Summary of Staples (SPLS) May 16, 2012 Earnings Conference Call Transcript (Q1/2012)

Overview of company's operations.

Staples' Q1 results were in line with company expectations. The United States top line performance was stable, while performance in Europe was weak. Staples acknowledges that it had poor performance outside of North America. 

One top priority for 2012 was to continue increase product categories adjacent to core office supplies. To that end, during Q1, Staples had strong growth in facilities and breakroom supplies, copy and print, mobile phones and accessories, and tablets and eReaders.

Another top priority for 2102 was to improve profitability. In Q1, Staples eliminated 300 positions in Europe and Australia, but this will not be sufficient to improve profitability internationally. The company also eliminated 200 salary positions in the United States and Canada, which will allow it to be more efficient and streamlined. It intends to be very selective with spending.

Staples' online business had stronger growth in Q1. There is a strong connection between the online and retail store business. Customers can shop online and then pick up the product at the store, which generates more traffic. There was also rapid growth in Copy & Print through Staples' relationship with Vistaprint. Customers utilized the company's software download capabilities, especially during tax season. Staples believes the bulk of its growth will come from its online business. 

Staples is offering several new services with attractive margins, which have had good early results: (1) wide format printing and shredding services in all stores, and (2) computer rental workstations in over 500 stores.

Staples launched a Managed Print Services solution in late Q1 which helps customers create more efficient, customized and sustainable printing networks. Based on the success of facilities and break room supplies, it will be expanding its industrial and safety supplies.

Staples is also expanding offerings geared toward small business customers. It recently announced a new and improved technology recycling program with HP, which allows customers to recycle all brands of business technology in a safe and responsible way at any of its retail locations at no cost. It expects this service to drive incremental traffic to its stores.

Staples has been changing its marketing. It is reducing marketing on television and instead focusing on email marketing. It now has 300 salespeople in Copy & Print, and are starting to see a benefit from it. In Europe, most of our marketing spending is on mailing paper catalogs to customers.

The introduction of Apple products in Canada was well received, but the products are not available in all Canadian stores yet. There have been some slight problems with product availability and Staples expects that to improve when Staples shows good results. Staples is still discussing with Apple the possibility of placing Apple products in United States stores.

In the computing market in general, not much is going on until the release of Windows 8 in October or November. The lastest trend is ultrabooks and they have been selling well, but there has been pressure on that category and growth is slightly negative. There will probably continue to be pressure on the computing category as customers wait until the Windows 8 release.

With regard to competition by Amazon, Amazon's efforts are more toward MRO supplies, rather than office supplies. Most of Staples' North American sales are based on a sales force driven model to business customers, which insulates it a bit from Amazon. Although Amazon prices aggressively, Staples believes it can compete with its rewards program and Amazon moving toward having a sales tax. Further, 98 percent of Staples customers get free shipping because there is free shipping on orders over $45 and most orders exceed $45. 

In its international business, Staples acknowledged its performance was weak. In Australia, it hopes to improve performance by reducing its costs and launching a mid-market Contract offering. Its U.S. real estate and pricing teams are giving support to the international team. For instance, based on the U.S. model, it will be growing its Copy Center business and focusing on attachment selling. It is looking to close or downsize unprofitable stores as leases expire. It has increased international brand penetration by 40 basis points, which has helped margins. Internationally, Staples prefers to focus on a handful of countries, and it will not enter a new market unless it expects a good return on investment. Further, it will not hestitate to leave a market if the investment is not working. 

Overview of markets.

The United States economy is modestly improving. Staples expects slow growth in the United States market. It is cautiously optimistic about improvement in the economy during 2012.

The Canadian economy is very similar to the United States economy.

Europe is still weak and European retail is very challenging. Most of the Eurozone is in a recession. Scandinavia and Germany are performing a little better. Staples expects demand in Europe to remain soft and does not expect any improvement in the economy in 2012. Sales trends in Australia are also soft.

Financials.

Company-wide.

Total sales in Q1 were flat in local currency, but declined 1 percent in U.S. dollars versus last year. Staples expects single digit sales growth for 2012.

Gross profit margin was 26.4 percent, a reduction of 14 basis points. International operations reduced margin, while supply chain improvements partially offset the reduction.

Earnings per share on a GAAP basis decreased about 4% to $0.27. Two negative actions impacted earnings per share by $.03: (1) severance payments, and (2) the payment of a legal settlement in connection with acquisition of Corporate Express in 2008. Staples projects high single-digit EPS growth for 2012.

Staples currently has free cash flow of $95 million and it expects to generate more than $1 billion in free cash flow for 2012.

In Q1, Staples opened 4 stores and closed 7 stores. At the end of the quarter, it had 1,580 stores in the United States and 334 in Canada. It does not expect any net store growth in North America in 2012.

During Q1, Staples spent about $93 million on share repurchases and increased its quarterly dividend by 10%. It continues to use excess cash to buy back stock through the year.

Business segments.

1.     North American delivery. Sales increased 2 percent. Each of the three delivery units had top line growth. The highest growth came from Staples.com, which had top line growth in the mid-single digits. Operating margin increased by 3 basis points, to 7.9%, due to supply chain efficiencies, although that improvement was partially offset by 30 basis points for (1) headcount reductions, (2) the legal settlement, and (3) decline in product margin.

Staples continues to gain market share in the North American delivery segment. Facility and breakroom supplies were 50 percent of the North American delivery business. Staples.com and Quill.com had year-over-year growth in customer file and order frequency, but the average order size declined in both businesses.  

2.    Contracts. Last year, Staples lost a couple of large legacy Corporate Express accounts, which will negatively impact top line growth this year. This was rare circumstance resulting from Staples walking away from unprofitable accounts.   

Average order size improved, and the number of small orders with mid-market and entreprise customers significantly declined. Since the consumer segment is performing better than the small business segment, this is impacting the Contracts segment, which is exclusively businesses. Pricing is stable in the higher-margin, mid-market business, which is the majority of the company's Contract business.   

3.      North American retail. Sales were flat. Same stores sales were flat in the United States and a little stronger in Canada. Average order size and traffic were unchanged. Consumers outpaced small business customers. In North American retail, core office supplies increased in the low single digits, while toner and paper decreased in the low single digits. Sales of mobile phones and accessories doubled, and there was double digit growth in tablets and eReaders. Sales of facilities and breakroom assortment increased almost 30%. Copy & Print had top line growth in the mid-single digits.

Operating margin was 7.2, percent, which was a decrease of 43 basis points. 20 basis points of the margin reduction was due to headcount reduction, the legal settlement, and investments in categories beyond office supplies. The remainder of the reduction was due to flat sales and increased expenses. Some of the increased expenses were as a result of the 500-store mobile phone initiative. The margin reduction due to these items was partially offset by lower marketing and depreciation expense. Staples expects margins to remain the same in Q2, since no new products will be happening until late Q2 or early Q3. The headcount reductions in North America are complete.

The loss of white collar jobs during the recession has impacted the retail sector. The jobs that are coming back are not in high-paper consumption jobs. Instead, the jobs are in manufacturing, hospitality, utilities, and transportation. The financials and large companies have not added jobs.

Staples believes there are too many North American retail stores open in the industry. Its competitors will be closing about 2 stores a week. It is remaining flat on the number of stores.

4.      Staples International. Sales declined 5 percent in local currency and 8 percent in U.S. dollars. Sales for European office products declined 4 percent in local currency. Top line was also weak in Australia and Staples expects sales to remain weak through the rest of the year. The European delivery business outperformed European retail. The Contract business increased customers, but declined overall due to lower sales to existing customers. Same-store sales were down 6%, with technology categories such as computers declining in the mid-teens. Core categories declined in the low to mid-single digits. There was top line growth in European Copy & Print in the mid-single digits. Staples' biggest problem in Europe is retail, which thas been hurt by the poor economy.

International operating margin was a negative 1.5 percent of sales, a decline of 225 basis points. 130 basis points of that decline was the result of the reduction of personnel and the settlement. The decline was also due to a deleverage of fixed expenses on lower sales in Europe and Australia, and lower product margins in Europe. The company had strong gross margin improvement in China, Brazil and Argentina.

Staples expects the first half of the year to be very difficulty internationally, but for it to get better in the second half due to cost cutting and overlap with a much weaker third quarter last year.

The long-term margin opportunity in Europe is more than the 150 basis point expansion mentioned in the last conference call, which really dealt only with general and administrative expense reduction. Staples has given up on its 3-year program to reduce G&A expenses by 450 basis points because of the decline in sales over the last year.

The full transcript of the earnings conference call can be found on Seeking Alpha at the following link:
http://seekingalpha.com/article/594951-staples-management-discusses-q1-2012-results-earnings-call-transcript