yeah, new store productivity is something we are pleased with. As you know, we've opened in several new markets. Ron mentioned Denver will continue to in-fill nicely in southern Florida, in Miami and Fort Lauderdale. And I feel we are overall pleased with new stores, new store productivity is good, good versus last year. And I don't really think its affecting the categories that you mentioned though.

Danielle Fox - Merrill Lynch

Okay. And then the other question was just about the comp outlook for low single digits. I think you mentioned John that you did not expect to see comps get any better. I think your comp comparisons actually get a little bit tougher. So, I am just wondering if part of the reason you feel comfortable remaining at low single digits as you start to wrap your 3s and 4s over the next couple of quarters. Is that the current trend is actually inline with the guidance as the comparison has gotten a little bit tougher?

John Mahoney

Yeah, I think some of the things that Mike talked about we expect will continue to drive improvements in traffic in our stores. We certainly have had up and down weeks throughout the quarter. Overall, we think that the guidance we are providing is reasonable compared to what we have seen so far this year. Coupled with the fact that it's a little hard to get visibility very precisely to the comp point isn't worth all that much compared to the total sales of the North American stores business. So, I think combination of the trends we are seeing in the business, the activities we have and the level of precision we can lead to we are very comfortable with the guidance we have provided.

Danielle Fox - Merrill Lynch

Thank you.

Ron Sargent

Thanks Danielle.

Operator

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

Colin McGranahan - Bernstein

Good morning. Thank you.

Ron Sargent

Good morning, Colin.

Colin McGranahan - Sanford Bernstein

First of all folks on gross margin down 6 basis points here in the first quarter, obviously there it sounds like there were some mix issues. But, as I think about going forward, it seems like the fulfillment centers should be ramping up to capacity given the strong growth in NAD. Paper pricing I know you've had continued increases, but you should be anniversarying some of that. And then private label I would say it should be a driver that may be could offset some of the mix, how should we be thinking about your ability to grow gross margin rate going forward?

John Mahoney

Well, as we found in this quarter, we were surprised that the mix that we saw, we mentioned that core supplies were flat and so we saw growth in categories that are little bit less attractive from a margin perspective. We don't see a change in that trend coming as into the next quarter. As far as the distribution centers are concerned remember that we didn't build those to build right up to capacity in one year. Those are facilities that are expected to help us sustain our mid-teens growth over the longer term. So, there is a fair level of fixed expenses that we need to grow into which will certainly take a couple of years given the fact that we brought on three large facilities all in one year. So, I think that our guidance, our expectation is around gross margin is that while we could see some improvement, there's some challenging elements in the environment out there that lead us to believe that we want to approach gross margin fairly cautiously as we move into the second quarter.

Ron Sargent

Well, I think your point's a fair one. We will be wrapping fulfillment centers, we will be anniversarying paper, although we just got another paper increase in May. And then you are right we are offset by own brand, which continues to grow nicely as well. So, just there is a lot of moving parts and it's hard for us to be terribly bullish on gross margin given all the moving parts.

Colin McGranahan - Sanford Bernstein

Okay. Just a quick question on the balance sheet John, looks like the payables to inventory ratio deteriorated a bit given the stronger growth in inventory and not much growth in the payables is that intentional and can you get that back?

John Mahoney

Yes, I think some of the items that turned more rapidly in the inventory have poor returns particularly technology. So, I think the mix of inventory that we have is a little bit different than what we would have planned based on the sales projections for the quarter. So, I think as we get better visibility into what's going to sell we will be in a position to improve the payables to inventory ratio.

Colin McGranahan - Sanford Bernstein

Okay. And just quick final follow-up on Danielle's question, was April a particularly week month for you and that has impacted first quarter and influencing your outlook for continued positive comps against the tougher compares?

John Mahoney

No, Colin, in fact, April was the best month of the three.

Colin McGranahan - Sanford Bernstein

Interesting.

John Mahoney

With some of the stuff that I've talked about in terms of marketing activities were present in April. We got after little bit more in the way of circulars, little bit better direct marketing, little bit more traffic driving and offers and that paid off and that's the strategy that we expect will help us out a little bit in the second quarter.

Colin McGranahan - Sanford Bernstein

We actually saw an accelerating trend in your comps through the quarter then.

John Mahoney

I think I don't want to give specifics by month, but no think I think April was the strongest of the three.

Colin McGranahan - Sanford Bernstein

Okay.

Mike Miles

I guess as I pointed out, our results were kind of bit up and down through the whole quarter. And there has been talk about whether and there has been talk about all sorts of factors that we try to ignore and try just play our own game. But I think that choppiness in spite of the fact that when we did play our own game in April we saw it fully better, is it what gives us the reason to be cautious going forward.

Colin McGranahan - Sanford Bernstein

Okay, great thank you.

Ron Sargent

Thanks Colin.

Operator

Your next question comes from the line of Gary Balter with Credit Suisse.

Gary Balter - Credit Suisse

Thank you. Hi guys.

Ron Sargent

Hi Gary.

Gary Balter - Credit Suisse

Just couple of questions, just trying to reconcile the guidance with the results. Could you go back on the retail? Have you seen historically when you've looked at your business, the Delivery business has stayed stronger and retail has slowed the way you are seeing it now first of all.

Ron Sargent

Well, I think the answer to that is no. We have only had two recessions, one very early in the company's history and we grew right through that and most recent one was really 2001. And there we saw continued growth in customer count on the retail side. A fall off in the capital goods purchases on the retail side. But on the delivery side we saw a kind of a slowdown based on kind of customer size, up and down.

So, we saw kind of a slowdown in smaller customers and then a slowdown in medium customers and then a slowdown in large customers last. And then on the way up after the recession we saw small customers pick up first and then go to medium and then go to large. So, it's a little unusual to see kind of softness in the retail business and really no impact at all on the delivery business.

Gary Balter - Credit Suisse

Is it possible, one, whether it has related, and two that, the competitive dynamics in the two businesses are a little different like you have an improving competitor retail and Office Max and you had Viking just disappear in the other business and then [Alec] get swallowed up, so is it possible that competitive dynamics is claiming some of the reasons?

Joe Doody

Well, when we look at the share gain reports that we get to look at categories, we are gaining share or losing share, I don't think that's really an issue and I frankly do hope it is the weather Gary and when the sun comes out the business will improve. But I think, we got to be cautious going forward based on the last two quarters with a 1% comp on the retail side.

Gary Balter - Credit Suisse

Could you talk about geographic regions that are weaker?

Joe Doody

Really, I don't think there's a whole lot of difference in geography, it's more kind of product mix issues.

Gary Balter - Credit Suisse

And then finally, John given now that the stock may react a little bit on the negative side, this warning, does this is encourage you to use that $400 million you got last quarter?

John Mahoney

Well, I think we've said that our program is really intended to be able to use our operating cash flow that are not necessary to invest in the business to steadily buyback shares and we're not nearly as good as all of you folks are guessing what direction the market is going to go in so we try and be fairly steady about it.

Gary Balter - Credit Suisse

Okay, thank you.

John Mahoney

Thanks, Gary.

Operator

Your next question comes from the line of Chris Horvers with Bear Stearns.

Chris Horvers - Bear Stearns

Good morning everybody.

Ron Sargent

Hi Chris.

Chris Horvers - Bear Stearns

Are you able to quantify how much of the retail revenue mix and/or traffic is driven by the casual consumer and does very small business customer that you refer to?

Demos Parneros

Yeah Demos, I mean, basically we've said that if you look at our retail business, you got probably a third of our business is small business you got a third of our businesses really tend to be home office type business and then the last third is consumer. I think over the last few years the consumer portion is smaller. So, in terms of percentage at 22%, 25% may be would be casual consumer then at home office and small business splitting the other 75%. But in retail, small business is really, really small business in terms of one employee, two employees up that may be five employees. Once you get into the larger employees then you really more of a delivery customer.

Chris Horvers - Bear Stearns

So, you're saying about a 55% of your business was where you saw the slowing?

Demos Parneros

No, I think we saw slowness in customer count and I think we saw some slowing not only on the retail side, but also the very, very small business slowdown as well. So, basically customer count was flat for the quarter, and I think it affected really all three of those segments.

Chris Horvers - Bear Stearns

Right, okay. And any sense of what the sequential trend was in the aspect of retail that performed and held up throughout the quarter, is that similar with your comments on April?

Demos Parneros

Well again, we don't want to get into reporting the monthly comps, but I can tell you that April, well we saw some good improvements in both customer count and top line.

Chris Horvers - Bear Stearns

Okay. And do you think that is the tax strength on the PC and laptop side, is that relative to the core that softened or do you think it's fundamentally stronger than what you expected it to be. And may be you will suspect that its just to relate in and that adds to your overall caution as if that could be the next you?

Demos Parneros

No, I think there is laptop demand is strong and has been strong kind of before and after this and we are continuing to see that. It's a relatively small part of our mix and we are relatively small player in that space. But we have probably sold as many laptops as we want and we more manage that because of the profitability challenges continue to be a small part of our portfolio.

Chris Horvers - Bear Stearns

Okay. And then finally Ron, I just love to give you the public opportunity to comment about the recent articles about OfficeMax and potential consolidation in the industry?

Ron Sargent

May be I should decline the opportunity.

Mike Miles

I think I'll say what I have always said this is a great industry. The industry is still growing. It's very fragmented. Obviously, we are doing pretty well in that based on the results this morning on really 8% and 16%% on the bottom line. There are a lot of markets we are not in yet. We think we still got opportunity there. But as really from my perspective no burning platform that says that industry consolidation has to occur for us to do well in it. So if it does happen, obviously we'd look at kind of any acquisition like we look at all of our acquisition, if they earn great returns for us to even consider it. But at this point, we don't certainly comment on any industry consolidation, rumors or reports out there.

Chris Horvers - Bear Stearns

Okay. Thank you very much.

Ron Sargent

My pleasure.

Operator

Your next question comes from the line of Michael Baker with Deutsche Bank.

Michael Baker - Deutsche Bank

Thanks guys. Two real simples ones, one I just how are the comps calculated, are that calendar shift that you spoke about the 200 basis points that impacts the costs as well as the total sales? And then my second question lot of this traffic driving initiatives that Mike Miles that you are talking about, what are the margin implication for those? Thanks.

Mike Miles

The answer to the first question Michael is, no. It doesn't affect the comp. We measure the comp on week. We line the weeks up exactly, but it does affect the total overall top line.

Michael Baker - Deutsche Bank

Okay.

Mike Miles

And that's true for the second quarter comments John made as well. With respect to the traffic driving activities, although the offers that we've had tend to be fairly attractive and aggressive, there have been supplies offers more than Tech offers. And so we are driving traffic to the side of the store that hopefully is little bit higher margin. And we are trying to manage the offers in that way so that we can drive some comps and some traffic comps may be more than anything else, because that's what we are focused on as getting more customers in our stores.

Michael Baker - Deutsche Bank

And when you say hopefully, it sounds like you have some early success with these initiatives in April, so is that both on the traffic and on the mix part of that initiative?

Mike Miles

That's right. And as you think ahead, Q2 obviously includes the first month of our back-to-school period, so that's going to be a supplies intensive time for us as well and one that is by nature somewhat promotional.

Michael Baker - Deutsche Bank

Okay. Thanks a lot.

Mike Miles

Thanks Michael.

Operator

Your next question comes from the line of Oliver Wintermantel with Morgan Stanley.

Oliver Wintermantel - Morgan Stanley

Hi, I just want to ask you about the optimal capital structure, in your balance sheet you have more than 1 billion in cash and short-term investments? And the second question was about EasyTech rollout, so it sounds like your initial rollout is successful and where do you want to go with that?

Ron Sargent

Sure, I'll ask John Mahoney to talk about capital structure and Demos to talk about EasyTech. John.

John Mahoney

Yes, we are strong believers in maintaining a strong balance sheet that gives us flexibility to continue to make investments in our business. Our first priority is to invest in our core growth and we expect to spend about $550 million in capital this year to help sustain our growth long-term. The second priority is to make the sorts of acquisitions that allow us to grow the business, some of those like the Thrive acquisition or the Chiswick acquisitions, which give us a small company with a decent return that creates a platform to grow on. As well as some of the contract tuck-ins that are more or like customer acquisition cost comparisons that yield great returns immediately.

So these will be our top two priorities then beyond that with excess cash we've begun to pay dividend a few years ago and we have a share buyback program that gives us a flexible way to return excess cash to shareholders. So I guess maintaining our credit profile in the sort of investment grade range where we are right now coupled with being able to return some of our excess cash to shareholders would be the profile we'd expect to maintain going forward.

Ron Sargent

So, Demos.

Demos Parneros

Yes. And a comment on EasyTech, we continue to roll out the EasyTech initiative. We have created a very strong in-store presence where it's very clear for customers to know where to drop their hardware off and get consultation from one of our resident Techs. We now have at least one resident Tech in every single store throughout North America. And as we mentioned some of the basic services are nicely accepted by customers these days. We did launched back when Vista launched and continue to come through with more promotions and just different ways to get the awareness stuff with EasyTech. It's relatively early in the process prior but so far so good and we continue to run, push it along.

Oliver Wintermantel - Morgan Stanley

Thank you.

Ron Sargent

Thanks Oliver.

Operator

And the next question comes from the line of Jack Murphy with William Blair & Company.

Jack Murphy - William Blair & Company

Good morning.

Ron Sargent

Good morning, Jack.

Jack Murphy - William Blair & Company

Good morning, couple of few questions. On the guidance, just want a clarification when you talk about the international top line growth. Did you say that you're looking for low double digit full year and if that's true could you explain a little bit more how you are going to get from local currency, mid-single digit to low double-digit full year?

Mike Miles

Well, I think our businesses particularly in Europe are performing well. Ron talked about trying to drive the business customers particularly in Europe. The UK saw a change really in the mix of customers that they saw after seeing a richer mix of consumers in the fourth quarter and a higher comp, returned more towards building the base of small business customers, we expected that base continues to build that will result in an acceleration of sales.

In the same way our delivery businesses in Europe, all have good circulation programs for their catalogues that we expect given the response rates we're seeing their growth rates accelerate a little bit as well. And then I guess finally in our emerging markets, which China last year did about $100 million, so it has some impact on our growth rate. They have a much stronger second half of the year seasonally than the rest of the business and they are growing the fastest. So that would impact the growth rate somewhat there as well. So, we believe that the trends we're seeing will get reflected in a low double digit revenue growth rate in local currency for the year.

Jack Murphy - William Blair & Company

So should we see steady acceleration or more acceleration in the third quarter from the second?

Mike Miles

I think it will be fairly steady.

Jack Murphy - William Blair & Company

Okay. Question on furniture; I know that you've been putting new collections in the stores and I just want to understand that a little better. Are we at the point where the majority of stores have new collections, and can we see a discernable difference between the stores that have that and notes that don't?

Ron Sargent

Mike?

Mike Miles

Yeah, we've now got the new furniture collections pretty fully rolled out to the chain. It was a little bit longer process than we had hoped due to some really making sure that we had the quality exactly right. And they are now ramping nicely, so there is clearly a difference between the stores that had them first in the stores that didn't have anything, and that's largely because we clearanced our old collections completely out of the store. And so, we are operating in a little bit of a vacuum in terms of our furniture sales. I think the fruitful be in the putting still in terms of whether the new collections can pull their weight. We are obviously operating in somewhat of a tougher housing environment, and a lot of our furniture sales go to homes and home offices. But we are confident that the new collections that we have our significant improvement in quality from what we had been selling. And our experience with our chair assortment is that by offering our customers a higher quality and higher ticket product we can improve our sales significantly.

Jack Murphy - William Blair & Company

And then just last question on the rewards program, I know that the real focus is on core. Do you expect that core to get a benefit from the rollout of rewards programs as early as next quarter? And what sort of a time line on the impact for driving more core sales there. And what type of impact are you counting on for gross margin from that?

Mike Miles

Well, we are more focused on it from a comp standpoint than a gross margin standpoint. I think that the thing that we like about the rewards program is it really focuses in on our core customers of paper, ink and the Copy Centers, who are more of the business and home office customer. And we have seen a significant improvement in the sales that are done on the rewards program since we've made the changes. So, we expect that beginning in the second quarter that will have an impact on our traffic from those customers and our sales of those key categories.

Jack Murphy - William Blair & Company

Thanks.

Ron Sargent

Thanks Jack.

Operator

Your next question comes from the line of Anthony Tacumbe with FTN Midwest Securities.

Anthony Tacumbe - FTN Midwest Securities

Good morning, just one quick question. I was just wondering if you could comment on your private label penetration in the first quarter, I know for last I believe it was 20%, your long-term goal is 30%. So, I just wonder if you had any comment on that?

John Mahoney

Yeah, I don't want to start kind of necessarily reporting penetration rates every quarter but I can tell you that we expect to improve our penetration rate a couple of percentage points each year and we are on-track to do that in the first quarter.

Anthony Tacumbe - FTN Midwest Securities

Okay, thank you.

John Mahoney

Thank you, Anthony.

Operator

Your next question comes from the line of Joe Feldman with Telsey Advisory Group.

Joe Feldman - Telsey Advisory Group

Hi guys.

Ron Sargent

Hi Joe.

Joe Feldman - Telsey Advisory Group

Just a quick question on, I notice CapEx came in a lot lower than last year, I was just wondering if you guys were adjusting the guidance to off of the year or you are expecting spend or is it just a flow or a timing issue?

Ron Sargent

It's pretty much in line with budget so.

John Mahoney

It is slow, we mentioned that we opened more stores in the first quarter this year than we did last year, I think was 24 versus 4, but we had a lot of spending against the three distribution centers that opened up last year early in the year, which we won't see this year because we don't have three facilities opening. So, I think it's more a matter of flow than anything else. The stores will open fairly, evenly throughout the quarters, with more in the first three quarters, little bit less than the fourth quarter.

Joe Feldman - Telsey Advisory Group

Thanks. And then the one other thing just on the American Identity acquisition, is there any more color you can give us today, I noticed in the release you didn't do too much beyond the $18 billion market, you just maybe the type of revenue run rate or profitability of the business or anything else that you can give us?

Ron Sargent

Joe Doody?

Joe Doody

Yeah. Well first we are not going to get into very specific numbers in terms of what the current revenue is, but we said within NAD that we would achieve about 1% to 2% of our total sales from acquisitions and this would be within that range. So, that gives you some size. But we do expected to be slightly accretive to earnings this year and that it's a very nice fit for a new category in a highly fragmented market that will definitely appeal to our vast customer base. So, we are very excited to have American Identity as part of the Staples family.

Ron Sargent

Yes, obviously the early days we will be focused on our Delivery business, but we think based on some tests we've done, we think there is some application to the retail side as well.

Joe Doody

Absolutely.

Joe Feldman - Telsey Advisory Group

Got it, great. And then the one other thing I wanted to ask just again the focus on the consumer, have you seen any loss in business among the consumers to just other competitors. I mean we know that the Office People, OfficeMax are not performing as well as you guys in the retail business, but is it going elsewhere, is it going to the discount is out there, the electronics stores anywhere else?

Ron Sargent

Yes, it's hard for us to know. And I always preference my comments about the economy by saying I am not an economist. But I am a little cautious about what we are seeing out there. We do seem to be gaining share, but the traffic was light and I am not sure if that's a reflection of $3 or $4 gas, whether it's tighter credit, whether it’s the consumer confidence or business confidence. Not quite sure, but I am not sure it's really affecting our larger business customers at all. But it really does seem to be a kind of taking a bite of the consumer piece.

Joe Feldman - Telsey Advisory Group

Great, thanks guys.

Ron Sargent

Thanks.

Operator

And your final question comes from the line of Ryan Renteria with Karsch Capital.

Ryan Renteria - Karsch Capital

Thanks a lot, good morning.

Ron Sargent

Good morning, Ryan.

Ryan Renteria - Karsch Capital

I just got a question for you, two questions. One is on the free cash flow guidance. If you just take your net income guidance and your CapEx guidance and some very reasonable depreciation and stock option assumptions, you get to sort of $1 billion plus in free cash flow. Is there a negative drag from working Capital anticipated this year, or is it more that greater than 700 million could be well greater than 700 million?

Ron Sargent

John.

John Mahoney

Obviously, we would need to be sure to head all the other assumptions right. We are not expecting significant improvement in our working capital performance this year in the free cash flow guidance that we've given. And I think that answer to your question, but I think we would want to be sure that the other assumptions you have are also accurate before we would comment on your actual number.

Ryan Renteria - Karsch Capital

Okay. And the other question is on the new store product activity, if you add back the 200 basis points, it still looked light by our own metrics but you spoke sort of bullishly about it. And so I was wondering if you give a little color if the store openings were waited towards the end of the quarter, if the actual metrics you track were inline with your expectations, if you can get some color there that could be great.

Mike Miles

I guess starting on last, Demos can kind of add in, but we got 1680 stores of which we opened only 24 this quarter, so it's really in the ocean in terms of new store impacting any of our numbers. Having said that I think the new stores opened pretty much exactly as we expected. Demos?

Demos Parneros

Yeah. Exactly, they opened as expected and they were fairly balanced through the quarters so there's no real waiting one way or the other.

Ron Sargent

Yeah. I would not take any kind of assumption about new store productivity based on softness in overall in North American Retail.

Ryan Renteria - Karsch Capital

Okay thanks very much.

Ron Sargent

Okay, thank you, Ryan.

Operator

And there are no further questions. I will now turn the call back over to management for closing remarks.

Ron Sargent

Well just to wrap up, I'd like to thank again the Staples team for delivering solid results in a pretty challenging quarter. Going forward our focus remains to deliver profitable sales growth across each of our business units. And for those folks on the call, thanks for your time this morning, we look forward to speaking with you again soon.

Operator

And thank you for your participation in today's conference. This concludes the presentation, you may now disconnect. Good day.

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