Staples F1Q08 (Qtr End 5/3/08) Earnings Call Transcript

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

Operator

Good day, ladies and gentlemen and welcome to the Staples Incorporated first quarter 2008 earnings conference call. My name is Dan and I will be your coordinator for today. (Operator Instructions) I would now like to turn the call over to your host for today’s call, Laurel Lefebvre, Vice President of Investor Relations. Please proceed.

Laurel Lefebvre

Good morning, everyone and thanks for joining us for our first quarter 2008 earnings announcement. During today’s call, we’ll discuss some non-GAAP metrics, such as return on net assets, to provide investors with useful information about our financial performance. Please view the section entitled financial measures and other data in the investor information portion of Staples.com for an explanation and reconciliation of such measures and other calculations and 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 or 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.

Ronald L. Sargent

Thanks, Laurel. Good morning, everybody. This morning I am pleased to announce sales and earnings growth for our first quarter. During the quarter, the top line grew 6% and our earnings per share were up $0.01 year over year to $0.30. Our North American Delivery business continued to gain market share with top line growth of 8% and operating income growth of 7.5%.

In international, we once again made great progress with total sales up 19% in U.S. dollars or 8% in local currency. We had same-store sales of 4% in international and a 71 basis point increase in operating margin to 3.2%.

Our North American retail business grew by 1.9% but again experienced weak same-store sales, down 6%, and operating margins declined 103 basis points from last year to 7%.

I would also like to quickly recap some of the other headlines from the quarter. We did a great job managing working capital. We finished the quarter with lower inventory per store, which contributed to strong free cash flow for the quarter. Also our focus on doing the right things for the customer continued to pay off. We are particularly pleased that our customer service scores reached record levels across the board.

I think that everyone knows that the current economic environment is tough. In North American retail, we’ve seen slower customer traffic and weak sales of big ticket items, and in North American delivery, we’ve seen a decline in sales per account.

We can’t predict when things are going to pick up again but we are not standing around waiting for the economy to improve. We are continuing to invest in the business and we have great confidence in the future. And most importantly, we’ve got the people in the field and in the home office to drive our performance.

To be a little more specific, in North American retail we continue to gain market share through store growth in both new and existing markets. We are improving our customer service programs. We are sharpening our merchandising to make our stores more exciting to shop and we are fine-tuning the mix of marketing vehicles to drive traffic. All of these efforts will help get same-store sales back on track.

In North American delivery, we are doing a great job both acquiring and retaining customers and we are also selling more product categories to drive sales. And meanwhile, outside of North America, business is going great. In Europe we continue to make good progress toward our goal of 7.5% operating margin. In South America and Asia, we are seeing tremendous growth and we will continue to grow as fast as possible. And finally across the company, we are making our supply chain more efficient, tightening our operating and capital expenses, and building a stronger global brand.

To sum up, we made great progress on many aspects of our business during the first quarter. Overall, we are becoming a stronger, more efficient company and we are extremely well-positioned to deliver outstanding results in the future.

I’ll now turn it over to Mike to talk about our first quarter results in North America. Mike.

Michael A. Miles Jr.

Thanks, Ron. Good morning, everybody. We’ll start with the results for North American retail. Sales for the quarter were $2.4 billion, up 1.9% versus Q1 of 2007. Same-store sales were down 6% for the quarter, driven in equal parts by lower average order size and slower traffic. Laptops were again our strongest comping category and we’ve also achieved positive comps in ink, successfully defending this destination category.

Copy center, although negative, was also stronger than the average for the house. Overall, consumables were only slightly negative while durables performed poorly. Our weakest performing categories were business machines and furniture, categories that contain a lot of higher ticket discretionary items.

Segment operating profit declined 11.2% from last year’s Q1 to $168 million and operating margin dropped 100 basis points to 7% of sales. The strength in supplies and services relative to tech hardware and good discipline in pricing and promotion resulted in higher product margins. We also did a great job managing expenses in our stores and supply chain.

Our process improvement program and global sourcing initiative continue to drive improvements in our cost structure. However, the combination of rent inflation and active new store program and negative 6 comps created major deleverage on the rent and depreciation line.

While disciplined expense management will continue to mitigate the impact of soft sales, we are focused on turning around the top line. Here are several things that we are working on: our exclusive line of Dell products continued to show good results from both a sales and margin perspective. We’ve expanded our assortment of Dell ink and toner, laptops, desktops, and monitors. In February, we began offering Dell product in Canada.

We advertised Dell ink at our national television ads and have seen great results from that campaign. As ink and toner grow as a percent of the Dell sales mix, margins for the whole product line improve and having the broadest assortment of Dell ink reinforces Staples’ position as the destination for ink and toner.

We are also working closely with HP and have a number of exciting initiatives underway and plans for the future. These include the exclusive debut of the new office jet pro printers, the broadest assortment of genuine HP ink and toner available at any national retailer, innovative promotions like rewards for toner cartridges and machinery cycling, and targeted co-marketing campaigns.

Office supplies remain our bread and butter and we are making a major investment to reset important parts of that department. We are rolling out new planograms to all of our U.S. stores, showcasing high margin, distinctive supplies like post-it notes, M by Staples stationary and business essentials, and the one-touch family of products. We are expanding our line of M products that bring style and fun to the office at great value. We’ve just launched an innovative website, mbystaples.com, that presents the full line of M products.

We’ve significantly ramped up our marketing of security by Staples, which we launched last year. This cross-category offering of data storage products, anti-virus software, shredders and services makes Staples a destination for information security solutions.

Finally, we continue to evolve our customer service programs to make it easier to shop at Staples. We have maintained our investment in training and selling programs, revamped our bonus plan for store associates, and continue to closely monitor customer feedback. Our focus on the customer helped us achieve record customer satisfaction levels during Q1 even as we managed labor very tightly.

We are maintaining our steady pace of new store openings and continue to see good opportunities to drive profitable sales through unit growth. We opened 35 stores this quarter and plan to open about 100 for the year, including several standalone copy and print shops. So far this year, we’ve opened our first stores in Houston, Omaha, Kansas City, and Minneapolis, and we will open stores in San Antonio and Austin this year as well. We feel the Staples brand, as well as our local store marketing capabilities, will allow us to successfully open stores and grow them almost anywhere in the country.

We continue to be satisfied that our four store formats, dover, urban, rural, and copy and print shops, give us the flexibility to choose the right format for the right location.

During the fourth quarter -- excuse me, during the quarter, we opened our fourth standalone copy and print shop in the Boston area, which combined with the shops in Manhattan and Montreal brings our current total to 11. The first new stores we opened in the U.S. are starting to comp and they are ramping well. Overall, early results for this concept are encouraging, with a good mix of supplies and copy and print services.

To wrap up, we are working hard to drive our same-store sales, improve customer service, and build a more efficient cost structure. We are also continuing to invest in building our retail business with an eye to the future.

Moving on to North American delivery, the NAD team delivered industry leading top line results again this quarter. Sales grew 8% year over year to $1.7 billion. Our organic growth of 5% was driven by customer acquisition and retention, which was somewhat offset by lower spend per customer.

Our contract business continues to be our fastest growing business. We are seeing good account growth with medium and large sized customers. Across the business, we saw strength in laptops, [inaudible], paper, and ink, and again our weakest category was furniture. We’ve seen that in general customers are behaving cautiously and are looking for deals before making purchases of large ticket items.

Overall we continue to see excellent results from our share of wallet initiatives, including Staples' promotional products, copy and print, and cleaning and break-room supplies.

In terms of geography, we are seeing growth in all regions of the country, including Florida and California. Our sales in the Chicago, Miami, and Denver markets, where we’ve recently entered with a retail presence, are growing at multiples of the overall sales for the segment.

Worldwide e-commerce sales in the first quarter were $1.5 billion, a 9% increase year over year. Electronic sales now represent 87% of total sales in our contract segment and 77% of sales for North American delivery overall.

Staples was again ranked as the second-largest Internet retailer after amazon.com in the Internet retailers’ list of the top 500 retail websites.

SBU income increased 7.5% to $163 million, or 9.5% of sales, a four basis point decrease from last year’s first quarter. Improved margins at contract and cost improvements in logistics across all of NAD were offset by investments in share of wallet initiatives and unfavorable product mix in Quill and SBD.

We’ve done a great job mitigating the impact of higher fuel costs and we’re able to leverage delivery expenses during the quarter.

Operationally, we are in great shape. Customer satisfaction ratings are at all-time highs. Logistics and operating metrics continue to set records and we are tightly managing our G&A and capital spend.

Despite seeing softer sales than we’d like, our business is doing well and we expect to see margin growth accelerate when the market rebounds.

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

Ronald L. Sargent

Thanks, Mike. I am very pleased with our results in international this quarter. Sales for the first quarter were $756 million. That’s up 19.4% in U.S. dollars and 8% in local currencies versus the same quarter last year. SBU income increased 53.8% to $23.8 million, or 3.2% of sales, which was a 71 basis point improvement over last year’s Q1 results.

In European retail, we opened three new stores, including two in the U.K. and one in Belgium. A double-digit comp in our U.K. retail business fueled 4% comps in Europe overall. The U.K. in particular had a terrific quarter. Our U.K. team drove strong top and bottom line performance by doing a better job with furniture, selling technology products more profitably, and providing a great customer experience in our stores.

Our European catalog business also saw strong sales growth and margin improvement overall. We made good progress on buying better and owned brand penetration. We also benefited from higher online sales rates and now see an overall rate of 38% of our business is done online, with penetration in several business units over 50%.

And finally, we are making great progress on our multi-channel offering, particularly in the U.K.

Turning to our businesses in South America and Asia, our businesses in Brazil and Argentina saw good growth and a significant improvement in the bottom line versus last year. That’s helped by a strengthened management team as well as better execution.

Last Tuesday we opened our first retail store in Argentina. In China, we continued to expand our business very rapidly at double-digit growth rates, and as we continue to develop our business in India, we are growing faster than plan and are very encouraged by initial results.

In summary, we are very happy with the great progress our international team has made over the past several quarters. We are showing good momentum and are well on our way to achieving our goals for the year.

Now let me turn it over to John to review our financials.

John J. 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 full year.

Turning to our Q1 results, total company sales of $4.9 billion were up 6.4% versus last year’s first quarter. Including the currency benefit in our Canadian and international businesses, sales grew 3.1%. Gross profit margin increased by seven basis points to 28.07% during the quarter, as improvements in product margin and leverage and logistics expense were partially offset by deleverage of rent expense in North American retail.

Operating and selling expenses for Q1 were 48 basis points unfavorable versus last year’s first quarter at 17.03% of sales. North American retail tightly managed expenses but saw modest deleverage on many expense lines on negative comps. In North American delivery, we saw good leverage in contract operating expenses, offset by investments in marketing and in our catalog business.

Turning to general and administrative expense, G&A as a rate of sales deleveraged 2 basis points year over year at 4.36%, reflecting good expense control across the board in a soft sales environment.

Moving on to the balance sheet, we did a tremendous job managing working capital this quarter. Although total inventory turns were down 18 basis points versus last year to 5.66 turns on softer sales, total inventory declined during the quarter. By carefully managing our working capital, we generated $299 million in operating cash flow, which is over $100 million more than last year’s Q1.

Our liquidity and financial resources remained very strong. At the end of the first quarter, Staples had $2.0 billion in liquidity, including cash and short-term investments of $1.2 billion and available lines of credit of about $800 million.

Return on net assets for the quarter declined to 13.7%, down 70 basis points compared to the end of the first quarter a year ago.

During the quarter, we bought back 2.8 million shares for $65 million. Our diluted weighted average shares outstanding declined by just under 21 million shares year over year for the quarter, as a result of our repurchase program, offset by stock option exercises.

We are not currently buying back shares in anticipation of the acquisition of corporate express and have about $1 billion remaining on our authorization. CapEx for the quarter came in at $74 million, up from the $64 million we spent for the same period in 2007, reflecting higher store openings, increased investment in information systems, and investments to build our business in Asia. For the year, we expect $500 million in capital expenditures.

We generated $225 million in free cash flow during the quarter.

Looking ahead, we expect the weak economic climate to continue throughout 2008. As a result, we expect second quarter earnings per share to be flat versus last year’s Q2, our lowest sales volume quarter. Our full year outlook hasn’t changed. We expect to achieve mid-single-digit sales growth and high-single-digit earnings per share growth for 2008. This excludes the previously disclosed impact to 2007 of the $38 million pretax charge related to the settlement of the California wage an hour class action litigation. This guidance excludes any impact relating to our proposal to acquire all of the outstanding capital stock of Corporate Express.

Before we wrap up, I would like to update you on where we stand with our plans to acquire Corporate Express. Yesterday we announced our tender offer to acquire the company for EUR8 per ordinary share after receiving approval of our offering memorandum from the AFM. We have anti-trust clearance in the U.S. and anticipate receiving clearance in Canada and in the E.U. in the coming weeks. The enterprise value for the transaction, including net debt, is $4.3 billion. The tender period runs from today until June 27th and carries a minimum acceptance condition of 75% of the ordinary share capital.

We believe that by combining the complementary strengths of both companies, we can build a strong, global delivery business and deliver considerable value to our customers, shareholders, and associates around the world.

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

Question-and-Answer Session

Operator

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

Matthew Fassler - Goldman Sachs

Thanks a lot. Good morning, everyone. Just a couple of quick questions here -- can you shed a little more light on the share of wallet initiatives and delivery in the investments that you made there? How new are these, how significant are they and how much did they contribute, if you would, to the sales momentum?

Ronald L. Sargent

Sure. Let me ask Joe Doody to respond.

Joseph G. Doody

The share of wallet initiatives, the areas that we’ve really focused heavily on is copy and print, which we’ve been after on the print side for a few years but have added closed door facilities for overflow copy for our contract customers, and that’s continuing to ramp up as we continue to add new locations throughout the U.S. to service that need. Staples' promotional products, formerly AI, American Identity, another big share of wallet initiative to drive not only within contract customers but over time among all of our customer base, both delivery and eventually retail.

And then cleaning and break room has been an ongoing initiative from share of wallet, as well as the mail and ship and furniture. The one that’s the most disappointing right now is clearly furniture, with the economic headwinds that we are hitting there and it’s the one category, quite honestly, within all of NAD that was flat for the quarter.

So it -- all of these do contribute. Some are not in our comp number so that’s why the difference of about 3% between our total growth and our organic growth. That’s mainly made up of Staples promotional products, but the initiatives are going well in all cases, with the one exception on the furniture side.

Matthew Fassler - Goldman Sachs

And then just by way of quick follow-up, I guess this would be for Demos or for Mike, your retail margin finally showed some of the impact of the tough environment, though clearly you outperformed your competitors and obviously a negative 6 is a heck of a headwind to face. Is this in your view what retail pretax margin probably looks like going forward, in the event that comps kind of stay where they are?

Michael A. Miles Jr.

I think that we’ve at this point squeezed the P&L about as hard as we want over the last four quarters with the negative comps. Obviously the makeup of the comp is going to have some impact on what the margin looks like. To the extent that we can grow supplies and the copy center faster, we’ll be able to do a little bit better. But you know, the rent deleverage that we’ve got at this level of comp is something that’s pretty well baked in and we are not comfortable squeezing labor a lot harder than we have frankly in the second quarter of last year, we had very good labor leverage and it will be tough for us to have more leverage on the labor line until we see comps get back to positive again.

Matthew Fassler - Goldman Sachs

Thank you so much.

Operator

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

Christopher Horvers - Bear Stearns

Good morning. Thank you. Ron, I was curious if you could give some commentary about, you know, as we always ask you where we think you -- where you think we are in this cycle. Do you think we are kind of bouncing along the bottom here and things aren’t necessarily getting worse? Or do you see any indications that you could see another leg down in retail or delivery?

Ronald L. Sargent

As you saw from our first quarter, there’s really nothing to indicate that the economy is getting better or there is nothing to really indicate that it’s getting worse, either. I mean, when you look at our minus 6 was against a positive 1 the year before and last quarter’s minus 6 was also against a positive 1 from the year before, so it’s really kind of very flat fourth quarter to first quarter.

I think when you look at our comparisons, they do get easier throughout the year and I think we are doing a lot of things to drive the business. You look at our comps last year was minus 2 in Q2, then they were minus 3, and then they were minus 6, so the comparisons certainly get easier but that’s just math.

But I feel like we are kind of in the trough and if I were picking, I would say that the general direction is up from here, not down from here.

You know, there is a standard business cycle and when you look at -- our job is -- we are tasked with growing and managing our business even during the tough times and I think we’ve done a nice job of controlling what we can control and still providing great service and continuing to invest in the business.

And I think just like we tend to be an early indicator going into the recession, I believe that last time and this time, we are going to be an early indicator coming out of the recession.

You know, somebody asked me the other day about what do I think about the trends throughout the quarter and my answer was when you report minus 6% same-store sales, the monthly trend is bad, bad, and bad. Having said that, you look at our sales, I mean, they are very choppy, which is typical for a recessionary kind of environment. I mean, obviously the weak Easter week, our comps were lousy and then when you look at the week in April versus Easter prior year, our comps were very good. But when you look, you know, you have good weeks and bad weeks and the indication is kind of up, down, sideways, and there’s really not a clear trend or direction at this point but I do feel like we are in the trough and the general direction is up from there.

Christopher Horvers - Bear Stearns

Thank you very much.

Operator

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

Oliver Wintermantel - Morgan Stanley

Good morning. Can you comment on your performance in the national advantage division versus business advantage segment? I just want to get a feel for the margin difference between your Fortune 1000 business versus the middle market and what your opportunities are to bring Corporate Express’ margins up to your levels.

Ronald L. Sargent

Sure. Let me ask Joe Doody -- I mean, certainly the margins are not as good on the national accounts but they are still pretty good if you manage the business correctly. Joe.

Joseph G. Doody

Yeah, Ron, I mean, as you said, they are not as good as our -- what we call our SBA, which is more of the mid-market. Just as far as the overall business within the SNA business, we continue to remain very disciplined in that business. We are very satisfied. One, it’s not our fastest growth area of our contract business. Our mid-market is definitely our fastest growth area but we are very satisfied with our overall account growth within the large national accounts and we certainly are seeing some of our competitors who are focused a little bit more on profitability than they are growing market share, so we’ve seen that in the marketplace over the last quarter or two.

But our model that we have in terms of the lowest cost provider to our customers is one that we have been driving very effectively into the market. We partner very closely with our customers and as a result, in spite of overcoming large increases in paper prices, as well as fuel, we certainly are still able to drive higher profitability and partner with our customers to drive larger orders.

So our lowest cost delivery model that we have in partnering with our customers is really our secret to success in that business and really yields the type of margins that we have been able to achieve historically and plan on continuing into the future.

Oliver Wintermantel - Morgan Stanley

All right. Thank you very much. That’s very helpful.

Operator

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

Colin McGranahan - Sanford C. Bernstein

Good morning, guys. First question, I want to focus a little bit on the North American delivery operating margins. Obviously with fuel and diesel doing what they did, it’s fairly impressive to manage some leverage on delivery expenses. I was hoping you could talk a little bit more about how you did that. I know you are anniversarying some DC, the fulfillment center openings from last year, so when does the benefit of those extra costs begin to be anniversaried and fade away and how long do you think you can leverage or see this kind of strong delivery operating performance in this kind of fuel environment?

Ronald L. Sargent

Joe.

Joseph G. Doody

First of all, I’m very proud of the team for what they are doing in terms of being able to leverage in this environment, as you noted, Colin. I mean, just one example of that is diesel fuel last week was 56% higher than it was a year ago, where your typical unleaded is around 20% higher. So having to overcome that is a major, major success and the team has done that. We are leveraging both our delivery expense as well as our fulfillment expense this quarter and we do expect to continue to do that throughout the rest of this year in spite of the softening sales environment.

So again, kudos to the team and it’s not just one thing. It’s the team overall working with our customers to ensure that we are driving higher average order sizes, that we are delivering a higher percentage of our orders completely so that we drive fewer trips per order, as well as working to improve our fleet productivity.

So all of those factors really are what’s driving the leverage that we’ve been able to achieve on the delivery line.

As far as fulfillment, you noted our major new buildings that we’ve added over the last couple of years have ramped up very well. We are very satisfied with the productivity of those buildings as they continue to improve and that’s what’s driving our leverage in that line as well. And we anticipate that that will continue throughout the rest of this year as well.

Colin McGranahan - Sanford C. Bernstein

Okay, that’s a nice job on that. And then just shifting to Europe, obviously it’s surprising to see double-digit comps out of the U.K., given the U.K. environment is starting to look and feel a little bit more like the U.S. these days. Maybe you could just talk a little bit more about what some of the initiatives were there that achieved that.

Ronald L. Sargent

I am very pleased with our international business in total. We had not only positive comps in the U.K. but also in Germany and Portugal and we had a big improvement in our comps in The Netherlands. But I think when you are given all the things that we’ve got to do to improve our business in the U.K., and we are doing to improve our business in the U.K., I think we’ll do just fine there, despite what might happen or is happening to the European economy.

During the first quarter, U.K. was certainly the standout and that’s true of the retail business but also true of the delivery business as well. I think we are operating those businesses a lot closer together than we have in the past to take advantage of this multi-channel offering. So I think multi-channel was part of the idea. I think selling technology a lot more intelligently than we’ve done in the past was part of it. I think they’ve done a nice job with furniture.

I think frankly it always comes down to people and I think for the first time in several years, we’ve got a good, strong management team and leadership team in the U.K. that is really just kind of hitting on all cylinders. Dick [Neff] came over to the U.K. a couple of years ago and kind of got us back on track and I think what you are seeing is the people he hired -- you know, Peter Burkes has been with us for closing in on I guess a little over a year now, or about a year now, and I think he and the team have really made a difference in running this great U.K. business. And frankly, our market share is very low and I believe we are taking gobs of share both on the retail side as well as the delivery side.

Colin McGranahan - Sanford C. Bernstein

Okay. Congratulations, good luck going forward.

Operator

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

Seth Bastien - Credit Suisse

It’s actually Seth Bastien for Gary. Just one quick question for you, focusing in on North American delivery -- we’ve seen a deceleration in the growth rate there and we’ve seen stabilization on the retail side in terms of the comps. Do you think we should see stabilization in that growth rate in North American delivery or are we not at the trough yet in that one?

Ronald L. Sargent

It’s kind of hard to predict the future. I mean, the nice thing about our delivery business is that we are continuing to acquire lots of new customers, so I think that bodes well for the future if the economy gets worse or if the economy gets better.

If you look at -- you know, we’ve done a great job retaining customers, we’ve done a great job acquiring customers. We are starting to sell them more things through some of Joe’s share of wall initiatives, but the thing that we are feeling the slowdown in is sales to existing customers, which to me is kind of economy related.

Whether it’s down from here or up from here, it’s just a little harder to peg that one. I don’t know, Joe, do you have any --

Joseph G. Doody

No, we’re similar, Ron, to your statements regarding the quarter. It’s pretty much moving around but it’s pretty stable that we are currently performing, and I think it just bodes well for the future, as Ron said, with the customer acquisition, with the customer retention, our absolute highest levels of customer satisfaction, and our best operating metrics that we’ve ever had in the business. So it all bodes well when we come out of the economic headwinds.

Ronald L. Sargent

Seth, just in the interest of full disclosure, I mean, we will slow down next quarter a bit because we will be lapping the American Identity acquisition, so if you look at organic growth this quarter, we are probably between 5, 5.5, and American Identity gave us another 2.5 to 3 points on top of our sales growth.

Seth Bastien - Credit Suisse

Okay, that’s fair. And just one follow-up regarding Quill and SBD, you mentioned unfavorable product mix shift. Can you give us some more color on that and whether or not that’s temporary or something that might persist?

Michael A. Miles Jr.

Most of that is, especially on the SBD side, is furniture, a significant slowing of furniture, which is a margin negative for us and is an area where we’ve seen the slowest growth from a category standpoint. And also softening of core office supplies is a factor in it too, so it’s mainly product category mixes affected heavily by furniture, especially within SBD.

Seth Bastien - Credit Suisse

Great. Thank you, guys.

Operator

Your next question comes from the line of Dan Binder from Jefferies.

Dan Binder - Jefferies

Hi, there. They got it right this quarter.

Ronald L. Sargent

Good morning, Dan. We provided some management guidance to our moderator before the call, so --

Dan Binder - Jefferies

I appreciate it. A couple of questions; first, given the current guidance, just curious what your free cash flow outlook is for the year, given the strong performance you showed this quarter.

Ronald L. Sargent

John.

John J. Mahoney

Well, as I think we’ve been talking about, we are counting on our ability to manage our working capital a little bit more effectively this year. I think there’s been good work in a variety of areas. We’ve talked about collection of vendor receivables. They were a little up this quarter, as we had some specific promotions that ran through -- around the end of the quarter that we received shortly after the new quarter began. So we think there is still opportunity in working capital.

Certainly in the inventory area, we’ve been cautious in the way we’ve been buying to make sure that we didn’t wind up with a lot of overstock in the inventory area, so I think that bodes well for our ability to balance the inventory with sales for the rest of the year and for purchases, and we continue to emphasize getting terms from vendors.

So I think you can expect to see the working capital or the cash flows continue to improve versus last year, and last year I guess we were about $900 million or so and the hope would be that we’d be in that range or a little bit better this year.

Dan Binder - Jefferies

Okay. And I’m not sure if you’d be willing to share it with us but in terms of doing like a sensitivity analysis on vendor support or vendor rebate dollars versus your sales growth, if for a moment we just assume that maybe things get a little worse and let’s say instead of doing it -- I know you are not counting on that but let’s say mid-single-digit sales growth were to be low-single-digit sales growth, can you give us a rough idea of what kind of impact it would be on gross margin from a change in vendor rebates?

John J. Mahoney

Sure. I mean, without being real specific about it, there’s a lot of things that come into play, including mix of products, certain categories carry better vendor programs than others but assuming the mix doesn’t change dramatically, most of our programs really are oriented towards a percentage of our sales, so as you saw in this quarter, we saw our margin, our gross margin improve a little bit as a result of the fact that all of the factors that enter into that, other than rent, were fairly favorable and that I think reflects the fact that we’ve worked with our vendors to try and maintain the rate of promo money throughout the year. So I wouldn’t expect to see a change in the rate unless there is some major change in the sales patterns, but anything certainly within the ranges of what we’ve seen so far would yield vendor money at about the same rate of sales as we saw in the first quarter.

Dan Binder - Jefferies

Okay, and then last question, more of a housekeeping item, tax rate for the remainder of the year?

John J. Mahoney

We’re expecting the tax rate to be 35% for the year.

Dan Binder - Jefferies

Great, thanks.

Operator

(Operator Instructions) Your next question comes from the line of Brian Nagel from UBS.

Brian Nagel - UBS

Good morning. A couple of questions; first off, recently you guys have talked about some changes you were going to make to your loyalty program, your rewards program in the stores. I just want to maybe get an update there, if you have started to implement some changes there and if these changes at all helped to stabilize your retail sales in Q1.

Ronald L. Sargent

Mike.

Michael A. Miles Jr.

Brian, we are continuing to feel like the rewards program is a really cost-effective way for us to reach our best customers and so we are trying to drive as much of our marketing communication and value to our best customers through that program as we can. I think you saw in the first quarter that we had the -- actually in January, the first quarter of the calendar year, we had the 20% back offer, which we delivered through the rewards program. We’ve recently shifted our ink rebate money for people who bring back an empty cartridge into the rewards program. And again, that focuses that money back to our best customers and away from casual consumers. We’ve seen a real significant increase in rewards sign-ups this year. Our stores are really behind it and I think it’s paying dividends. I think it’s part of the reason that we’ve performed better than the competition during the year so far.

Brian Nagel - UBS

So the changes, are they -- would you characterize still as ongoing then? It’s an ongoing type of improvement to that program?

Michael A. Miles Jr.

Yes. I mean, I think the -- we are very excited about the program in general. The changes I mentioned with respect to ink are ongoing. The promotion that we did in January was a one-time event but we will continue to do activities like that that feature the rewards program as a vehicle for delivering value back to our customers.

Brian Nagel - UBS

Okay, great. And the final question, just an update on anything we’ve seen -- in light of the still obviously very challenging sales environment out there, anything new on the competitive environment from a pricing perspective or merchandising, et cetera?

Ronald L. Sargent

Demos.

Demos Parneros

Good morning. Not much in terms of pricing or promotions. Obviously they have both talked about less store openings for the remainder of the year and beyond. I would say that the [inaudible] promotions from a lot of the competitors out there, whether it be a mass or an OSS competitor, but nothing really noteworthy to point out here.

Brian Nagel - UBS

Great. Well, good luck in the coming quarters.

Operator

Your next question comes from the line of Stephen Chick from J.P. Morgan.

Stephen Chick - J.P. Morgan

Thanks. I guess Ron, I wanted maybe a factual clarification, if I could, on the Corporate Express offer. I was under the impression that in The Netherlands there’s an independent body of some sort, a trust that can, if they decide, to exercise some type of call option. Is your official -- is that still something that could take place, or is the official offer that’s been approved negate that somehow?

Ronald L. Sargent

Let me ask John to provide some clarification on that one.

John J. Mahoney

The way that works is somewhat similar to the way most poison pill programs work in the U.S. The different in The Netherlands for Corporate Express is the exercise of the preference share option is in the hands of the foundation. In other words, the company has a governance change that they put in place last year, changed the fact that they can’t put the shares to the foundation. The foundation would have to conclude that it’s in the best interest of all of the stakeholders to exercise the right to call those preference shares.

As you probably have read, it’s something that has been used in The Netherlands to delay but not prevent a takeover.

Stephen Chick - J.P. Morgan

Okay. So if it -- I guess if it’s used and the date goes beyond your expiration date of June 27th, what would happen then? Would you just wait in accordance with the delay?

John J. Mahoney

Well, I think there’s sort of multiple variables there. You’d expect that there could be some litigation regarding the exercise of these preference shared rights and we do have the ability, as you can see in the offering memorandum, which is very easy to get, by the way. It’s right on the top right-hand side of Staples.com. You can click on that and get the offering memorandum if you have some specific questions, but it’s I think something where we have some flexibility in terms of extending the offer under Dutch law.

So timing, it would be important to figure out when they exercise the rights and how long litigation would take and so forth, but in general, you’d expect the Dutch court system to facilitate a quick resolution of a matter like that.

Stephen Chick - J.P. Morgan

Okay, and I’ll take a look at the offering memorandum more closely but is that something -- like, do you have interaction with the body or is this something they do unilaterally?

John J. Mahoney

The foundation board is an independent board in The Netherlands that’s not a regulatory entity and it is not tied to the company. They are independent people who are charged with acting in the best interests of all the stakeholders of a Dutch firm.

Stephen Chick - J.P. Morgan

Okay. All right, thanks, I appreciate that.

Ronald L. Sargent

Just maybe if I could make a few comments about Corporate Express, as kind of a follow-up to your question, Steve. I just want to make it clear that we are very positive about the idea of a business combination with Corporate Express. We know their business, we like their business, we respect it and like their people. We think that the offer is certainly good for both Corporate Express shareholders as well as Staples shareholders, and I think it is going to be very good for Corporate Express employees as well as Corporate Express customers.

When you look at our frustration is that Corporate Express has been unwilling to negotiate or allow us to do due diligence at a price of EUR7.25, or even at EUR8. When you look at a little bit of the history, on Friday, May 9th, I told them that we plan to raise our offer to EUR8 on Monday, May 12th, in an effort to break the impasse and secure a recommended, a management recommended deal. I certainly wanted them to have three days of fair warning in case they were willing to engage with us. And on Monday the 12th, I was told that the gap was still too large with no indication as to how large the gap was, just that it undervalued Corporate Express’ business and was perceived by them as opportunistic.

Frankly, it was kind of surprising to us given the trajectory of their business and the fact that our offer represents a 90% premium over where their stock was trading prior to our involvement.

So at this point, we are going to let the shareholders decide if EUR8 cash is a fair price or if they would prefer to bet on Corporate Express’ turnaround plan for 2011. And if the shareholders reject our offer, then we move on.

Stephen Chick - J.P. Morgan

Thank you.

Operator

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

Joseph Feldman - Telsey Advisory Group

One quick question with regard to the store rollout -- I noticed this quarter you guys rolled out in quite a few new markets, which is a little different than the approach you’ve taken in the past couple of years with more focused market entries. And I just wanted to know if you found any differences and what worked, what didn’t work, and what drove that in the first place.

Ronald L. Sargent

I’ll ask Mike Miles to handle that one.

Michael A. Miles Jr.

Joe, when we went into both Miami and Denver, we opened a couple of stores in advance of kind of the full market entry. And what we found was that we could support stores with our national brand advertising that we do and then our direct marketing capabilities to just that store trade area very successfully without having the big scale launch. And as I think everybody knows, we see ourselves as a national retailer so we felt that those entries gave us kind of the confidence to go really almost anywhere in the country right now and we would -- you know, given the real estate market, it’s a good time to be a buyer. It feels like a good time for us to be competing for the sites of the future in all the markets in the country. And that’s why you see us in Minneapolis and Houston and Kansas City right now and as I mentioned, we’ll be in Austin and San Antonio before the year is out.

And I think you will see us continue to grow in those markets. You know, we want to be number one or number two in all the markets we compete in, so that hasn’t changed at all but we probably won’t be doing it kind of with the scale that we did in the Chicago market where we opened as many stores as we did in the first year.

Demos, do you want to comment on how those stores are doing in those new markets we just opened?

Demos Parneros

It’s early, obviously, but as Mike said, we’ve got a lot of confidence in the local teams. We’ve done a real nice job at getting strong teams out in the field. We have a very stable management team out there and so far, so good. And we’ve got a little bit more to go this year, so I think we are on track.

Joseph Feldman - Telsey Advisory Group

Excellent. Thanks for the update, guys.

Operator

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

Ronald L. Sargent

Just to wrap up, let me again thank you for your time and your interest in our company and also let me thank the Staples team for again delivering solid results in a challenging quarter. Our team is working hard on the many opportunities to improve our business and we believe that we are very well-positioned for the future. Thanks, everybody.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.

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