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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549


FORM 10-Q

Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended: May 3, 2003

Commission File Number: 0-17586


STAPLES, INC.
(Exact name of registrant as specified in its charter)

Delaware
(State or other jurisdiction of
Identification No.)
  LOGO   04-2896127
(I.R.S. Employer
Identification No.)

Five Hundred Staples Drive, Framingham, MA 01702
(Address of principal executive office and zip code)

508-253-5000
(Registrant's telephone number, including area code)


        Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

Yes ý    No o

        Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes ý    No o

        The registrant had 474,926,984 shares of Staples common stock outstanding as of May 15, 2003.





STAPLES, INC. AND SUBSIDIARIES
FORM 10-Q
May 3, 2003
TABLE OF CONTENTS

 
  Page
Part I—Financial Information:    
Item 1. Financial Statements (unaudited):    
  Consolidated Balance Sheets   3
  Consolidated Statements of Income   4
  Consolidated Statements of Cash Flows   5
  Notes to Consolidated Financial Statements   6-14
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations   15-23
Item 3. Quantitative and Qualitative Disclosures about Market Risks   23
Item 4. Controls and Procedures   23
Part II—Other Information   25
Signature   26
Certifications   27-28

2


PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

STAPLES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(Dollar Amounts in Thousands, Except Share Data)

 
  May 3,
2003
(Unaudited)

  February 1,
2003

 
ASSETS              
Current Assets:              
Cash and cash equivalents   $ 226,019   $ 596,064  
Merchandise inventories, net     1,452,633     1,555,205  
Receivables, net     396,051     364,419  
Deferred income taxes     133,935     96,229  
Prepaid expenses and other current assets     95,141     105,559  
   
 
 
    Total current assets     2,303,779     2,717,476  
Property and Equipment:              
Land and buildings     528,676     524,730  
Leasehold improvements     644,976     621,713  
Equipment     975,474     951,439  
Furniture and fixtures     481,257     472,935  
   
 
 
    Total property and equipment     2,630,383     2,570,817  
Less accumulated depreciation and amortization     1,190,416     1,123,065  
   
 
 
    Net property and equipment     1,439,967     1,447,752  
Lease Acquisition Costs, Net of Accumulated Amortization     50,024     51,450  
Intangible assets, Net of Accumulated Amortization     214,493     216,391  
Goodwill     1,207,824     1,207,824  
Other Assets     79,956     80,495  
   
 
 
    Total Assets   $ 5,296,043   $ 5,721,388  
   
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY              
Current Liabilities:              
  Accounts payable   $ 1,008,625   $ 1,092,172  
  Accrued expenses and other current liabilities     664,665     755,483  
  Debt maturing within one year     2,017     327,671  
   
 
 
    Total current liabilities     1,675,307     2,175,326  
Long-Term Debt     744,192     732,041  
Deferred Income Taxes     53,122     50,267  
Other Long-Term Obligations     108,313     104,862  
Stockholders' Equity:              
Preferred stock—authorized 5,000,000 shares of $.01 par value; no shares issued          
Common stock—authorized 2,100,000,000 shares of $.0006 par value;              
issued 502,504,546 shares at May 3, 2003 and 500,831,408 shares at February 1, 2003     299     299  
Additional paid-in capital     1,513,496     1,484,833  
Cumulative foreign currency translation adjustments     14,255     11,481  
Retained earnings     1,743,847     1,719,091  
Treasury stock at cost—27,717,994 shares at May 3, 2003, and 27,724,578 shares at February 1, 2003     (556,788 )   (556,812 )
   
 
 
    Total stockholders' equity     2,715,109     2,658,892  
   
 
 
    Total liabilities and stockholders' equity   $ 5,296,043   $ 5,721,388  
   
 
 

See notes to consolidated financial statements.

3



STAPLES, INC. AND SUBSIDIARIES
Consolidated Statements of Income
(Dollar Amounts in Thousands, Except Per Share Data)
(Unaudited)

 
  13 Weeks Ended
 
  May 3,
2003

  May 4,
2002

Sales   $ 3,146,757   $ 2,744,766
Cost of goods sold and occupancy costs     2,403,924     2,084,848
   
 
    Gross profit     742,833     659,918
Operating and other expenses:            
  Operating and selling     566,912     445,610
  Pre-opening     1,237     1,886
  General and administrative     126,506     107,084
  Amortization of intangibles     1,943    
  Interest and other expense, net     6,940     2,372
   
 
    Total operating and other expenses     703,538     556,952
   
 
    Income before income taxes     39,295     102,966
Income tax expense     14,539     9,097
   
 
    Net income   $ 24,756   $ 93,869
   
 
Basic earnings per common share   $ 0.05   $ 0.20
   
 
Diluted earnings per common share   $ 0.05   $ 0.20
   
 

See notes to consolidated financial statements.

4



STAPLES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Dollar Amounts in Thousands)
(Unaudited)

 
  13 Weeks Ended
 
 
  May 3,
2003

  May 4,
2002

 
Operating Activities:              
  Net income   $ 24,756   $ 93,869  
  Adjustments to reconcile net income to net cash provided by operating activities:              
    Depreciation and amortization     70,798     63,117  
    Tax benefit from worthless stock deduction         (29,000 )
    Deferred tax (benefit) expense     (37,461 )   7,349  
    Other     13,792     11,551  
    Change in assets and liabilities              
    Decrease (increase) in merchandise inventories     121,111     (11,472 )
    (Increase) decrease in receivables     (28,043 )   9,101  
    Decrease in prepaid expenses and other assets     9,254     5,942  
    Decrease in accounts payable, accrued expenses and other current liabilities     (196,339 )   (24,158 )
    Increase in other long-term obligations     1,798     3,428  
   
 
 
Net cash (used in) provided by operating activities     (20,334 )   129,727  
Investing Activities:              
  Acquisition of property and equipment     (43,876 )   (62,944 )
  Other         (276 )
   
 
 
Net cash used in investing activities     (43,876 )   (63,220 )
Financing Activities:              
  Proceeds from sale of capital stock     15,825     24,415  
  Proceeds from borrowings         1,425  
  Payments on borrowings     (326,427 )   (677 )
  Reissuance (purchase) of treasury stock     24     (484 )
   
 
 
Net cash (used in) provided by financing activities     (310,578 )   24,679  
Effect of exchange rate changes on cash     4,743     1,746  
Net (decrease) increase in cash and cash equivalents     (370,045 )   92,932  
Cash and cash equivalents at beginning of period     596,064     394,824  
   
 
 
Cash and cash equivalents at end of period   $ 226,019   $ 487,756  
   
 
 

See notes to consolidated financial statements.

5


STAPLES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements

Note A—Basis of Presentation

        The accompanying interim unaudited consolidated financial statements include the accounts of Staples, Inc. and subsidiaries ("Staples", "the Company", "we", "our" or "us"). These financial statements are for the period covering the thirteen weeks ending May 3, 2003 (also referred to as the "first quarter of 2003") and the period covering the thirteen weeks ending May 4, 2002 (also referred to as the "first quarter of 2002"). All intercompany accounts and transactions are eliminated in consolidation.

        These financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, such interim statements reflect all adjustments (consisting only of normal recurring accruals) considered necessary to present fairly the financial position and the results of operations and cash flows for the interim periods presented. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full fiscal year. These financial statements should be read in conjunction with the audited consolidated financial statements and footnotes included in the Company's Annual Report on Form 10-K for the year ended February 1, 2003.

        Certain previously reported amounts have been reclassified to conform with the current period presentation.

Note B—Change in Accounting Principle

        In November 2002, the Emerging Issues Task Force ("EITF") reached consensus on Issue No. 02-16, "Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor" ("Issue 02-16"). Issue 02-16 addresses the accounting for vendor consideration received by a customer and is effective for new arrangements, or modifications of existing arrangements, entered into after December 31, 2002. Under this consensus, there is a presumption that amounts received from vendors should be considered a reduction of inventory cost unless certain restrictive conditions are met. Under previous accounting guidance, we accounted for all non-performance based volume rebates as a reduction of inventory cost and all cooperative advertising and other performance based rebates as a reduction of marketing expense or cost of goods sold, as appropriate, in the period the expense was incurred. Beginning with contracts entered into in January 2003, we adopted a policy to treat all vendor consideration as a reduction of inventory cost rather than as an offset to the related expense because the administrative cost of tracking the actual related expenses, to determine whether we meet the restrictive conditions required by Issue 02-16, would exceed the benefit.

        To record the impact of including cooperative advertising and other performance based rebates in inventory as of May 3, 2003, we recorded an aggregate, non-cash adjustment of $98 million ($62 million net of taxes) as an increase to cost of goods sold and occupancy costs, or $0.13 per diluted share. This adjustment reflects all of our outstanding vendor contracts, as substantially all contracts were either entered into or amended in the first quarter of 2003. In addition, the impact of the new accounting method has resulted in the reclassification of $59 million of the Company's cooperative advertising rebates earned in the first quarter of 2003 from operating and selling expenses to cost of goods sold and occupancy costs. Prior periods have not been restated to reflect the impact of this reclassification. The aggregate adjustment recorded in the first quarter of 2003 was not materially different from what the aggregate effect would have been for all outstanding contracts as of February 2, 2003.

6



        The following summarizes the as reported and pro forma results for the first quarters of 2003 and 2002, assuming the retroactive application of this accounting principle as of February 2, 2002 (in thousands, except per share data):

 
  As Reported
13 Weeks Ended

  Pro Forma
13 Weeks Ended

 
  May 3, 2003
  May 4, 2002
  May 3, 2003
  May 4, 2002
Sales   $ 3,146,757   $ 2,744,766   $ 3,146,757   $ 2,744,766
Cost of goods sold and occupancy costs     2,403,924     2,084,848     2,305,949     2,028,383
   
 
 
 
    Gross profit     742,833     659,918     840,808     716,383
Operating and other expenses:                        
  Operating and selling     566,912     445,610     566,912     502,075
  Other expenses     136,626     111,342     136,626     111,342
   
 
 
 
    Total operating and other expenses     703,538     556,952     703,538     613,417
   
 
 
 
    Income before income taxes     39,295     102,966     137,270     102,966
Income tax expense     14,539     9,097     50,790     9,097
   
 
 
 
    Pro forma net income   $ 24,756   $ 93,869   $ 86,480   $ 93,869
   
 
 
 
Pro forma earnings per share:                        
    Basic   $ .05   $ .20   $ .18   $ .20
   
 
 
 
    Diluted   $ .05   $ .20   $ .18   $ .20
   
 
 
 

Note C—Employee Benefit Plans

        Staples accounts for its stock-based plans under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25") and provides pro forma disclosures of the compensation expense determined under the fair value provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123") as amended by Statement of Financial Accounting Standards No. 148 "Accounting for Stock-Based Compensation—Transition and Disclosure" ("SFAS No. 148"). The Company does not record compensation expense using the fair value provisions, because the alternative fair value accounting provided for under SFAS No. 123 requires the use of option valuation models that were not developed for use in valuing employee stock options.

        Pro forma information regarding net income and earnings per share is required by SFAS No. 148, which also requires that the information be determined as if Staples had accounted for its employee stock options granted subsequent to January 28, 1995 under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option-pricing model. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. For purposes of SFAS No. 148's disclosure requirements, the amended Employee Stock Purchase Plan is considered a compensatory plan. The expense was

7



calculated based on the fair value of the employees' purchase rights. Staples' pro forma information follows (in thousands, except for per share information):

 
  13 Weeks Ended
 
  May 3, 2003
  May 4, 2002
Net income as reported   $ 24,756   $ 93,869
Stock based compensation excluded from reported net income     7,472     8,371
   
 
Pro forma net income   $ 17,284   $ 85,498
   
 
Pro forma basic earnings per common share   $ 0.04   $ 0.18
Pro forma diluted earnings per common share   $ 0.04   $ 0.18

Note D—Comprehensive Income

        Comprehensive income includes net income and foreign currency translation adjustments, which are reported separately in stockholders' equity (in thousands):

 
  13 Weeks Ended
 
  May 3, 2003
  May 4, 2002
Net income   $ 24,756   $ 93,869
Other comprehensive income:            
  Foreign currency translation adjustments, net     2,774     10,966
   
 
Total comprehensive income   $ 27,530   $ 104,835
   
 

Note E—Store Closure Charge

        In January 2002, Staples committed to a plan to close 31 underperforming stores and recorded a charge of $50.1 million related to these closings. This charge includes an accrual for net lease obligations, asset write-offs, fees and other expenses and severance related to the store closures. All of the store closures were completed during the first quarter of fiscal 2002. Management believes that the remaining accruals will be entirely utilized by 2009, however, some payments may be made over the remaining lease terms. The following is a rollforward of the store closure charges utilized in the first quarter of 2003 (in thousands):

 
  Balance at
February 1,
2003

  Charges
Utilized

  Balance at
May 3,
2003

Lease terminations   $ 24,453   $ (4,061 ) $ 20,392
Legal and settlement costs     4,605     (273 )   4,332
   
 
 
    $ 29,058   $ (4,334 ) $ 24,724
   
 
 

Note F—Debt and Credit Agreements

        On March 28, 2003, Staples completed an exchange offer pursuant to which the holders of its 7.375% senior notes due October 2012 (the "Notes") exchanged privately placed notes for publicly tradable notes. Staples sold $325 million principal amount of the Notes in September 2002 in a private placement to qualified institutional investors pursuant to Rule 144A and Regulation S of the Securities Act of 1933, as amended, with proceeds to the Company of approximately $319.7 million. The Company used the net proceeds to finance a portion of the European mail order acquisition. Staples has entered into an interest rate swap to convert the Notes into variable rate obligations.

8



        On May 2, 2003, Staples repaid, in its entirety, its $325 million 364-Day Term Loan Agreement that it entered into on October 4, 2002.

Note G—Income Taxes

        In the fourth quarter of fiscal 2000, Staples recognized impairment losses related to the goodwill and fixed assets of Staples Communications. Due to the uncertainty concerning the ultimate deductibility of those losses, no corresponding tax benefit was recognized in fiscal year 2000. During fiscal 2001, Staples sold its Staples Communications business and applied for a pre-filing agreement with the Internal Revenue Service regarding deductibility of Staples' investment in, and advances to, Staples Communications. In the first quarter of fiscal 2002, the Internal Revenue Service agreed to allow as an ordinary deduction Staples' investment in, and advances to, Staples Communications. Accordingly, the provision for income taxes for the first quarter of 2002 includes a $29 million tax benefit attributable to the Staples Communications losses.

Note H—Computation of Earnings Per Common Share

        The computation of basic and diluted earnings per share for the thirteen weeks ended May 3, 2003 and May 4, 2002 is as follows (in thousands, except per share data):

 
  13 Weeks Ended
 
  May 3, 2003
  May 4, 2002
Numerator:            
  Net income   $ 24,756   $ 93,869
Denominator:            
  Weighted-average common shares outstanding     470,930     463,854
  Effect of dilutive securities:            
    Employee stock options and restricted stock     6,891     7,974
   
 
  Weighted-average common shares outstanding assuming dilution     477,821     471,828
Basic earnings per common share   $ 0.05   $ 0.20
   
 
Diluted earnings per common share   $ 0.05   $ 0.20
   
 

Note I—Segment Reporting

        Staples has three reportable segments: North American Retail, North American Delivery, and European Operations. Staples' North American Retail segment consists of the U.S and Canadian business units that operate office supply stores. The North American Delivery segment consists of the U.S. and Canadian business units that sell and deliver office products and services directly to customers, and is comprised of Staples Business Delivery (North American catalog and internet operations), Staples' contract stationer operations (Staples National Advantage and Staples Business Advantage), and Quill. The European Operations segment consists of operating units that operate office supply stores in the United Kingdom, Germany, the Netherlands and Portugal and that sell and deliver office products and services directly to customers throughout the United Kingdom, France, Belgium, Spain, Italy and Germany.

        Staples evaluates performance and allocates resources based on profit or loss from operations before interest and income taxes, the impact of changes in accounting principles and other charges ("business unit income/(loss)"). Intersegment sales and transfers are recorded at Staples' cost; therefore, there is no intercompany profit or loss recognized on these transactions.

9



        The following is a summary of sales and business unit income/(loss) by reportable segment for the first quarters of 2003 and 2002 and a reconciliation of business unit income/(loss) to consolidated income before income taxes (in thousands):

 
  13 Weeks Ended
 
 
  May 3, 2003
  May 4, 2002
 
Sales:              
North American Retail   $ 1,842,721   $ 1,726,893  
North American Delivery     919,520     811,991  
European Operations     384,516     205,882  
   
 
 
  Total sales   $ 3,146,757   $ 2,744,766  
   
 
 
Business Unit Income/(Loss):              
North American Retail   $ 75,703   $ 59,218  
North American Delivery     58,912     47,734  
European Operations     9,595     (1,614 )
   
 
 
  Total business unit income   $ 144,210   $ 105,338  
Interest and other expense, net     (6,940 )   (2,372 )
Impact of change in accounting principle     (97,975 )    
   
 
 
  Income before income taxes   $ 39,295   $ 102,966  
   
 
 

Note J—Guarantor Subsidiaries

        Under the terms of the Company's Notes and 7.125% senior notes, certain subsidiaries guarantee repayment of the debt. Both sets of senior notes are fully and unconditionally guaranteed on an unsecured, joint and several basis by Staples the Office Superstore, Inc. and certain of its subsidiaries, Staples the Office Superstore East, Inc. and Staples Contract & Commercial, Inc., all of which are wholly owned subsidiaries of Staples (the "Guarantor Subsidiaries"). The term of the guarantees is equivalent to the term of the related debt. The following condensed consolidating financial data is presented for the holders of the notes and illustrates the composition of Staples (the "Parent Company"), the Guarantor Subsidiaries, and the non-guarantor subsidiaries as of and for the thirteen weeks ended May 3, 2003 and May 4, 2002. The non-guarantor subsidiaries represent more than an inconsequential portion of the consolidated assets and revenues of Staples. Separate complete financial statements of the respective Guarantor Subsidiaries, however, would not provide additional information which would be useful in assessing the financial condition of the Guarantor Subsidiaries and thus are not presented.

        Investments in subsidiaries are accounted for by the Parent Company on the equity method for purposes of the supplemental consolidating presentation. Earnings of subsidiaries are, therefore, reflected in the Parent Company's investment accounts and earnings. The principal elimination entries eliminate the Parent Company's investment in subsidiaries and intercompany balances and transactions.

10




Condensed Consolidating Balance Sheet
As of May 3, 2003
(in thousands)

 
  Staples, Inc.
(Parent Co.)

  Guarantor
Subsidiaries

  Non-
Guarantor
Subsidiaries

  Eliminations
  Consolidated
Cash and cash equivalents   $ 71,208   $ 46,167   $ 108,644   $ — .   $ 226,019
Merchandise inventories     4,353     978,295     469,985         1,452,633
Other current assets     141,337     107,316     376,474         625,127
   
 
 
 
 
  Total current assets     216,898     1,131,778     955,103         2,303,779
Net property, equipment and other assets     203,006     900,870     680,564         1,784,440
Goodwill, net of amortization     138,609     45,777     1,023,438         1,207,824
Investment in affiliates and intercompany     2,636,404     2,100,312     2,309,741     (7,046,457 )  
   
 
 
 
 
  Total assets   $ 3,194,917   $ 4,178,737   $ 4,968,846   $ (7,046,457 ) $ 5,296,043
   
 
 
 
 
Total current liabilities   $ 63,059   $ 1,029,357   $ 582,891   $ — .   $ 1,675,307
Total long-term liabilities     185,527     597,736     122,364         905,627
Intercompany     1,722,972     317,995     1,629,910     (3,670,877 )  
Total stockholders' equity     1,223,359     2,233,649     2,633,681     (3,375,580 )   2,715,109
   
 
 
 
 
  Total liabilities and stockholders' equity   $ 3,194,917   $ 4,178,737   $ 4,968,846   $ (7,046,457 ) $ 5,296,043
   
 
 
 
 

11



Condensed Consolidating Balance Sheet
As of February 1, 2003
(in thousands)

 
  Staples, Inc.
(Parent Co.)

  Guarantor
Subsidiaries

  Non-
Guarantor
Subsidiaries

  Eliminations
  Consolidated
Cash and cash equivalents   $ 390,575   $ 57,519   $ 147,970   $ — .   $ 596,064
Merchandise inventories     483     1,082,069     472,653         1,555,205
Other current assets     109,058     87,289     369,860         566,207
   
 
 
 
 
  Total current assets     500,116     1,226,877     990,483         2,717,476
Net property, equipment and other assets     211,342     917,155     667,591         1,796,088
Goodwill, net of amortization     138,609     45,777     1,023,438         1,207,824
Investment in affiliates and intercompany     2,609,156     2,095,127     2,052,675     (6,756,958 )  
   
 
 
 
 
  Total assets   $ 3,459,223   $ 4,284,936   $ 4,734,187   $ (6,756,958 ) $ 5,721,388
   
 
 
 
 
Total current liabilities   $ 416,734   $ 1,091,799   $ 666,793   $ — .   $ 2,175,326
Total long-term liabilities     243,174     597,795     46,201         887,170
Intercompany     1,687,544     323,176     2,498,819     (4,509,539 )  
Total stockholders' equity     1,111,771     2,272,166     1,522,374     (2,247,419 )   2,658,892
   
 
 
 
 
  Total liabilities and stockholders' equity   $ 3,459,223   $ 4,284,936   $ 4,734,187   $ (6,756,958 ) $ 5,721,388
   
 
 
 
 


Condensed Consolidating Statement of Income
For the 13 weeks ended May 3, 2003
(in thousands)

 
  Staples, Inc.
(Parent Co.)

  Guarantor
Subsidiaries

  Non-Guarantor
Subsidiaries

  Consolidated
Sales   $   $ 2,131,840   $ 1,014,917   $ 3,146,757
Cost of goods sold and occupancy costs     367     1,663,524     740,033     2,403,924
   
 
 
 
Gross profit     (367 )   468,316     274,884     742,833
Operating and other expenses     14,184     462,184     227,170     703,538
   
 
 
 
Income/(loss) before income taxes     (14,551 )   6,132     47,714     39,295
Income tax expense         4,753     9,786     14,539
   
 
 
 
Net income (loss)   $ (14,551 ) $ 1,379   $ 37,928   $ 24,756
   
 
 
 

12



Condensed Consolidating Statement of Income
For the 13 weeks ended May 4, 2002
(in thousands)

 
  Staples, Inc.
(Parent Co.)

  Guarantor
Subsidiaries

  Non-Guarantor
Subsidiaries

  Consolidated
Sales   $   $ 2,000,888   $ 743,878   $ 2,744,766
Cost of goods sold and occupancy costs     260     1,525,569     559,019     2,084,848
   
 
 
 
Gross profit     (260 )   475,319     184,859     659,918
Operating and other expenses     2,807     413,406     140,739     556,952
   
 
 
 
Income/(loss) before income taxes     (3,067 )   61,913     44,120     102,966
Income tax expense (benefit)     (29,000 )   22,348     15,749     9,097
   
 
 
 
Net income   $ 25,933   $ 39,565   $ 28,371   $ 93,869
   
 
 
 


Condensed Consolidating Statement of Cash Flows
For the 13 weeks ended May 3, 2003
(in thousands)

 
  Staples, Inc.
(Parent Co.)

  Guarantor
Subsidiaries

  Non-Guarantor
Subsidiaries

  Consolidated
 
Net cash (used in) provided by operating activities   $ (6,975 ) $ 17,654   $ (31,013 ) $ (20,334 )
Investing Activities:                          
  Acquisition of property and equipment     (2,180 )   (29,030 )   (12,666 )   (43,876 )
  Other                  
   
 
 
 
 
Cash used in investing activities     (2,180 )   (29,030 )   (12,666 )   (43,876 )
Financing Activities:                          
  Payments on borrowings     (326,037 )       (390 )   (326,427 )
  Other     15,825     24         15,849  
   
 
 
 
 
Cash (used in) provided by financing activities     (310,212 )   24     (390 )   (310,578 )
Effect of exchange rate changes on cash             4,743     4,743  
   
 
 
 
 
Net decrease in cash     (319,367 )   (11,352 )   (39,326 )   (370,045 )
Cash and cash equivalents at beginning of period     390,575     57,519     147,970     596,064  
   
 
 
 
 
Cash and cash equivalents at end of period   $ 71,208   $ 46,167   $ 108,644   $ 226,019  
   
 
 
 
 

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Condensed Consolidating Statement of Cash Flows
For the 13 weeks ended May 4, 2002
(in thousands)

 
  Staples, Inc.
(Parent Co.)

  Guarantor
Subsidiaries

  Non-Guarantor
Subsidiaries

  Consolidated
 
Net cash provided by (used in) operating activities   $ 112,171   $ 26,504   $ (8,948 ) $ 129,727  
Investing Activities:                          
  Acquisition of property and equipment     (4,335 )   (38,889 )   (19,720 )   (62,944 )
  Other             (276 )   (276 )
   
 
 
 
 
Cash used in investing activities     (4,335 )   (38,889 )   (19,996 )   (63,220 )
Financing Activities:                          
  Payments on borrowings     (677 )           (677 )
  Other     24,415     (484 )   1,425     25,356  
   
 
 
 
 
Cash provided by (used in) financing activities     23,738     (484 )   1,425     24,679  
Effect of exchange rate changes on cash             1,746     1,746  
   
 
 
 
 
Net increase (decrease) in cash     131,574     (12,869 )   (25,773 )   92,932  
Cash and cash equivalents at beginning of period     226,342     53,809     114,673     394,824  
   
 
 
 
 
Cash and cash equivalents at end of period   $ 357,916   $ 40,940   $ 88,900   $ 487,756  
   
 
 
 
 

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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

        Our business is comprised of three segments: North American Retail, North American Delivery and European Operations. The North American Retail segment consists of the U.S. and Canadian business units that operate office supply stores. The North American Delivery segment consists of the U.S. and Canadian business units that sell and deliver office products and services directly to customers, and is comprised of Staples Business Delivery (North American catalog and internet operations), our contract stationer operations (Staples National Advantage and Staples Business Advantage) and Quill. The European Operations segment consists of operating units that operate office supply stores in the United Kingdom, Germany, the Netherlands and Portugal and that sell and deliver office products and services directly to customers throughout the United Kingdom, Germany, France, Belgium, Spain and Italy.

        In November 2002, the Emerging Issues Task Force ("EITF") reached consensus on Issue No. 02-16, "Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor" ("Issue 02-16"). Issue 02-16 addresses the accounting for vendor consideration received by a customer and is effective for new arrangements, or modifications of existing arrangements, entered into after December 31, 2002. Under this consensus, there is a presumption that amounts received from vendors should be considered a reduction of inventory cost unless certain restrictive conditions are met. Under previous accounting guidance, we accounted for all non-performance based volume rebates as a reduction of inventory cost and all cooperative advertising and other performance based rebates as a reduction of marketing expense or cost of goods sold, as appropriate, in the period the expense was incurred. Beginning with contracts entered into in January 2003, we adopted a policy to treat all vendor consideration as a reduction of inventory cost rather than as an offset to the related expense because the administrative cost of tracking the actual related expenses, to determine whether we meet the restrictive conditions required by Issue 02-16, would exceed the benefit. To record the impact of including cooperative advertising and other performance based rebates in inventory as of May 3, 2003, we recorded an aggregate, non-cash adjustment of $98 million ($62 million net of taxes) as an increase to cost of goods sold and occupancy costs, or $0.13 per diluted share. This adjustment reflects all of our outstanding vendor contracts, as substantially all contracts were either entered into or amended in the first quarter of 2003. In addition, the impact of the new accounting method has resulted in the reclassification of $59 million of the Company's cooperative advertising rebates earned in the first quarter of 2003 from operating and selling expenses to cost of goods sold and occupancy costs. Prior periods have not been restated to reflect the impact of this reclassification. The aggregate adjustment recorded in the first quarter of 2003 was not materially different from what the aggregate effect would have been for all outstanding contracts as of February 2, 2003.

        We acquired two businesses during fiscal year 2002. On October 18, 2002, we acquired multiple European mail order businesses. The acquired businesses sell and deliver office products and services under a variety of different brand names, including JPG and Bernard in France and Belgium, Kalamazoo in Spain, Neat Ideas in the United Kingdom and MondOffice in Italy ("European mail order acquisition"). The European mail order acquisition is reported as part of European Operations for segment reporting. On July 17, 2002, we acquired Medical Arts Press, Inc. ("MAP"), a leading direct marketer of specialized printed office products and practice-related supplies to medical offices. MAP is an operating division of Quill and is included in North American Delivery for segment reporting.

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Forward Looking Statements

        This Quarterly Report on Form 10-Q and, in particular, this management discussion and analysis contain or incorporate a number of forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements are based on current expectations, estimates, forecasts and projections about the industry and markets in which we operate and management's beliefs and assumptions. Any statements contained herein (including without limitation statements to the effect that Staples or its management "believes", "expects", "anticipates", "plans" and similar expressions) that are not statements of historical fact should be considered forward-looking statements and should be read in conjunction with our consolidated financial statements and notes to consolidated financial statements included in this report. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. There are a number of important factors that could cause our actual results to differ materially from those indicated by such forward-looking statements. These factors include, without limitation, those set forth below under the heading "Cautionary Statements." We do not intend to update publicly any forward-looking statements whether as a result of new information, future events or otherwise.

Results of Operations

        We have discussed below our operating results at the consolidated level, followed by an overview of our segment performance. Our discussion includes both our results presented on the basis required by accounting principles generally accepted in the United States ("GAAP") and a pro forma basis reflecting the retroactive application of EITF Issue 02-16 (see Note B to Consolidated Financial Statements) as of February 2, 2002. Management uses net income adjusted for accounting changes and non-recurring items, among other standards, to measure operating performance. We have incorporated this information into the below discussion because we believe it will assist you in understanding our results of operations on a comparative basis. This adjusted information supplements, and is not intended to represent a measure of performance in accordance with, disclosures required by GAAP.

Consolidated Performance:

        Net income for the first quarter of 2003 was $24.8 million or $0.05 per diluted share compared to $93.9 million or $0.20 per diluted share for the first quarter of 2002. Our results for the first quarter of 2003 include a $62 million adjustment, net of taxes, related to the change in accounting for vendor consideration required by EITF Issue 02-16. Our results for the first quarter of 2002 included the impact of a $29 million non-recurring tax benefit (see Note G to the consolidated financial statements). On a pro forma basis to reflect the retroactive application of Issue 02-16, net income for the first quarter of 2003 was $86.5 million or $0.18 per diluted share. Excluding the tax benefit, net income for the first quarter of 2002 was $64.9 million or $0.14 per diluted share.

        On a pro forma basis for the first quarter of 2003 to reflect the retroactive application of Issue 02-16 and excluding the tax benefit in the first quarter of 2002, net income increased 33% for the first quarter of 2003. This increase reflects our continued focus on customer service, expense control and improved execution. These results were achieved despite the challenging retail environment caused by the war and the economy.

        Sales:    Sales for the first quarter of 2003 were $3.15 billion, an increase of 14.6% from the first quarter of 2002. Excluding the impact of the European mail order and MAP acquisitions, sales increased 7.9% for the first quarter of 2003. Comparable sales for our North American retail locations increased 2% and comparable sales for our European retail operations decreased 1% for the first quarter of 2003. We had 1,494 open stores as of May 3, 2003 compared to 1,427 stores as of May 4,

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2002 and 1,488 stores as of February 1, 2003. This includes 13 stores opened and 7 stores closed during the first quarter of 2003.

        Gross Profit:    Gross profit as a percentage of sales was 23.6% for the first quarter of 2003 compared to 24.0% for the first quarter of 2002. On a pro forma basis to reflect the retroactive application of Issue 02-16, gross profit increased to 26.7% for the first quarter of 2003 from 26.1% for the first quarter of 2002. This increase in pro forma gross profit is primarily due to the impact of the European mail order and MAP businesses, which have significantly higher margins, as a percentage of sales, than our other businesses. The increase also reflects our improved product mix directed at more profitable business customers, our continued focus on higher margin private label products, and better buying as a result of our procurement initiatives.

        Operating and Selling Expenses:    Operating and selling expenses, which consist of payroll, advertising and other operating expenses, were 18.0% of sales for the first quarter of 2003 compared to 16.2% in the first quarter of 2002. On a pro forma basis to reflect the reclassification of cooperative advertising rebates under Issue 02-16, operating expenses were 18.0% of sales for the first quarter of 2003 and 18.3% of sales for the first quarter of 2002. The decrease in pro forma operating expenses reflects our focus on expense control across all business units. This decrease was partially offset by the impact of the acquired businesses which have higher marketing costs as a percentage of sales than our other businesses.

        Pre-opening Expenses:    Pre-opening expenses relating to new store openings, consisting primarily of salaries, supplies, marketing and distribution costs, are expensed as incurred and therefore fluctuate from period to period depending on the timing and number of new store openings. Pre-opening expenses decreased to $1.2 million in the first quarter of 2003 from $1.9 million in the first quarter of 2002. This decrease is due to a decrease in the number of stores opened, as we opened 13 stores in the first quarter of 2003 compared to 22 in the first quarter of 2002.

        General and Administrative Expenses:    General and administrative expenses increased as a percentage of sales to 4.0% for the first quarter of 2003 compared to 3.9% for the first quarter of 2002.    This increase reflects the investment in our supply chain and procurement initiatives as well as the impact of our acquired businesses which have higher general and administrative costs as a percentage of sales than our other businesses.

        Amortization of Intangibles:    Amortization of intangibles was $1.9 million for the first quarter of 2003, reflecting the amortization of customer-related intangible assets and noncompetition agreements associated with our European mail order and MAP acquisitions. Prior to the second quarter of 2002, we had no amortizable intangible assets.

        Interest and Other Expense, Net:    Net interest and other expense totaled $6.9 million for the first quarter of 2003 compared to $2.4 million for the first quarter of 2002. Interest and other expense relate primarily to existing borrowings. The increase in interest expense reflects an increase in borrowings during the second half of fiscal 2002 and through the first quarter of 2003 primarily to fund our two acquisitions in 2002, partially offset by a decrease in interest rates.

        Income Taxes:    Our effective tax rate was 37.0% for the first quarter of 2003 compared to 8.8% for the first quarter of 2002. In the fourth quarter of fiscal 2000, we recognized impairment losses related to the goodwill and fixed assets of Staples Communications. Due to the uncertainty concerning the ultimate deductibility of those losses, no corresponding tax benefit was recognized in fiscal year 2000. During fiscal 2001, we sold our Staples Communications business and applied for a pre-filing agreement with the Internal Revenue Service regarding deductibility of our investment in, and advances to, Staples Communications. In the first quarter of fiscal 2002, the Internal Revenue Service agreed to allow, as an ordinary deduction, our investment in, and advances to, Staples Communications.

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Accordingly, the provision for income taxes for the first quarter of 2002 includes a $29 million tax benefit attributable to the Staples Communications losses. Excluding this tax benefit, our effective tax rate for the first quarter of 2002 was 37.0%.

Segment Performance:

        The following provides a summary of our sales and business unit income/(loss) by reportable segment (see reconciliation of business unit income/(loss) to income before income taxes in Note I to our consolidated financial statements):

 
  (Amounts in thousands)
13 Weeks Ended

   
   
 
 
  May 3, 2003
Increase From
Prior Year

  May 4, 2002
Increase From
Prior Year

 
 
  May 3, 2003
  May 4, 2002
 
Sales:                      
North American Retail   $ 1,842,721   $ 1,726,893   6.7 % 1.2 %
North American Delivery     919,520     811,991   13.2 % 9.2 %
European Operations     384,516     205,882   86.8 % 7.2 %
   
 
 
 
 
  Total sales   $ 3,146,757   $ 2,744,766   14.6 % 2.9 %
   
 
 
 
 
 
  (Amounts in thousands)
13 Weeks Ended

   
   
 
 
  May 3, 2003
% of Sales

  May 4, 2002
% of Sales

 
 
  May 3, 2003
  May 4, 2002
 
Business Unit Income/(Loss):                      
North American Retail   $ 75,703   $ 59,218   4.1 % 3.4 %
North American Delivery     58,912     47,734   6.4 % 5.9 %
European Operations     9,595     (1,614 ) 2.5 % (0.8 )%
   
 
 
 
 
  Total business unit income   $ 144,210   $ 105,338   4.6 % 3.8 %
   
 
 
 
 

        North American Retail:    Sales for North American Retail increased 6.7% for the first quarter of 2003. This growth was primarily due to non-comparable store sales for stores opened in the prior year. This increase also reflects an increase in comparable store sales of 2%, the positive impact of Canadian exchange rates to the U.S. dollar as well as the net addition of six stores in the first quarter of 2003. At May 3, 2003, the North American store base included 1,306 open stores compared to 1,247 open stores as of May 4, 2002 and 1,300 stores at February 1, 2003. Our sales growth reflects positive performance in furniture, improving trends in technology and related products and strong results in our copy center businesses. Business unit income as a percentage of sales increased to 4.1% for the first quarter of 2003 from 3.4% for the first quarter of 2002. The improvement in business unit income reflects our improved product mix directed at more profitable business customers, our continued focus on higher margin private label products, better buying as a result of our procurement initiatives and our focus on expense control.

        North American Delivery:    Sales for North American Delivery increased 13.2% for the first quarter of 2003. Excluding the impact of our MAP acquisition, sales grew 7.2% for the first quarter of 2003. This sales growth reflects the positive results of marketing between our catalog, websites and retail stores; the continued success of our customer acquisition efforts in our contract and Quill businesses; and improved service levels across all of our delivery businesses. Business unit income increased to $58.9 million for the first quarter of 2003 from $47.7 million for the first quarter of 2002 driven in large part by the acquisition of MAP. The results of our existing businesses remained in line with the prior year and reflect our investments in service improvement and customer acquisition.

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        European Operations:    Sales for European Operations increased 86.8% for the first quarter of 2003. Excluding the impact of the European mail order acquisition, sales grew 20.3% for the first quarter of 2003. The sales growth for the first quarter of 2003 primarily reflects non-comparable store sales for stores opened in the prior year as well as the positive impact of European exchange rates to the U.S. dollar. This increase was slightly offset by a decrease in comparable store sales of 1% reflecting weaknesses in non-consumable categories, including furniture and computers. Business unit income improved to $9.6 million for the first quarter of 2003 from a loss of $1.6 million for the first quarter of 2002. This improvement primarily reflects the acquisition of the European mail order businesses. In addition, our European retail business unit income continued to improve over the prior year.

Critical Accounting Policies

        Our financial statements are based on the application of significant accounting policies, many of which require management to make significant estimates and assumptions. We believe that the following are some of the more critical judgment areas in the application of our accounting policies that currently affect our financial condition and results of operations.

        Inventory:    We record inventory at the lower of weighted-average cost or market value. We reserve for obsolescence based on the difference between the weighted-average cost of the inventory and the estimated market value based on assumptions of future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional reserves may be required.

        Purchase and Advertising Rebates:    We earn rebates from our vendors which are based on various quantitative contract terms that can be complex and subject to interpretation. Amounts expected to be received from vendors relating to the purchase of merchandise inventories or the reimbursement of costs incurred are recognized as a reduction of cost of goods sold as the merchandise is sold. Several controls are in place, including direct confirmation with vendors, which we believe allow us to ensure that these amounts are recorded in accordance with the terms of the contracts. Should vendors reach different judgments regarding the terms of these contracts, they may seek to recover amounts from us.

        Impairment of Long-Lived Assets:    We review our long-lived assets for impairment when indicators of impairment are present and the undiscounted cash flow estimated to be generated by those assets are less than the assets' carrying amount. Our policy is to evaluate long-lived assets for impairment at a store level for retail operations and an operating unit level for our other operations. Our retail stores typically take three years to achieve their full profit potential. If actual market conditions are less favorable than management's projections, future write-offs may be necessary.

        Impairment of Goodwill and Indefinite Lived Intangible Assets:    As a result of our adoption of Statement of Financial Accounting Standards No. 142 "Goodwill and Other Intangible Assets" ("SFAS No. 142"), we now annually review goodwill and other intangible assets that have indefinite lives for impairment and when events or changes in circumstances indicate the carrying value of these assets might exceed their current fair values. We determine fair value using discounted cash flow analysis, which requires us to make certain assumptions and estimates regarding industry economic factors and future profitability of acquired businesses. It is our policy to conduct impairment testing based on our most current business plans, which reflect changes we anticipate in the economy and the industry. If actual results are not consistent with our assumptions and judgments, we could be exposed to a material impairment charge.

        Deferred Taxes:    We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. We have considered estimated future taxable income and ongoing tax planning strategies in assessing the amount needed for the valuation allowance. If actual

19



results differ unfavorably from those estimates used, we may not be able to realize all or part of our net deferred tax assets and additional valuation allowances may be required.

Liquidity and Capital Resources

        We traditionally use a combination of cash generated from operations and debt or equity offerings to fund our expansion and acquisition activities. We have also utilized our revolving credit facility to cover seasonal fluctuations in cash flows and to support our various growth initiatives.

        Cash used in operations was $20.3 million for the first quarter of 2003 compared to cash provided by operations of $129.7 million for the first quarter of 2002. This change is primarily due to a decrease in our current liabilities.

        Cash used in investing activities decreased to $43.9 million for the first quarter of 2003 compared to $63.2 million for the first quarter of 2002. This decrease primarily reflects the reduction in the number of stores opened, from 22 in the first quarter of 2002 to 13 for the first quarter of 2003, as well as the reduction of store remodels from 42 in the first quarter of 2002 to 7 in the first quarter of 2003.

        Cash used in financing activities was $310.6 million for the first quarter of 2003 compared to cash provided by financing activities of $24.7 million for the first quarter of 2002. This change is primarily due to the early repayment of our $325 million 364-Day Term Loan Agreement.

        We had $1.01 billion in total cash and available funds through credit agreements at May 3, 2003, which consisted of $691.6 million of available credit, $226.0 million of cash and cash equivalents and $92.6 million available under a receivables securitization agreement. The maximum amount available under the accounts receivable securitization agreement is $140 million, subject to further restriction depending on the amount and characteristics of the accounts receivable outstanding. At May 3, 2003, the maximum amount available under this agreement was $117.6 million, of which $25 million was utilized. We also issue letters of credit under our revolving credit facility in the ordinary course of business to satisfy certain vendor contracts. At May 3, 2003, we had $54.9 million of open letters of credit. A summary, as of May 3, 2003, of balances available under credit agreements and debt outstanding is presented below (amounts in thousands):

 
  Available
Credit

  Debt
Outstanding

Revolving Credit Facility effective through June 2005   $ 545,129   $
Senior Notes due October 2012         325,000
Euro Notes due November 2004         168,600
Senior Notes due August 2007         200,000
Uncommitted lines of credit     70,000    
Other lines of credit     76,454    
Capital leases and other notes payable         14,046
   
 
  Total Debt Obligations   $ 691,583   $ 707,646

        On March 28, 2003, we completed an exchange offer pursuant to which the holders of our 7.375% Senior Notes due October 2012 (the "Notes") exchanged privately placed notes for publicly tradable notes. We sold $325 million principal amount of the Notes in September 2002 in a private placement to qualified institutional investors pursuant to Rule 144A and Regulation S of the Securities Act of 1933, as amended, which resulted in proceeds to us of approximately $319.7 million. We used the net proceeds to finance a portion of the European mail order acquisition. We have entered into an interest rate swap to convert the Notes into variable rate obligations.

        On May 2, 2003, we repaid, in its entirety the $325 million 364-Day Term Loan Agreement that we entered into on October 4, 2002.

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        We expect to open up to 97 new stores during the last three quarters of 2003. We estimate that our cash requirements, including pre-opening expenses, net inventory, leasehold improvements and fixtures, will be approximately $1.3 million for each new store. We also plan to continue to make investments in information systems and distribution centers to improve operational efficiencies and customer service. We currently plan to spend approximately $280 million on capital expenditures during the last three quarters of 2003. We may also expend additional funds to acquire businesses or purchase lease rights from tenants occupying retail space that is suitable for a Staples store.

        We expect that our cash generated from operations, together with our current cash and funds available under our main revolving credit facility, will be sufficient to fund our planned store openings and other recurring operating cash needs for at least the next twelve months. We continually evaluate financing possibilities, including an equity offering, intended to maintain our current debt ratings and outlook. We may seek to raise additional funds through any one or a combination of public or private debt or equity-related offerings, the timing and amount of which will depend upon market conditions, or through additional commercial bank debt arrangements. There can be no assurance that we will be able to sell shares of our capital stock or debt securities on favorable terms, if at all.

Inflation and Seasonality

        While neither inflation nor deflation has had, and we do not expect either to have, a material impact upon our operating results, there can be no assurance that our business will not be affected by inflation or deflation in the future. We believe that our business is somewhat seasonal, with sales and profitability slightly lower during the first and second quarters of our fiscal year.

Cautionary Statements

        This quarterly report on Form 10-Q includes or incorporates forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. You can identify these forward-looking statements by the use of the words "believes", "anticipates", "plans", "expects", "may", "will", "would", "intends", "estimates" and other similar expressions, whether in the negative or affirmative. We cannot guarantee that we actually will achieve the plans, intentions or expectations disclosed in the forward-looking statements made. We have included important factors in the cautionary statements below that we believe could cause actual results to differ materially from the forward-looking statements contained herein. The forward-looking statements do not reflect the potential impact of any future acquisitions, mergers or dispositions. We do not assume any obligation to update any forward-looking statements contained herein.

        Our market is highly competitive and we may not continue to compete successfully.    We compete in a highly competitive marketplace with a variety of retailers, dealers and distributors. In most of our geographic markets, we compete with other high-volume office supply chains such as Office Depot and OfficeMax that are similar in concept to us in terms of pricing strategy and product selections, as well as mass merchants such as Wal-Mart, warehouse clubs, computer and electronic superstores such as Best Buy, and other discount retailers. In addition, both our retail stores and delivery operations compete with numerous mail order firms, contract stationer businesses, electronic commerce distributors and direct manufacturers. Many of our competitors have increased their presence in our markets in recent years. Some of our current and potential competitors in the office products industry are larger than we are and have substantially greater financial resources. It is possible that increased competition or improved performance by our competitors may reduce our market share, may reduce our profit margin, and may adversely affect our business and financial performance in other ways.

        We may be unable to continue to open new stores successfully.    An important part of our business plan is to increase our number of stores. We opened 13 stores during the first quarter of 2003 and currently plan to open up to 97 new stores in the last three quarters of 2003. For our growth strategy

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to be successful, we must identify and lease favorable store sites, hire and train employees and adapt management and operational systems to meet the needs of our expanded operations. These tasks may be difficult to accomplish successfully. If we are unable to open new stores as quickly as planned, our future sales and profits could be materially adversely affected. Even if we succeed in opening new stores, these new stores may not achieve the same sales or profit levels as our existing stores. Also, our expansion strategy includes opening new stores in markets where we already have a presence so we can take advantage of economies of scale in marketing, distribution and supervision costs. However, these new stores may result in the loss of sales in existing stores in nearby areas.

        Our Dover format store may not be successful.    In 2001, we experimented with a new store format called the Dover format, which was designed to appeal to customer shopping preferences, open up the interior of the store and give the customer a better view of the products we offer. At May 3, 2003, we had 278 stores in the Dover format and plan to remodel up to 39 additional stores and open our new stores in the United States in this format for the remainder of fiscal 2003. The reformatted stores and new stores based on the Dover format have only a limited operating history, and we cannot guarantee that the Dover stores will be successful or that they will generate sufficient additional revenue to justify the investment.

        Our growth may continue to strain operations, which could adversely affect our business and financial results.    Despite the recent decline in the rate of our growth and our planned slower store growth strategy, our business, including sales, number of stores, investment in Staples.com and number of employees, has grown dramatically over the past several years. In addition, we recently completed the acquisition of Medical Arts Press, Inc. and the European mail order businesses and may make additional acquisitions in the future. This growth has placed significant demands on management and operational systems. If we are not successful in upgrading our operational and financial systems, expanding our management team and increasing and effectively managing our employee base, this growth is likely to result in operational inefficiencies and ineffective management of the business and employees, which will in turn adversely affect our business and financial performance.

        Our quarterly operating results are subject to significant fluctuation.    Our operating results have fluctuated from quarter to quarter in the past, and we expect that they will continue to do so in the future. Our earnings may not continue to grow at rates similar to the growth rates achieved in recent years and may fall short of either a prior fiscal period or investors' expectations. Factors that could cause these quarterly fluctuations include the following: the extent to which sales in new stores result in the loss of sales in existing stores; the mix of products sold; pricing actions of competitors; the level of advertising and promotional expenses; and seasonality, primarily because the sales and profitability of our stores are typically slightly lower in the first and second quarters of the fiscal year than in other quarters. Most of our operating expenses, such as rent expense, advertising expense and employee salaries, do not vary directly with the amount of sales and are difficult to adjust in the short term. As a result, if sales in a particular quarter are below expectations for that quarter, we may not proportionately reduce operating expenses for that quarter, and therefore this sales shortfall would have a disproportionate negative effect on our net income for the quarter.

        Our operating results may be impacted by changes in the economy and international conflict.    Our operating results are directly impacted by the health of the North American and European economies. Current economic conditions and the state of the conflict in Iraq may adversely affect our business and our results of operations.

        Our stock price may fluctuate based on market expectations.    The public trading of our stock is based in large part on market expectations that our business will continue to grow and that we will achieve certain levels of net income. If the securities analysts that regularly follow our stock lower their ratings or lower their projections for future growth and financial performance, the market price of our stock is likely to drop significantly. In addition, if our quarterly financial performance does not meet

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the expectations of securities analysts, our stock price would likely decline. The decrease in the stock price may be disproportionate to the shortfall in our financial performance.

        Our expanding international operations expose us to the unique risks inherent in foreign operations.    In addition to our recently expanding operations in Europe, we have a significant presence in Canada through The Business Depot Ltd. We may also seek to expand further into other international markets in the future. Our foreign operations encounter risks similar to those faced by our U.S. operations, as well as risks inherent in foreign operations, such as local customs and competitive conditions and foreign currency fluctuations. Further, our recent European mail order acquisition has increased our exposure to these foreign operating risks, which could have an adverse impact on our European income and worldwide profitability.

        Our debt level could impact our ability to obtain future financing and continue our growth strategy.    Our consolidated outstanding debt at May 3, 2003 was $746.2 million. Our consolidated debt may have the effect generally of restricting our flexibility in responding to changing market conditions and could make us more vulnerable in the event of a downturn in our business. In addition, our level of indebtedness may have other important consequences, including: restricting our growth; making it more difficult for us to satisfy our obligations; limiting our ability to borrow additional amounts for working capital, capital expenditures, debt service requirements, future acquisitions or other corporate purposes; and limiting our ability to use operating cash flow in other areas of our business. In such a situation, additional funds may not be available on satisfactory terms when needed, or at all, whether in the next twelve to eighteen months or thereafter.

        Review by the SEC of certain accounting practices of major New England retailers.    As a part of a general review by the SEC of the accounting practices of major New England retailers relating to consideration received directly or indirectly from vendors (including rebates, allowances, discounts, coupons, bonuses, sales incentives, slotting fees, cooperative advertising, buydowns and free products or services), we responded to an informal inquiry from the SEC requesting certain information relating to our accounting for vendor consideration. We cannot predict the outcome of this informal inquiry.

        California wage and hour class action lawsuit.    Various class action lawsuits have been brought against us for alleged violations of what is known as California's "wage and hour" law. The plaintiffs have alleged that we improperly classified both general and assistant store managers as exempt under the California wage and hour law, making such managers ineligible for overtime wages. The plaintiffs are seeking to require us to pay overtime wages to the putative class for the period from as early as 1995 to the present. This litigation is in the beginning stages of discovery. While it is too early in the litigation for us to predict the outcome of the litigation, we believe the litigation will not have a material adverse effect on us.

Item 3. Quantitative and Qualitative Disclosures about Market Risks

        At May 3, 2003, there had not been a material change in any of the market risk information disclosed by us in our Annual Report on Form 10-K for the year ended February 1, 2003. More detailed information concerning market risk can be found under the sub-caption "Quantitative and Qualitative Disclosures about Market Risks" of the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" on page B-12 of our Annual Report on Form 10-K for the year ended February 1, 2003.

Item 4. Controls and Procedures

(a)
Evaluation of Disclosure Controls and Procedures

23


(b)
Changes in Internal Controls

24


STAPLES, INC. AND SUBSIDIARIES

PART II—OTHER INFORMATION

Item 1—Not Applicable

Item 2—Changes in Securities and Use of Proceeds

        On March 13, 2003, we issued to Senator Mitchell, one of our directors, 7,082 shares of our common stock having a value of approximately $125,000, in lieu of paying him (i) his annual fee of $75,000 for consulting services he provided to us during fiscal year 2003 pursuant to a consulting agreement between Senator Mitchell and us and (ii) his $50,000 annual outside director fee for services he provided to us as a member of our Board of Directors during fiscal year 2003. We issued these shares in reliance upon the exemption from registration under Section 4(2) of the Securities Act of 1933.

Item 3—Not Applicable

Item 4—Not Applicable

Item 5—Not Applicable

Item 6—Exhibits and Reports on Form 8-K

        The exhibits listed on the Exhibit Index immediately preceding such exhibits are filed as part of this Quarterly Report on Form 10-Q.

        No reports on Form 8-K were filed in the quarter ended May 3, 2003.

25




SIGNATURE

        Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

    STAPLES, INC.

Date: May 20, 2003

 

By:

 

/s/  
JOHN J. MAHONEY      
John J. Mahoney
Executive Vice President,
Chief Administrative Officer
and Chief Financial Officer
(Principal Financial Officer)

26



CERTIFICATION

I, Ronald L. Sargent, certify that:

        1.     I have reviewed this quarterly report on Form 10-Q of Staples, Inc.;

        2.     Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

        3.     Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

        4.     The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

        5.     The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or person's performing the equivalent function):

        6.     The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: May 20, 2003    

/s/  
RONALD L. SARGENT      
Ronald L. Sargent
President and Chief Executive Officer
(Principal Executive Officer)

 

 

27



CERTIFICATION

I, John J. Mahoney, certify that:

        1.     I have reviewed this quarterly report on Form 10-Q of Staples, Inc.;

        2.     Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

        3.     Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

        4.     The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

        5.     The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing equivalent function):

        6.     The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: May 20, 2003    

/s/  
JOHN J. MAHONEY      
John J. Mahoney
Executive Vice President,
Chief Administrative Officer and
Chief Financial Officer
(Principal Financial Officer)

 

 

28



EXHIBIT INDEX

Exhibit
Number

  Description
99.1   Chief Executive Officer—Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

99.2

 

Chief Financial Officer—Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002



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TABLE OF CONTENTS
Consolidated Balance Sheets
Consolidated Statements of Income
STAPLES, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows (Dollar Amounts in Thousands) (Unaudited)
Notes to Consolidated Financial Statements
Condensed Consolidating Balance Sheet As of May 3, 2003 (in thousands)
Condensed Consolidating Balance Sheet As of February 1, 2003 (in thousands)
Condensed Consolidating Statement of Income For the 13 weeks ended May 3, 2003 (in thousands)
Condensed Consolidating Statement of Income For the 13 weeks ended May 4, 2002 (in thousands)
Condensed Consolidating Statement of Cash Flows For the 13 weeks ended May 3, 2003 (in thousands)
Condensed Consolidating Statement of Cash Flows For the 13 weeks ended May 4, 2002 (in thousands)
Management's Discussion and Analysis of Financial Condition and Results of Operations
PART II—OTHER INFORMATION
SIGNATURE
CERTIFICATION
CERTIFICATION
EXHIBIT INDEX