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Staples, Inc. (NASDAQ:SPLS)

Q3 2007 Earnings Call

November 27, 2007 8:00 am ET

Executives

Ron Sargent - Chairman, CEO

Mike Miles - President, COO

John Mahoney - Vice Chairman, CFO

Joe Doody – President, NAD

Demos Parneros - President U.S. Stores

Laurel Lefebvre - VP Investor Relations

Analysts

Brian Nagel - UBS

Chris Horvers - Bear Stearns

David Strasser - Banc of America Securities

Danielle Fox - Merrill Lynch

Gary Balter - Credit Suisse Securities

Matthew Fassler - Goldman Sachs

Michael Baker - Deutsche Bank Securities

Colin McGranahan - Sanford C. Bernstein

Mitch Kaiser - Piper Jaffray

Analyst for Steve Chick - JP Morgan

Daniel Binder - Jefferies

Joe Feldman - Telsey Advisory Group

Brad Thomas - Lehman Brothers

Brigitte Neigut - W.P. Stewart

Operator

Welcome to the third quarter 2007 Staples, Inc. earnings conference call. (Operator Instructions) I would now like to turn the call over to Ms. Laurel Lefebvre, Vice President of Investor Relations. Please proceed.

Laurel Lefebvre

Good morning, everyone and thanks for joining us for our third quarter 2007 earnings announcement. Unless otherwise indicated, all numbers discussed in today's call exclude the impact of special one-time items that occurred in 3Q06 and 3Q07.

We will also discuss some non-GAAP metrics such as return on net assets to provide useful information about our financial performance. Please see the financial measures section of the investor information portion of Staples.com for a reconciliation of GAAP to non-GAAP numbers and an explanation of the financial measures.

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 or referenced under the heading risk factors and elsewhere in Staples' latest 10-Q, filed this morning.

Here to discuss our future 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; Steve Matyas, President of Staples Canada; and Joe Doody, President of North American Delivery.

Ron Sargent

Thanks, Laurel and good morning, everybody. This morning I'm pleased to report another quarter of solid performance. Our North American Delivery business again led the way with another quarter of industry-leading top line growth and steady margin improvement. Our International business continued to get better. We had strong sales growth as well as impressive operating margin leverage and in our North American Retail business, although we were not happy with the top line, we did a good job managing expenses in line with sales, and we grew operating margin 23 basis points.

I'd like to start this morning with some of the headlines for the quarter. Our adjusted earnings per share increased 17% to $0.42. Operating margin was up 34 basis points over last year to 9% and sales grew 8.7% to $5.2 billion. We generated $519 million in free cash flow during the quarter, largely due to improvements in working capital as well as better inventory management. Year-to-date we're well ahead of last year with free cash flow of $533 million versus $277 million in 2006.

Our North American retail business experienced weak sales during the quarter. Same-store sales fell 3% and total sales increased only 3.2%. While the overall comp for NAR was negative, we did have some good news in that we had positive comps in our high margin office supplies category.

Our North American Delivery business remains strong. The top line grew 15% and operating margin improved 21 basis points. Good leverage in distribution, as well as growth in high margin share of wallet initiatives, drove the margin improvement.

We also continue to make good progress in our international business. Total sales were up 18% in U.S. dollars, or 8% in local currency. We had same-store sales that were flat, but that was against pretty tough comparisons and operating margins jumped 185 basis points to 3.3%.

Also during the quarter we reached an important milestone in Staples' history, we opened our 2,000th store. Today we operate more than 2,000 stores in nine countries and delivery operations in 21 countries. I think it's worth taking just a few minutes to reflect on how far Staples has come during the last few years.

First of all, our retail business generates excellent returns. Since 2001 we've developed a terrific service culture, differentiated our brand based on Easy, we've created a half-billion dollar copy and print business and built a superior supply chain. We've added 450 stores and we now operate a portfolio of four unique store formats to take advantage of different market opportunities. We launched the first Dover store in 2001 and we now operate 750 Dover format stores. Since 2001, we've added $3 billion of sales. We've tripled operating profit and we've increased operating margin 500 basis points over that timeframe in our retail business.

Let's take a look at our delivery business. Our delivery business has also been transformed into the largest, most profitable, most Internet-penetrated and fastest-growing of any in our industry. We finetuned our customer acquisition model, we’ve developed a well-balanced portfolio of customers and we would argue that we have great visibility into future results.

Supply chain and service capabilities are dramatically better. We've developed several significant businesses that we didn't even think about a few years back, businesses like copy and print, Jansan, tech services, and logo merchandise, just to name a few.

In delivery, we've added $3 billion of sales and nearly 400 basis points of operating margin since 2001. On the international side, today we have a much stronger European business overall. From a fledgling delivery business in two countries in 2001 we've established a delivery platform with scale in 15 European countries. In retail, we've finally cracked the code for success in key markets like the U.K. and Germany. We have a terrific team in Asia to take advantage of the explosive growth occurring in India and China. Sales in our international segment have more than doubled in the last five years and, more importantly, we've built a foundation for long-term, profitable growth and we're well on our way to achieving our 7.5% operating margin goal for international.

In total, our businesses have produced terrific financial results. Since 2001, our top line has grown 11% per year on average. Operating income dollars have almost tripled and operating margin improved by more than 300 basis points. Our earnings per share grew impressive 24% per year on average over the same period and our strong performance on the P&L, combined with consistent capital discipline, has driven steady increases and return on net assets and that's the metric that we use to measure shareholder value. Our RONA has increased 550 basis points to 14%, well above our long-term cost of capital of 11.7%.

The team that produced these outstanding results is essentially the same one in place today. The key to driving tremendous value over the last several years has been the team's willingness to try new ideas, to scale the ones that work and take advantage of the abundant opportunities in the office products market and above all, never lose sight of the customer. We know that this approach of executing well, doing the right thing for our customers and investing for the future is a model that has delivered significant shareholder value historically, and we expect that this same model will drive value going forward.

While we're clearly operating in a tough environment that has dampened our overall results, our fundamental philosophy has not changed. This focus on customers and execution helps us do pretty well in tough times and puts us in a better position to have great results when the environment improves.

I'll now turn it over to Mike Miles to talk about third quarter results in North America.

Mike Miles

Thanks, Ron. Good morning. Let's start with the results for North American Retail. We increased sales 3.2% versus Q3 of 2006 to $2.8 billion, but same-store sales declined 3% for the quarter, reflecting slightly negative customer traffic and lower average order size. We've experienced a real slowdown in the purchase of durable goods which seems to be driven by some of the general economic trends, particularly in the housing market. Furniture has been weakest, which is a category at retail that is disproportionately skewed toward residential customers, with tech hardware and even computers also down in the quarter. We had positive comps in our consumables categories -- printer cartridges and office supplies -- and copy center continues to be the strongest growing part of our stores.

Operating income increased 5.4% to $306 million and operating margin increased 23 basis points to 11.1%. A better mix of high-margin office supplies and good labor expense management, slightly offset by deleverage and rent expense, drove the increase in the operating margin.

In the face of a tough sales environment, we're focused on differentiating Staples from our competition by making it easy for our customers and by assorting and presenting a unique and innovative line of merchandise. Earlier this month, we began selling Dell computers, printers, ink and toner. We are the exclusive supplier of Dell products in the office superstore channel. While the hardware will initially have center stage in advertising and promotion, we believe the ink and toner consumables also represent a real opportunity to drive substantial new customer traffic.

We are the only retailer offering a full line of Dell ink cartridges and Dell has about 8% of the printer placements in the U.S. We've already enjoyed nice share gains this year with our in-stock guarantee and compelling ink savings message. Adding Dell further establishes Staples as the destination for ink and toner.

Recently, we launched M by Staples, a higher-end line of office supplies and accessories. We believe M differentiates our assortment and will drive sales in key, high-margin product categories. We've gotten a very positive reaction from our customers, further verifying this line's appeal, and we look forward to expanding the offering this spring.

In October we launched our security initiative focused on providing our customers with affordable and effective solutions to help protect themselves from information security threats. We offer a wide assortment of security-related products and services including data storage, antivirus software and shredders. While the initiative will ramp to its potential over time, initial results have been encouraging not only in our retail business, but also in Staples' Business Delivery.

Over the next several weeks we will offer our customers an exciting assortment of great tech gifts for the holidays. We kicked off the season Friday with a circular that featured many of the products that we expect to sell well this season, including laptops, monitors, digital cameras and picture frames, GPS, and Bluetooth.

Finally, as I mentioned, our copy center continues to be our strongest growing category. We're gaining share in this very profitable segment which brings a good mix of business customers into our stores. Based on our success in this space, we continue to test standalone copy centers and opened our first of these in New York during Q3.

Turning to new store growth, we continue to see good results from our new stores and we are pressing our advantage with our real estate program. We opened 37 new stores in the U.S. and six in Canada during the quarter, bringing our total number of stores in North America to 1,715. For the full year, we're on track to open about 120 stores in North America. Our new stores in Miami and Denver are doing well, and in 2008 we expect to open about 100 stores, including several standalone copy and print shops.

Although North American retail sales fell short of our objectives during the quarter, we continue to gain share and grow the bottom line. We're confident our strong portfolio of new products will generate excitement through the end of the year and into 2008.

Turning to North America Delivery, our team delivered impressive top line results. Q3 sales grew 14.7% year over year to $1.7 billion with organic growth of 10%. Organic growth did slow modestly across all business units. Customer retention remained strong, however, sales per customer grew at a more moderate rate. We gained market share in all three business units, with strong growth throughout a broad range of product categories and geographic regions.

New product categories, such as Jansan, printing services, packaging supplies and logo merchandise grew at multiples of the overall rate. Other categories that grew faster than average included paper, computer and chairs. Geographically, we saw particularly strong growth in Denver and Miami, our latest retail market launches.

Worldwide ecommerce sales in the third quarter were $1.4 billion, a 14% increase year over year. For the quarter, electronics sales represent 86% of total sales in our contract segment and 74% of sales for North American Delivery overall.

SBU income increased 17% to $187 million, or 10.9% of sales. Gross margin improved through supply chain efficiency, increased utilization of the new fulfillment centers, expansion into new, higher margin categories such as logo merchandise, and better paper margins in contract as we've cycled through the impact of higher costs.

We made significant investments in new growth platforms such as contract copy centers, salesforce, American Identity, and Staples Industrial, while still posting a 21 basis point improvement in operating margin. All operational and service metrics remain solid. Quill just received the J.D. Power and Associate Customer Satisfaction award, so now each of our three delivery business units has been recognized with this award this year.

Our success in NAD is all about winning new customers, retaining existing customers, and increasing share of wallet. We have built a better mousetrap for acquiring new customers. Our supply chain and service helps retain them and our expansion into new product categories drives increased share of wallet. We expect to drive strong growth and steady margin improvement for the rest of the year and into 2008, regardless of the market conditions.

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

Ron Sargent

Thanks, Mike. We were very pleased with our performance in the international business. Sales for the third quarter were up 17.8% in U.S. dollars, or 8% in local currencies versus last year's $690 million. SBU income increased 164% to $23 million, or 3.3% of sales which was a 185 basis point improvement over last year's Q3 results.

In European retail we drove strong overall profit improvement with good gross margin comps, even with moderate growth on the top line and flat comps overall. In the U.K., we continue to sell more to business customers and as the business customer mix improved, we again saw positive comps and a nice pick up in gross margin. Better buying, increased own-brand penetration and more efficient distribution operations also helped margin.

We recently closed two distribution centers in the U.K. and we replaced them with a single, state-of-the-art facility. As we know, this type of integration can be difficult, but this time the transition was flawless and I think that reflects great team work on the part of our European as well as our U.S. supply chain teams.

Turning to store growth, during the quarter we opened one new store in the Netherlands and we closed one store in the U.K. to end Q3 with a total of 266 stores in Europe.

On the delivery side, both the top and bottom lines grew nicely. We increased customer satisfaction. We improved the perfect order metric and we drove higher web penetration. We've successfully completed the upgrade of JPG's website in France which includes a better search engine and improved functionality. Customers have responded very well to the new website and we'll complete similar upgrades to the websites of all of our other delivery businesses in Europe before the holidays. Similar to European retail, our investments in European delivery's distribution and supply chain are starting to pay off. Delivery's bottom line was its best third quarter performance in four years.

Outside of Europe, we're making great progress in our businesses and we're particularly pleased with our developments in China and India. China continues its explosive growth in Beijing. We've opened the first two Staples UPS Express stores and expect to have two open in Shanghai before year end. These co-branded Staples stores combine office supplies and document processing services from Staples with packaging and international shipping services from UPS. We've also opened two additional Staples stores in China bringing the total number of retail stores to 28.

In India, our delivery operations to contract customers are off to a great start. We've just begun retail operations in Bangalore with our partner, Pantaloon. The first 2500-square foot Staples branded store-in-store opened inside a big bazaar hypermarket and we just opened the first large format standalone Staples branded retail store.

In South America, our delivery business in Argentina is strong. In Brazil, while results there have been a little disappointing, we've been focusing on customer service and recently added guaranteed next day delivery, which is a key differentiation point in the Brazilian market.

In summary, we're encouraged by the strong sales and operating income results in our International segment. We remain very focused on margin improvement in Europe and rapid growth in Asia. We're confident that we can maintain our momentum and achieve our operating goal of 7.5% in the next two to four years.

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

John Mahoney

Thanks, Ron. I'll review the financials and explain what drove our results and then wrap up with some guidance for the fourth quarter as well as for 2008. However, before I do this, I want to quickly review the one-time items from Q3 2006 and Q3 2007 which are laid out in our earnings release. As I talk about the P&L, I'll exclude these items.

Last year in Q3 we recorded a $10.8 million expense or $8.6 million net of taxes to reflect the correction of measurement dates for past stock option grants. Also in Q3 2006, we recorded a $33 million reduction in income taxes related to changes in estimates regarding issues settled during the quarter.

A few weeks ago, we announced the settlement in a wage and hour class action lawsuit concerning our California-based assistant store managers. The settlement allows Staples to avoid further expense and distraction from lengthy litigation. As a result, in Q3 2007 we recorded a $38 million expense, or $24.3 million net of taxes.

Turning now to our Q3 results. Total company sales of $5.2 billion were up 8.7% versus last year's third quarter. Excluding currency benefit in our Canadian and other International businesses, sales grew 6.1%. Gross profit margin increased by 48 basis points to 29.13% during the quarter. Improvements in supply chain in North American Delivery and a lower mix of technology in North American retail and international drove the increase.

We're seeing nice leverage in our distribution costs as our new NAD fulfillment centers are performing well. Deleverage and rent expense on softer sales in North American retail partially offset these gains.

Operating and selling expenses for Q3 deleveraged 9 basis points versus last year's third quarter at 15.94% of sales. All three businesses did an excellent job managing expenses while continuing to invest in new growth ideas. We're particularly proud of our retail store teams, which did an excellent job flexing labor with sales while maintaining high levels of customer satisfaction.

General and administrative expenses and the rate of sales held essentially flat at 4.08% as we carefully managed expenses and made progress in our European cost structure. Variable compensation expense was a contributor, as we're accruing for bonuses at a slightly lower rate than last year.

Moving on to the balance sheet, total inventory turns were down 9 basis points versus last year to 5.7 turns. Our supply chain capabilities continue to improve and we've made substantial progress in working capital this year by refocusing on our Summit Supply Chain discipline. We continue to buy ahead of demand, but we're getting better and inventory levels are nearer our plan.

At the end of the third quarter, Staples had $1.8 billion in liquidity, including cash and short-term investments of $1.0 billion and available lines of credits of about $800 million. Year-to-date Cap Ex came in at $316 million, down from the $352 million we spent for the same period in 2006, primarily reflecting decreased investment in fulfillment centers, partially offset by increased investment in new stores.

With operating cash flow of $849 million, we generated $533 million in free cash flow year-to-date. During Q3, free cash flow was $519 million. For the year, we expect about $550 million in capital expenditures and more than $800 million in free cash flow.

During the third quarter, we repurchased 8 million shares for $181 million and now have approximately $1.25 billion remaining on our $1.5 billion authorization. Our diluted weighted average shares outstanding declined by just under 21 million shares year over year for the quarter. Return on net assets for the year improved to 14%, up 20 basis points compared to the end of the third quarter a year ago. This includes a 30 basis point negative impact from a legal settlement.

Looking forward to the fourth quarter, excluding the impact of the extra week in Q4 2006, we expect low double-digit total company sales growth; a flat to slightly negative comp and high single-digit sales growth in our North American Retail business; mid-teens growth in our North American Delivery business; and high single-digit sales growth in local currency in international. As a result, we expect to achieve Q4 and full year EPS growth of approximately 15%, excluding the extra week in 2006 and special items in 2006 and 2007.

We remain cautious about the economic climate driving the weak sales trends we've seen throughout 2007 and expect this to continue for at least the first half of 2008. For the year, we expect to achieve high single-digit sales growth for the total company; a low single-digit comp in North American Retail; low to mid-teens revenue growth in North American Delivery; low double-digit sales growth in local currency in international; and low teens EPS growth.

Our business and our industry remain strong and we're optimistic about our long-term future. We continue to gain share and we expect the industry to grow faster than GDP. As a result, our long-term expectations remain unchanged. We expect to return to 15% to 20% EPS growth driven by 10% to 15% sales growth with operating margins expanding to 10% and RONA continuing to improve as the economy returns to a more normal pattern.

Despite some softness in the market, we have a solid business that's performing well overall, but that offers plenty of opportunity for improvement. During tough times, you can often see weak spots in your business that might get covered up when sales are booming. Today we can identify some of the areas that we can fix and build a better business.

The last time we were faced with a challenging economic environment during the 2001 recession, we did the same thing. The steps we took back then to improve our business fueled tremendous growth, as Ron described at the beginning of the call. So while the economy is weak, we are taking the opportunity to get to work on the things we can control, focusing on our customers and new growth ideas that will drive outstanding results when the economy strengthens.

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

Question-and-Answer Session

Operator

Your first question comes from the line of Brian Nagel - UBS.

Brian Nagel - UBS

Congratulations on a nice quarter in a real tough environment. With respect to the gross margins -- you touched a little bit on this in the prepared remarks -- but we saw the biggest gross margin improvement in several quarters. Help me understand better what changed here in Q3 versus the prior quarters as far as drivers of gross margin?

Ron Sargent

I'll mention a couple and then turn it over to John to give you the color commentary. I think basically the story was around mix got better and consumables comp’d positively versus durables that comp’d negatively and as you know, we make a lot more money on the consumables side than we do on the durables side. I think Canada helped us a bit on the gross margin as well.

John Mahoney

I think that's right. Really across the board we did a pretty good job on gross margin. Canada's margin helped our North American retail business. I mentioned the improvements we've seen in supply chain areas; we're cycling against the new facilities that came online last year in our NAD business, and they've improved nicely and are helping show nice improvement in our gross profit year over year in that business.

Our international businesses as well have done a nice job of tending to all the elements of their margin, both in terms of the mix of product that they drive, a little bit less technology, as well as doing some nice things in supply chain and buying to help see their margin improve as well.

Brian Nagel - UBS

As far as the retail, the negative 3% retail comp, your competitors talked about a much more challenging back-to-school season. Did back-to-school weigh disproportionately upon the comps in the quarter?

Ron Sargent

To the contrary. I'll ask Mike Miles to answer that one.

Mike Miles

Good morning, Brian. Actually, I thought our back-to-school was pretty solid. The issue for us in the comps really was in those durable categories. This was our second year of doing the Hot Buys and some of those penny items that really drove a lot of traffic and we felt like we have that promotional strategy pretty well worked out. I'd actually add that to the list of things that John and Ron just mentioned about gross margin. Where some of our competitors were getting into that for the first time, I think it was our second time around for that and it led to us having a fairly successful back-to-school; to the extent you can say anything was real successful in a quarter when you had a negative 3 comp.

Operator

Your next question comes from Chris Horvers - Bear Stearns.

Chris Horvers - Bear Stearns

As we think about momentum within the quarter both on the delivery and retail side, first on delivery you mentioned it did soften in all three segments. Is that something that was at an increasing rate in the quarter in each month? As you think about the retail comp estimate for 4Q, it is up to zero to down 1 versus negative 3. Is that simply comparisons or is that also something you're seeing in momentum?

Ron Sargent

In terms of the comp, it was choppy so there were no trend lines to the comp in the third quarter. As Mike mentioned, back-to-school, which happened in the first half of the quarter was okay but it wasn't anything that got us to the positive comp. But there was no real trend down or up, it was really choppy depending on the week. I think that's true of our North American Delivery business as well.

Your second question was on the fourth quarter?

Chris Horvers - Bear Stearns

It was retail comp, why you have a better comp outlook in 4Q.

Ron Sargent

Frankly, when you look at the two-year trend, it's about the same. This quarter we had a comparison against a 4 last year and in the fourth quarter our comp, if you remember, is a 1%. So if you look at the two-year trend, it's about the same. So we're not assuming we're going to get a lot better, we're not assuming we're going to get a lot worse. That's why we came up with that zero to 1 for the expectations for Q4.

John Mahoney

That said, I think that the team in North American Retail has really worked hard with the merchandising initiatives and a better plan for holiday. Last year we felt we were disappointed with our holiday sales and we expect that we're going in with a lot of things that customers are going to find very attractive.

Chris Horvers - Bear Stearns

Just to follow-up on the North American Delivery comp, you saw a general softening 3Q versus 2Q, but it wasn't incrementally worse in each month of the quarter? Is that fair?

Joe Doody

Yes, that's generally fair. As Ron said, it's pretty choppy week to week and throughout the quarter. We certainly saw a softening all the way around. We're very satisfied with our account acquisition, very satisfied with our account retention. Just in general, fewer orders from our customers throughout the quarter.

Chris Horvers - Bear Stearns

As you think about the standalone copy center it seems like they are performing very well. Looking forward and thinking about the longer-term opportunity, how would you quantify that and what share of the normalized hundred store openings do you think they might contribute over time?

Ron Sargent

Chris, they tell me I'm too optimistic about this whole subject, so I'm going to ask Demos to answer that question.

Demos Parneros

Thanks, Ron. Actually, I'm optimistic on the subject as well. As you know, we have four standalone copy stores open at this time; three in the Boston area and we just opened our first one in New York City just a few weeks ago. Honestly, we're pleased so far, but again only four stores, it's fairly early.

We're learning a lot, I can tell you that. A lot of interesting learnings coming from those stores, not only for that business but also for our base business, and we'll have a small percentage of next year's growth plan dedicated to more standalone copy stores.

Operator

Your next question comes from David Strasser - Banc of America Securities.

David Strasser - Banc of America Securities

As you look out at the competitive environment, like over the past weekend, and you think about the holiday season do you think it's more significant/less significant than it was last year, at least the start of it?

Ron Sargent

My belief is it's always competitive and this weekend was no exception to that.

Mike Miles

I think it's getting a little earlier in the morning on Friday mornings, but other than that I think it's pretty much the same story. Remember for us, the holiday season is not really our core business, it's something that we participate in, but we make most of the money in Q4 in January and so we don't want to get too carried away with this past weekend one way or the other.

David Strasser - Banc of America Securities

Changing the topic to international, you talked about you have a 3.3% operating margin now, wanting to get to 7.5%. Maybe I misunderstood it as you were talking about it. Is that in retail specifically? Does that include contract? Either way, any sense of a timeframe for that type of change?

Mike Miles

We've talked about it in total international and that includes Europe, where you'd expect to be a little better than that because of the maturity of the business; you'd expect it to be a little lower in Asia where you're really in growth mode. But we've said in the next two to four years we think that the SBU income that we report for all of international should start to spike up. I mean obviously, fourth quarter's our best quarter of the year for international. We'll see where we are three months from now. But we think the next two to four years we'll be in that 7.5% operating profit for all of international.

David Strasser - Banc of America Securities

As you look at the comp, the comp on the two-year basis slowed a little bit Q2 to Q3. Was it an economic issue or anything that jumped out at you sequentially in that period?

Mike Miles

No. I mean we did have certainly tougher comparisons. I can tell you we were a little disappointed with our same-store sales because you want it to be lightly positive, but we did have tougher comparisons. We were up against a 5% in Q3 versus a very low comp in Q2. But in terms of the European economy, I think given where we are in terms of our small share, I don't think it really makes a lot of difference. You've got some countries that are doing better, some that are worse, but when you look at the marketplace in Europe, particularly where you've got great fragmentation of the market, I don't think that a deteriorating economic climate should keep us from growing or keep us from improving our performance. The things that we need to do, things like better buying, things like reducing our G&A, improving our supply chain, more own brand, that doesn't require a good economy for us to do well in Europe.

John Mahoney

I'd just add that I think one of the key things, particularly in the UK has been focusing on the business customer. We have improved the mix so we aren't quite as promotional with some of the technology products as we have been in the past, which is certainly part of what drove the higher comp last year.

I think going forward the objective is to have the same sort of healthy consumables-driven business in Europe that we have in North America.

Operator

Your next question comes from Danielle Fox - Merrill Lynch.

Danielle Fox - Merrill Lynch

If comps stay negative in 2008, is there any more room on costs at retail? You mentioned that weak demand creates opportunities to identify areas of improvement so maybe a related question to the costs at retail would be whether or not you could give us some examples of where you've found some opportunities?

John Mahoney

As we've discussed in the past, we have a planning range of revenue growth. We always believe that there are opportunities to get better. Some of the things that we've done with process improvement in the company, organizational structure including our shared services center in South Carolina, as well as some of the initiatives on buying better -- not just products, but also the other things we use in our business -- have driven real productivity in our cost structure year after year.

As we look at 2008, we're not planning for a robust comp. We are planning for it to get better and historically we've been able to leverage our expenses down with sales within a normal planning range. I would expect the same thing would be true for 2008.

Ron Sargent

When you look at the last time we had negative comps, which I guess was 2001, we continued to improve profits because the comp driver was really technology where we didn't make much money. As long as your core business, your core office supplies are comping positively like they did this quarter for us, we ought to be able to continue to grow profits.

Danielle Fox - Merrill Lynch

You also mentioned that Miami and Denver stores performed well. I'm wondering if there was anything else that was noteworthy from a regional perspective that you noticed for the stores or the delivery business?

Demos Parneros

Danielle, Miami and Denver continue to grow nicely as we add stores in those markets. We have a nice balanced portfolio of stores there and they continue to ramp as planned. The other geographic note that I'd make is just a little bit of the softness in the Southeast and West Coast market -- California, Arizona, Florida, in particular -- would be the ones that I'd call out as slightly off the rest of the average.

Danielle Fox - Merrill Lynch

Did any of those patterns change relative to the second quarter? Did they intensify or do you see any incremental weakness in some of the markets that had been strong? I'm just curious what the change was quarter to quarter.

Demos Parneros

I think the trend began in Q2. It also got slightly tougher in Q3; not significantly, but a little bit. It hasn't improved yet.

Operator

Your next question comes from Gary Balter - Credit Suisse.

Gary Balter - Credit Suisse Securities

Where is the store in New York City?

Ron Sargent

38th and Madison.

Gary Balter - Credit Suisse Securities

I'm actually near there.

Ron Sargent

Stop by this afternoon and make some copies.

Gary Balter - Credit Suisse Securities

Is it as good as the Canadian stores? When we go throughout results, like the combined North American Delivery, could you break down Canada and the U.S.? The Canadian economy obviously is much stronger. How much did that help in terms of the results that we're looking at?

John Mahoney

You're talking about just in the delivery business alone?

Gary Balter - Credit Suisse Securities

Retail and delivery.

John Mahoney

I think as you know, the delivery business is much smaller up in Canada. We don't have a contract business in Canada. It's certainly not significant to the NAD results overall. We haven't broken out the Canadian results separately in the past. I think you can do the same sort of thing on store count for North American retail.

Canada has been a great business for us and continues to perform well, but I would say that the performance in Canada hasn't been materially different than the U.S. retail business, and therefore I wouldn't say that our business is any better because we have Canada than it is otherwise. The U.S. retail business is performing along with NAR.

Gary Balter - Credit Suisse Securities

So the minus 3 comp was consistent in Canada?

John Mahoney

Yes.

Gary Balter - Credit Suisse Securities

When we look at your stock price and we look at your balance sheet and we look at the competitor's stock price, how have your thoughts evolved in terms of the potential to use your balance sheet a little bit more aggressively to either do something with your own stock or do something to help consolidate the sector?

John Mahoney

As we've said on a number of occasions, we believe that there's advantages to maintaining flexibility in our capital structure and that flexibility can either be for restructuring the balance sheet to some degree or for thinking about acquisition opportunities.

To date, our acquisition opportunities have focused on the small tuck-ins that have driven new categories, particularly in our delivery business. We said that any opportunities that would come about from a significant acquisition would be looked at in the same way we look at capital discipline for any other investment we'd make. We would consider anything like that opportunistically should the opportunity arise. I don't think we comment on any specific acquisition activity.

Gary Balter - Credit Suisse Securities

I was just hoping you would on this call.

Ron Sargent

How's that for a non-answer?

Gary Balter - Credit Suisse Securities

That's pretty good. I'm used to that. Just one last question to clarify the guidance because some people misunderstand low-teens to mean 10 to 12. Low teens based on my kids is 13 plus?

Ron Sargent

That's what I call low-teens.

Operator

Your next question comes from Matthew Fassler - Goldman Sachs.

Matthew Fassler - Goldman Sachs

First of all, you've clearly gained significant share in supplies as your competitors have been talking about negative comps in that category. Can you talk about levers that you think you pulled in that category in particular, vis-à-vis other promotional activity, the impact of your loyalty program, any merchandising changes that you might have made in the store that would help explain that share grab?

Mike Miles

Yes, I think there are a couple things going on there, Matt. Certainly the back-to-school program helped and as I mentioned earlier, I think we feel like in spite of the fact that our promotional strategy during back-to-school was copied by some of the competitors, that we still were able to extend our lead there.

I think more importantly with our core business customers on a daily basis we continue to drive share both through our rewards program, which as you know has been refocused on supplies -- paper, ink and toner and the copy center -- and also specifically through the ink business which we continue to gain share in and which has a nice basket of supplies.

We think that the addition of Dell to the mix will help us continue that trend because now we're tapping into a whole group of customers who have not yet had a retail alternative to get ink and we believe that they'll buy a basket of office supplies when they come in to get their ink or toner.

Matthew Fassler - Goldman Sachs

Can you try to quantify the impact of the change to the loyalty program, let us know whether they were measurable, and any early read on the success with Dell?

Mike Miles

It's way too soon on the Dell front to talk about any successes. We've seen good initial sales and we're pretty confident on that because we also had a pretty nice, although more limited business, in the [resale of] Dell ink before we got the OEM product in the stores.

The rewards program is something we're still working on. We're pleased with what we've seen to date but it is still something that I think continues to be an opportunity for us.

Matthew Fassler - Goldman Sachs

A little more color on some of the moderation in growth in sales per customer in the delivery business? If you could just clarify -- you might have said this -- whether that's in the large customer business or whether it's across customer sizes and also what impact that's having, or if it's having an impact on the mix of business by product category.

John Mahoney

First of all, as far as across customers are concerned, it was pretty consistent across all customer sizes where we saw modest softening, and that, as I said, was in purchase volume from customers.

That being said, among the largest customers, Fortune 1000, I think it's fair to say that we are seeing maybe a little bit bigger drop off there simply because in some instances we're finding some of our competitors are winning some of those accounts which we would say are probably at more unsustainable pricing levels; and as such, we continue to be very much disciplined in our approach to these customers and so we'll see a little bit further drop off in terms of that. It is fair to say that the large account segment is not our fastest growing segment right now.

Operator

Your next question comes from Michael Baker - Deutsche Bank.

Michael Baker - Deutsche Bank Securities

Joe, can you discuss the acquisition pipeline in the delivery business? Your guidance in the fourth quarter is still at 15%; next year, low to mid-teens. How are you thinking about the organic growth versus the acquisitions, both in the fourth quarter and into next year?

John Mahoney

We continue to see the vast majority of our growth being organic growth as it has been in the past, and as well, this past quarter. So we don't see that changing at all. We don't forecast acquisition activity into our growth, so we're looking at our existing business base, our view into the future. As I said, we're very satisfied with our account acquisition and our account retention during this last quarter and that has continued to be extremely solid. We view that when we look towards next year continuing to be very market-leading growth, low to mid-teens.

Michael Baker - Deutsche Bank Securities

So to clarify that, low to mid teens doesn't necessarily include acquisitions? That really is an organic outlook?

John Mahoney

Incremental above what we have today, yes.

Michael Baker - Deutsche Bank Securities

The extra week last year was $0.04 I recall? I just want to clarify that.

John Mahoney

Yes.

Operator

Your next question comes from Colin McGranahan – Sanford C. Bernstein.

Colin McGranahan - Sanford C. Bernstein

Just following up on the NAD a little bit more, I think you used the words “strong visibility” and growth regardless of the environment. I just want to understand your confidence there in obviously what is an uncertain environment? Is that based on the account wins that you've already got, the retention rates that you're seeing and the growth of some of these adjacent product categories like Jansan and industrial that are fairly early on in their maturity that gives you that incredible visibility into next year?

Ron Sargent

I'll ask Joe to provide feedback. I think it's all of those things plus it's the confidence that we have in our team.

John Mahoney

Well said, Colin. It's all of those and as you said, in some of those growth initiatives that we've invested heavily in, they are still in the very early stages and we expect to be reaping bigger rewards from them next year and into '09 than we have in '07.

So whether it be the local products, whether it be our copy and print initiative, our Jansan initiative, our mail and ship initiative, all of those are still continuing to evolve and we do expect increasing growth from those than we've seen in '07. So that's the visibility that I think we have, as well as our continuing acquisition machine across all of our businesses in NAD, combined with outstanding retention.

Colin McGranahan - Sanford C. Bernstein

More broadly, just on the general '08 outlook, I know your retail comps obviously get a lot easier as you go into '08. Can you talk about what you've embedded just in terms of your top down macro view, given your expectations for positive low single-digit retail comps and high single-digit revenue growth overall?

John Mahoney

As I indicated, we're not expecting the climate to change through the first half of '08 and we're expecting to see the second half of '08 become a period of recovery. We're certainly not counting on the economy to get a lot better in order to achieve that. I think you're right. We do have easier comparisons but as I mentioned, our team is also working really hard to try and identify new growth initiatives in categories that are consumable, that we expect customers will need to replenish regardless of the state of the economy. I think Mike talked about a number of those.

Colin McGranahan - Sanford C. Bernstein

Yesterday the stock was below $20. I think it would probably be up a bit today. But you have $1 billion of cash on the balance sheet. I have a hard time understanding that unless that is an explicit move to preserve some flexibility. I mean, why would you keep $1 billion of cash with your stock cheaper than it's been on a valuation basis, ever, on an absolute PE?

John Mahoney

I think our strategy regarding returning cash to shareholders has been to take our cash flows and return it both in the form of dividends and in terms of regular share buybacks, which we believe is the best way to add value for our shareholders. We've seen many occasions when companies have regretted large share buyback programs and as a result, we think that slow and steady is going to win the game in the end.

We don't think we have an opportunity to add tremendous value with a single one-time event, and so absent some change we would expect to stick with our strategy.

Colin McGranahan - Sanford C. Bernstein

I think you bought back $180 million in the current quarter?

John Mahoney

Yes.

Colin McGranahan - Sanford C. Bernstein

So on an annualized basis that's about $720 million. That's not even using your free cash flow, let alone deploying the excess $1 billion in cash. So it seems like slow and steady is maybe a little too slow here.

John Mahoney

We appreciate the feedback.

Operator

Your next question comes from Mitch Kaiser - Piper Jaffray.

Mitch Kaiser - Piper Jaffray

You talked about weakness in computer. Listening to some of the CE retailers -- Best Buy, Circuit City, for example -- talked about that category being a real strength. Could you talk about what you're seeing on that side of the business?

Ron Sargent

Sure. Probably the biggest trend on the computer side is the evolution from desktop to laptop. I mean, if you look at our comps for the quarter I think we were slightly negative on computers but laptops were positive, desktops were negative. Since I think our mix of desktop is a little higher than maybe some of the others, that probably affected us.

I think the other issue that's affecting the computer category is the selling price of computers, and that's been a trend not only here in the U.S. but particularly in Canada, where the SP is down.

Obviously, we like selling consumables that have some margin in them more than computers and we try to monitor sales to the extent that we can so that our mix does improve quarter to quarter. We like computers. We don't love computers. We love all the things that come with selling computers; all the attachments and the accessories and the ink and the cables and all that.

Mitch Kaiser - Piper Jaffray

So you see your mix evolving over time from desktop to laptop, then?

Ron Sargent

Yes.

Mitch Kaiser - Piper Jaffray

100 stores next year, I think you were saying 120 this year. Why are you lowering that number? Could you comment on the mix of new versus existing markets? Thanks.

Ron Sargent

That's not really a conscious decision, to lower or to increase. We basically say 100 every year and when we have an opportunity to get good stores quicker, we'll put them in the mix. We'll do about 100 inU.S. and we'll do about 20 in Canada. So that's where you got the 120 this year. Next year, our planning assumption is about 100 new stores. It might be a few more. It might be a few less. But in terms of new markets to existing markets, I would say the bulk of the stores next year are going to be in existing markets and I think probably 10%, 15% will be in new markets, something like that.

John Mahoney

Sounds right.

Operator

Your next question comes from Steve Chick – JP Morgan.

Analyst for Steve Chick - JP Morgan

First, you mentioned that you benefited from lower variable comp in the quarter. How much did that help?

Ron Sargent

I think right off the top of my head I think the variable comp was maybe 10 basis points; 15 year-to-date is what the variable comp is. Basically we're not going backwards, we're just accruing to basically our results and that's about 15 basis points.

Analyst for Steve Chick - JP Morgan

If you could talk about your consumer, are they trading down to private label brands, especially in office supply where you had positive comps?

Ron Sargent

Well, you could argue they're trading up to private label because we feel pretty great about the quality of the product. We've had a “steady eddy” approach, I guess, like we do a lot of things in terms of Staples brand. We think the opportunity's probably 30% of our sales at some point, last year we were at 20%.

I think you'll see a steady progression over the next few years to get us to 30% and we're continuing to see that this year. We don't report every quarter, but we're doing some things like launching a higher end, higher quality line of office supplies called M. It's early days, but I think that's going to be a big idea. Last year, the hottest binder we had in our store was the Better Binder, which was a Staples brand product. The one-touch stapler is another one of those innovative new things.

For an industry that does not have a tremendous number of brands, we think the Staples brand is really the right alternative for our customers and the fact that we're continuing to grow it would indicate that the customers agree.

Analyst for Steve Chick - JP Morgan

Regarding your softness with computers, is your switch to Dell a move to combat this in maybe some of the aggressiveness that you've seen from competitors in the segment?

Ron Sargent

No, not really. I think the Dell relationship is one that we've been really working on for the last several years, in fact. We think Dell creates a great opportunity and gives our customers more choice and we love the fact that there's not a lot of places you can buy Dell in retail. But it's early days. I think we just launched Dell on the 11th of November. It's early days, but we think Dell is a great brand and a great alternative to go with some of the other great brands we have in that category.

Operator

Your next question comes from Daniel Binder - Jefferies.

Daniel Binder - Jefferies

First, just given your view that the environment could be tough in the first half of '08, is it fair to assume that your guidance for next year is more back-end weighted in terms of the comps being positive?

John Mahoney

We're thinking about the year as a whole at this point. We haven't really completed our budget process and don't really know what to expect. I think as you looked at the results on a comparison basis, you'd expect that as the comparisons get easier the comps would get stronger. I think it's too early for us to make a call. We are expecting continued weakness in the first half though.

Daniel Binder - Jefferies

You talked about the things that benefited gross margin. I was wondering if you could touch on a couple of things that I suspect have been a little bit of a headwind, particularly what seems to be a little bit more promotional activity, certainly at the retail level. You mentioned a little bit more pricing, a little tougher pricing on the large accounts in delivery. How are you handling that promotional activity?

The second part of that question pertains to vendor support. I think unlike some of your competitors, a lot of the parts of your business are still doing pretty well. Are you still able to hit these vendor hurdles in order to get the support needed to hit your plan for the year?

Mike Miles

Dan, I would say although some may have asserted that the environment's gotten a lot more promotional at retail, we've not been a lot more promotional ourselves than we were a year ago and so I think we've been able to basically maintain the same kind of pricing structure and promotional structure at retail that we've had. In delivery, as you know, we won't go chasing unprofitable business, to the extent that that happens at different points in time, it's probably more of an issue for us on the top line than it is in our margin, because we're just not going to go after unprofitable business.

With respect to vendor support, that's something that we obviously measure closely and manage closely every quarter and so far I think we've been able to do a pretty good job driving sales of the products that have a good profitability mix, whether it's the overall margin or with the back-end added in. So, again, that's helping us sustain the margin numbers that you've seen.

Daniel Binder - Jefferies

Would you anticipate any kind of investment buys from an inventory standpoint to meet certain hurdles at year end?

Mike Miles

No, I don't think so. There's always a vendor here or a vendor there where you might adjust your plan slightly, but you shouldn't see anything major at the end of the year around that on the inventory line.

Daniel Binder - Jefferies

Lastly on the gross margin, you mentioned, I think, that Canada had helped the gross margin performance somewhat. Is there any kind of price optimization activity going on there that's helping it? Is it just mix as well?

Mike Miles

It's mix. They've done a little pricing in Canada in certain parts of the business, but basically they have seen the same phenomenon up there around computers in particular that we've seen here and their office supplies mix is up significantly relative to where it was a year ago compared to computers, which is a bigger business for them than it is here in the U.S.

Operator

Your next question comes from Joe Feldman - Telsey Advisory Group.

Joe Feldman - Telsey Advisory Group

I was just hoping you could discuss the back to business period and how you may be approaching that differently from last year. Similar to Dan's question, any opportunistic buys that you might have heading into that period, or things you'll be doing differently?

Mike Miles

We've been working closely with some of our major suppliers to make sure that we have a great back to business season this year. For competitive reasons, I don't want to get into the details of what our plans are for January, but we are excited about that and we think it will be a strong finish to the fourth quarter.

Joe Feldman - Telsey Advisory Group

Also, can you talk a little bit about CapEx for '08? I may have missed it on the call, but I know you're still looking at $550 million for '07, but was just kind of curious what you're thinking for '08.

John Mahoney

I think for '08 we'd expect CapEx -- again as I mentioned, we haven't finished our budget process -- but it would be in the $500 million to $550 million range. We'll give you more specific guidance when we have it.

Joe Feldman - Telsey Advisory Group

The one last thing was just private label penetration, where does it stand at this point and how much should it help with the gross margin this quarter, if at all?

Ron Sargent

Well, I think the private label penetration continues to grow, but it grows at a very steady rate. It's not something that's dramatically different quarter to quarter. Like I said we expect to increase private label penetration a couple hundred basis points every year and I think we're probably on track to do that.

Operator

Your next question comes from Brad Thomas - Lehman Brothers.

Brad Thomas - Lehman Brothers

On the back to business period that's coming up, do you get any sense that any of your customers are putting off some expenses until next year and that there could be a little bit of a pent-up demand as we get into 2008?

Joe Doody

Brad, you always get that. Almost every year we see companies getting into their fourth quarter and getting tight for purchases so holding things off in December, waiting until after the first of the year. So our busiest week is always the first week of January. It's back to the job, it's back to changing file cabinets around, and it's a new budget in many cases. So they've delayed, and that's traditional. I can't say that right now we see any more of that going on, it's hard to really judge. But it seems to always be there and it gets even more there once you get closer to the end of the calendar year.

Mike Miles

The only other thing I'd add on the retail side is that it appears that maybe some of the bigger ticket furniture purchases may be put off a bit. But everyday things like paper and ink cartridges people are obviously coming in for, but you can hold on a little bit longer for some of the bigger ticket goods.

Brad Thomas - Lehman Brothers

After a quarter like this where you have margins coming in on the stronger side and comps maybe a little bit on the softer side, I know you're gaining share in supplies but how do you think about getting more aggressive within your pricing in some of the other categories like furniture and tech?

John Mahoney

Our experience is that the elasticity of some of those bigger ticket items isn't great, so turning highly promotional doesn't seem to increase sales and as you know, we're interested in driving gross margin dollars so we try and think about how we're going to optimize our gross margin dollars.

Brad Thomas - Lehman Brothers

John, you had alluded to the recession in 2001. I was wondering if you could talk about some of the similarities and differences in the environment and the competitive landscape from what you saw back then versus what's going on right now.

John Mahoney

It's been kind of interesting, every recession tends to be different. In 2001, right after the election when the election was up in the air for a while, demand seemed to fall off a cliff, particularly for the capital goods items. We think largely because capital was not available to small businesses after the dot-com bubble sort of burst caused that and it caused relatively weak demand for really about six quarters at that time in our business.

We have seen this be much slower. Over the course of the summer, I think there was a lot of uncertainty and Ron mentioned that we had choppy sales. It seemed to follow the news cycle. When there were bad stories, sales were bad and when that tailed off a little bit, sales improved a little bit. I think as capital became less available throughout the summer and into the fall, we've seen things really get to about where they are now.

I think that the same thing in terms of demand for capital goods items has occurred a little bit, but it's been later and it hasn't been as precipitous.

Ron Sargent

It seems like this time it's more consumer-led, where last time was more jobs-led. We felt that pretty significantly in our delivery business last time, this time I don't think we're feeling it as significantly.

Certainly we felt a little bit this quarter, but it seems to be more like a consumer-led recession if that's the way we're heading -- and I don't know if we are -- but I think the hard part is it affects retail business and retail comps.

Operator

Your final question comes from Brigitte Neigut - W.P. Stewart.

Brigitte Neigut - W.P. Stewart

On North American retail, is it fair to say margins on Dell products are in line with other electronics margins?

Your guidance in International ex-currency looks like it implies a bit of an acceleration. Is that store growth or delivery? A bit more color there would be great.

Ron Sargent

I think Dell margins are comparable to other margins in the technology category.

John Mahoney

We tend to look at the currency forecasts that are consensus based on the forward contracts as we plan for '08, so therefore we would expect that we're going to see continuing strengthening of the euro. As we said, we are not finalized on our budget yet and so I think you're talking about a little precision beyond where we are as of right now.

Brigitte Neigut - W.P. Stewart

I'm sorry. I meant ex-currency – actually your guidance implies it looks like a bit of an acceleration, low double-digit growth in local currencies.

John Mahoney

You're talking about for '08? I think as I mentioned, we've seen nice traction on accumulating business customers which we expect will continue to comp, and so I think that some of the comparisons are going to be more reasonable as we go into next year where I think the '06 comparisons often included a little bit more promotional activity.

We're expecting to see solid comps in the retail business. We're not going to see an acceleration in the store growth there and we also expect to see the catalog business to continue to perform steadily.

Operator

I'd like to turn the call back over to Ron Sargent for closing remarks.

Ron Sargent

I'd just like to wrap up by thanking our associates for a solid quarter and for delivering results in a tough environment. We're certainly improving our offering in North American retail. We continue to gain market share in North American Delivery, and in international, we're making good progress. I think we're well-positioned to finish the year strong and set ourselves up for even more success in 2008. Thanks, everybody. I appreciate your time this morning.

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