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:  November 1, 2003

 

Commission File Number:  0-17586

 

STAPLES, INC.

(Exact name of registrant as specified in its charter)

 

 

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 495,146,743 shares of Staples common stock outstanding as of November 13, 2003.

 

 

STAPLES, INC. AND SUBSIDIARIES

FORM  10-Q

November 1, 2003

TABLE OF CONTENTS

 

Part I – Financial Information:
Item 1.  Financial Statements (unaudited):
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.  Quantitative and Qualitative Disclosures about Market Risk
Item 4.  Controls and Procedures
Part II – Other Information
Signature
Exhibit Index

 

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PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

 

STAPLES, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(Dollar Amounts in Thousands, Except Share Data)

 

		November 1, 2003			February 1, 2003
		(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	1,048,571		$	596,064
Receivables, net		408,862			364,419
Merchandise inventories, net		1,619,294			1,555,205
Deferred income taxes		133,197			96,229
Prepaid expenses and other current assets		103,619			105,559
Total current assets		3,313,543			2,717,476
Property and equipment:
Land and buildings		583,265			524,730
Leasehold improvements		670,039			621,713
Equipment		1,015,070			951,439
Furniture and fixtures		512,290			472,935
Total property and equipment		2,780,664			2,570,817
Less accumulated depreciation and amortization		1,304,468			1,123,065
Net property and equipment		1,476,196			1,447,752
Lease acquisition costs, net of accumulated amortization		44,818			51,450
Intangible assets, net of accumulated amortization		211,478			216,391
Goodwill		1,209,785			1,207,824
Other assets		69,074			80,495
Total assets		$	6,324,894		$	5,721,388
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	1,276,506		$	1,092,172
Accrued expenses and other current liabilities		762,008			755,483
Debt maturing within one year		3,608			327,671
Total current liabilities		2,042,122			2,175,326
Long-term debt		735,165			732,041
Deferred income taxes		27,700			50,267
Other long-term obligations		133,606			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 523,043,511 shares at November 1, 2003 and 500,831,408 shares at February 1, 2003		314			299
Additional paid-in capital		1,886,994			1,484,833
Cumulative foreign currency translation adjustments		62,678			11,481
Retained earnings		1,997,414			1,719,091
Treasury stock at cost - 27,927,201 shares at November 1, 2003, and 27,724,578 shares at February 1, 2003		(561,099		)	(556,812		)
Total stockholders’ equity		3,386,301			2,658,892
Total liabilities and stockholders’ equity		$	6,324,894		$	5,721,388

 

See notes to consolidated financial statements.

 

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STAPLES, INC. AND SUBSIDIARIES

Consolidated Statements of Income

(Dollar Amounts in Thousands, Except Per Share Data)

(Unaudited)

 

		13 Weeks Ended						39 Weeks Ended
		November 1, 2003			November 2, 2002			November 1, 2003			November 2, 2002
Sales		$	3,484,784		$	3,089,725		$	9,500,068		$	8,260,966
Cost of goods sold and occupancy costs		2,497,117			2,286,911			6,982,528			6,200,272
Gross profit		987,667			802,814			2,517,540			2,060,694
Operating and other expenses:
Operating and selling		585,867			471,805			1,665,867			1,317,421
Pre-opening		2,314			2,393			5,961			6,625
General and administrative		130,422			120,006			382,289			325,788
Amortization of intangibles		2,076			—			5,962			—
Interest and other expense, net		3,854			5,406			15,679			10,159
Total operating and other expenses		724,533			599,610			2,075,758			1,659,993
Income before income taxes		263,134			203,204			441,782			400,701
Income tax expense		97,360			75,186			163,459			119,259
Net income		$	165,774		$	128,018		$	278,323		$	281,442
Basic earnings per common share		$	0.34		$	0.27		$	0.58		$	0.60
Diluted earnings per common share		$	0.33		$	0.27		$	0.57		$	0.60

 

See notes to consolidated financial statements.

 

4

 

STAPLES, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Dollar Amounts in Thousands)

(Unaudited)

 

		39 Weeks Ended
		November 1, 2003			November 2, 2002
Operating Activities:
Net income		$	278,323		$	281,442
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		212,749			195,097
Deferred tax (benefit) expense		(36,597		)	34,679
Other		25,662			24,790
Changes in assets and liabilities:
Increase in receivables		(34,192		)	(13,777		)
Increase in merchandise inventories		(17,248		)	(96,502		)
Decrease in prepaid expenses and other assets		219			6,463
Increase in accounts payable		147,921			96,532
Increase (decrease) in accrued expenses and other liabilities		30,141			(31,361		)
Increase in other long-term obligations		7,944			3,719
Net cash provided by operating activities		614,922			501,082
Investing Activities:
Acquisition of property and equipment		(190,809		)	(192,442		)
Acquisition of businesses, net of cash acquired		(2,910		)	(1,171,187		)
Other		—			624
Net cash used in investing activities		(193,719		)	(1,363,005		)
Financing Activities:
Proceeds from sale of capital stock		357,736			46,138
Proceeds from borrowings		—			730,655
Payments on borrowings		(336,826		)	(85,785		)
Purchase of treasury stock		(4,287		)	(474		)
Net cash provided by financing activities		16,623			690,534
Effect of exchange rate changes on cash and cash equivalents		14,681			2,754
Net increase (decrease) in cash and cash equivalents		452,507			(168,635		)
Cash and cash equivalents at beginning of period		596,064			394,824
Cash and cash equivalents at end of period		$	1,048,571		$	226,189

 

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 its subsidiaries (“Staples”, “the Company”, “we”, “our” or “us”).  These financial statements are for the period covering the thirteen and thirty-nine weeks ending November 1, 2003 (also referred to as the “third quarter of 2003” and “year-to-date 2003”) and the period covering the thirteen and thirty-nine weeks ending November 2, 2002 (also referred to as the “third quarter of 2002” and “year-to-date 2002”).  All intercompany accounts and transactions are eliminated in consolidation. Certain previously reported amounts have been reclassified to conform with the current period presentation.

 

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 financial statements reflect all normal recurring adjustments 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.

 

Note B – Issuance of Common Stock

 

On June 4, 2003, the Company issued and sold 13,800,000 shares of its common stock in a public offering for a purchase price of $18.89 per share, including 1,800,000 shares related to an over-allotment option that was granted to the underwriters. Upon closing, the Company received net proceeds of $252.9 million. The offering proceeds will be used for working capital and general corporate purposes.

 

Note C – Change in Accounting Principle

 

In November 2002, the Emerging Issues Task Force 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 at the end of the first quarter of 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 reflected all of our outstanding vendor contracts, as substantially all contracts were either entered into or amended in the first quarter of 2003. While there was no material impact to the Company’s results of operations for the third quarter of 2003, the new accounting method resulted in reporting $66 million and $177 million of the Company’s cooperative advertising rebates earned in the third quarter and year-to-date 2003, respectively, as cost of goods sold and occupancy costs. These amounts would have been reported as a reduction of operating and selling expenses under previous accounting guidance. Prior periods have not been restated to reclassify amounts recorded as a reduction of operating and selling expenses to cost of goods sold and occupancy costs in accordance with current accounting guidance.  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 third quarter and year-to-date 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
		November 1, 2003			November 2, 2002			November 1, 2003			November 2, 2002
Sales		$	3,484,784		$	3,089,725		$	3,484,784		$	3,089,725
Cost of goods sold and occupancy costs		2,497,117			2,286,911			2,497,117			2,221,639
Gross profit		987,667			802,814			987,667			868,086
Operating and other expenses:
Operating and selling		585,867			471,805			585,867			537,077
Other expenses		138,666			127,805			138,666			127,805
Total operating and other expenses		724,533			599,610			724,533			664,882
Income before income taxes		263,134			203,204			263,134			203,204
Income tax expense		97,360			75,186			97,360			75,186
Pro forma net income		$	165,774		$	128,018		$	165,774		$	128,018
Pro forma earnings per share:
Basic		$	0.34		$	0.27		$	0.34		$	0.27
Diluted		$	0.33		$	0.27		$	0.33		$	0.27

 

		As Reported 39 Weeks Ended						Pro Forma 39 Weeks Ended
		November 1, 2003			November 2, 2002			November 1, 2003			November 2, 2002
Sales		$	9,500,068		$	8,260,966		$	9,500,068		$	8,260,966
Cost of goods sold and occupancy costs		6,982,528			6,200,272			6,884,553			6,027,331
Gross profit		2,517,540			2,060,694			2,615,515			2,233,635
Operating and other expenses:
Operating and selling		1,665,867			1,317,421			1,665,867			1,490,362
Other expenses		409,891			342,572			409,891			342,572
Total operating and other expenses		2,075,758			1,659,993			2,075,758			1,832,934
Income before income taxes		441,782			400,701			539,757			400,701
Income tax expense		163,459			119,259			199,710			119,259
Pro forma net income		$	278,323		$	281,442		$	340,047		$	281,442
Pro forma earnings per share:
Basic		$	0.58		$	0.60		$	0.71		$	0.60
Diluted		$	0.57		$	0.60		$	0.70		$	0.60

 

Note D – Employee Benefit Plans

 

Staples accounts for its stock-based plans under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” 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” as amended by Statement of Financial Accounting Standards No. 148 “Accounting for Stock-Based Compensation – Transition and Disclosure” (“SFAS No. 148”).

 

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, Staples’ employee stock

 

7

 

purchase plans are considered compensatory plans. The expense was calculated based on the fair value of the employees’ purchase rights. Staples’ pro forma information follows (in thousands, except per share data):

 

 

		13 Weeks Ended						39 Weeks Ended
		November 1, 2003			November 2, 2002			November 1, 2003			November 2, 2002
Net income as reported		$	165,774		$	128,018		$	278,323		$	281,442
Stock based compensation excluded from reported net income		9,846			7,372			26,944			25,966
Pro forma net income		$	155,928		$	120,646		$	251,379		$	255,476
Pro forma basic earnings per common share		$	0.32		$	0.26		$	0.52		$	0.55
Pro forma diluted earnings per common share		$	0.31		$	0.26		$	0.51		$	0.54

 

Note E - Comprehensive Income

 

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

 

		13 Weeks Ended						39 Weeks Ended
		November 1, 2003			November 2, 2002			November 1, 2003			November 2, 2002
Net income		$	165,774		$	128,018		$	278,323		$	281,442
Other comprehensive income:
Foreign currency translation adjustments, net		31,267			11,094			51,197			24,741
Total comprehensive income		$	197,041		$	139,112		$	329,520		$	306,183

 

Note F - 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 year-to-date 2003 (in thousands):

 

		Balance at February 1, 2003			Charges Utilized			Balance at November 1, 2003
Lease terminations		$	24,453		$	(6,512	)	$	17,941
Legal and settlement costs		4,605			(659		)	3,946
		$	29,058		$	(7,171	)	$	21,887

 

Note G – 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 net 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.

 

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.

 

8

 

Note H – 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 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 I - Computation of Earnings Per Common Share

 

The computation of basic and diluted earnings per share for the third quarter and year-to-date 2003 and 2002 is as follows (in thousands, except per share data):

 

		13 Weeks Ended						39 Weeks Ended
		November 1, 2003			November 2, 2002			November 1, 2003			November 2, 2002
Numerator:
Net income		$	165,774		$	128,018		$	278,323		$	281,442
Denominator:
Weighted-average common shares outstanding		491,049			467,498			480,642			465,953
Effect of dilutive securities:
Employee stock options and restricted stock		10,982			4,214			8,538			6,172
Weighted-average common shares outstanding assuming dilution		502,031			471,712			489,180			472,125
Basic earnings per common share		$	0.34		$	0.27		$	0.58		$	0.60
Diluted earnings per common share		$	0.33		$	0.27		$	0.57		$	0.60

 

Note J - 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, Germany and Sweden.

 

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.

 

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

 

 

Note K - 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. (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 for the third quarter and year-to-date 2003 and 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 November 1, 2003

(in thousands)

 

		Staples, Inc. (Parent Co.)			Guarantor Subsidiaries			Non- Guarantor Subsidiaries			Eliminations			Consolidated
Cash and cash equivalents		$	792,672		$	42,473		$	213,426		$	—		$	1,048,571
Merchandise inventories		—			1,093,314			525,980			—			1,619,294
Other current assets		138,591			94,904			412,183			—			645,678
Total current assets		931,263			1,230,691			1,151,589			—			3,313,543
Net property, equipment and other assets		178,769			913,817			708,980			—			1,801,566
Goodwill		140,570			45,777			1,023,438			—			1,209,785
Investment in affiliates and intercompany		2,860,719			2,405,837			2,718,757			(7,985,313		)	—
Total assets		$	4,111,321		$	4,596,122		$	5,602,764		$	(7,985,313	)	$	6,324,894
Total current liabilities		$	146,577		$	1,225,353		$	670,192		$	—		$	2,042,122
Total long-term liabilities		181,620			586,616			128,235			—			896,471
Intercompany		2,096,657			385,702			2,060,388			(4,542,747		)	—
Total stockholders’ equity		1,686,467			2,398,451			2,743,949			(3,442,566		)	3,386,301
Total liabilities and stockholders’ equity		$	4,111,321		$	4,596,122		$	5,602,764		$	(7,985,313	)	$	6,324,894

 

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		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

 

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Condensed Consolidating Statement of Income

For the 13 weeks ended November 1, 2003

(in thousands)

 

		Staples, Inc. (Parent Co.)			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Consolidated
Sales		$	—		$	2,357,061		$	1,127,723		$	3,484,784
Cost of goods sold and occupancy costs		325			1,700,710			796,082			2,497,117
Gross profit		(325		)	656,351			331,641			987,667
Operating and other expenses		8,123			487,320			229,090			724,533
Income (loss) before income taxes		(8,448		)	169,031			102,551			263,134
Income tax expense		—			57,872			39,488			97,360
Net income (loss)		$	(8,448	)	$	111,159		$	63,063		$	165,774

 

Condensed Consolidating Statement of Income

For the 13 weeks ended November 2, 2002

(in thousands)

 

		Staples, Inc. (Parent Co.)			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Consolidated
Sales		$	—		$	2,193,219		$	896,506		$	3,089,725
Cost of goods sold and occupancy costs		257			1,637,696			648,958			2,286,911
Gross profit		(257		)	555,523			247,548			802,814
Operating and other expenses		12,680			423,861			163,069			599,610
Income (loss) before income taxes		(12,937		)	131,662			84,479			203,204
Income tax expense		—			44,355			30,831			75,186
Net income (loss)		$	(12,937	)	$	87,307		$	53,648		$	128,018

 

Condensed Consolidating Statement of Income

For the 39 weeks ended November 1, 2003

(in thousands)

 

		Staples, Inc. (Parent Co.)			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Consolidated
Sales		$	—		$	6,431,692		$	3,068,376		$	9,500,068
Cost of goods sold and occupancy costs		979			4,793,770			2,187,779			6,982,528
Gross profit		(979		)	1,637,922			880,597			2,517,540
Operating and other expenses		24,348			1,378,108			673,302			2,075,758
Income (loss) before income taxes		(25,327		)	259,814			207,295			441,782
Income tax expense		—			93,227			70,232			163,459
Net income (loss)		$	(25,327	)	$	166,587		$	137,063		$	278,323

 

Condensed Consolidating Statement of Income

For the 39 weeks ended November 2, 2002

(in thousands)

 

		Staples, Inc. (Parent Co.)			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Consolidated
Sales		$	—		$	5,949,342		$	2,311,624		$	8,260,966
Cost of goods sold and occupancy costs		773			4,493,285			1,706,214			6,200,272
Gross profit		(773		)	1,456,057			605,410			2,060,694
Operating and other expenses		24,035			1,195,183			440,775			1,659,993
Income (loss) before income taxes		(24,808		)	260,874			164,635			400,701
Income tax expense		—			68,051			51,208			119,259
Net income (loss)		$	(24,808	)	$	192,823		$	113,427		$	281,442

 

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Condensed Consolidating Statement of Cash Flows

For the 39 weeks ended November 1, 2003

(in thousands)

 

		Staples, Inc. (Parent Co.)			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Consolidated
Net cash provided by operating activities		$	392,682		$	122,197		$	100,043		$	614,922
Investing Activities:
Acquisition of property and equipment		(11,495		)	(132,956		)	(46,358		)	(190,809		)
Other		—			—			(2,910		)	(2,910		)
Net cash used in investing activities		(11,495		)	(132,956		)	(49,268		)	(193,719		)
Financing Activities:
Payments on borrowings		(336,826		)	—			—			(336,826		)
Other		357,736			(4,287		)	—			353,449
Net cash provided by (used) in financing activities		20,910			(4,287		)	—			16,623
Effect of exchange rate changes on cash and cash equivalents		—			—			14,681			14,681
Net increase (decrease) in cash and cash equivalents		402,097			(15,046		)	65,456			452,507
Cash and cash equivalents at beginning of period		390,575			57,519			147,970			596,064
Cash and cash equivalents at end of period		$	792,672		$	42,473		$	213,426		$	1,048,571

 

Condensed Consolidating Statement of Cash Flows

For the 39 weeks ended November 2, 2002

(in thousands)

 

		Staples, Inc. (Parent Co.)			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Consolidated
Net cash provided by (used in) operating activities		$	681,736		$	117,517		$	(298,171	)	$	501,082
Investing Activities:
Acquisition of property and equipment		(11,526		)	(127,011		)	(53,905		)	(192,442		)
Acquisition of business, net of cash acquired		(1,171,187		)	—			—			(1,171,187		)
Other		—			—			624			624
Net cash used in investing activities		(1,182,713		)	(127,011		)	(53,281		)	(1,363,005		)
Financing Activities:
Payments on borrowings		(85,785		)	—			—			(85,785		)
Other		440,835			(474		)	335,958			776,319
Net cash provided by (used in) financing activities		355,050			(474		)	335,958			690,534
Effect of exchange rate changes on cash and cash equivalents		—			—			2,754			2,754
Net decrease in cash and cash equivalents		(145,927		)	(9,968		)	(12,740		)	(168,635		)
Cash and cash equivalents at beginning of period		226,342			53,809			114,673			394,824
Cash and cash equivalents at end of period		$	80,415		$	43,841		$	101,933		$	226,189

 

Note L – New Accounting Pronouncements

 

In January 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46, “Consolidation of Variable Interest Entities,” (“Interpretation 46”) to clarify the conditions under which assets, liabilities and activities of another entity should be consolidated into the financial statements of a company. Interpretation 46 requires the consolidation of a variable interest entity (including a special purpose entity such as that utilized in an accounts receivable securitization transaction) by a company that bears the majority of the risk of loss from the variable interest entity’s activities, is entitled to receive a majority of the variable interest entity’s residual returns or both. The Company is required to adopt the provisions of

 

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Interpretation 46 in fiscal 2003. The Company does not believe the adoption of Interpretation 46 will have a material impact on its overall financial position or results of operations.

 

In April 2003, the FASB issued Statement No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities”. This Statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities”. The provisions of this Statement are effective for the Company for all derivatives and hedging activity entered into after June 30, 2003.  The adoption of this Statement had no impact on the Company’s overall financial position and results of operations.

 

In May 2003, the FASB issued Statement No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”. This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. The provisions of this Statement are effective for financial instruments entered into or modified after May 31, 2003. The adoption of this Statement had no impact on the Company’s overall financial position and results of operations.

 

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STAPLES, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

of Financial Condition and Results of Operations

 

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, France, Belgium, Spain, Italy, Germany and Sweden.

 

In November 2002, the Emerging Issues Task Force 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 at the end of the first quarter of 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 reflected all of our outstanding vendor contracts, as substantially all contracts were either entered into or amended in the first quarter of 2003. While there was no material impact to our results of operations for the third quarter of 2003, the new accounting method resulted in reporting $66 million and $177 million of our cooperative advertising rebates earned in the third quarter and year-to-date 2003, respectively, as cost of goods sold and occupancy costs. These amounts would have been reported as a reduction of operating and selling expenses under previous accounting guidance. Prior periods have not been restated to reclassify amounts recorded as a reduction of operating and selling expenses to cost of goods sold and occupancy costs in accordance with current accounting guidance.  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 (“the 2002 acquisitions”). 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.

 

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 we or our 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

 

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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 Issue 02-16 (see Note C 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 discussion below because we believe it is a meaningful measure of our normalized operating performance and will assist you in understanding our results of operations on a comparative basis and in recognizing underlying trends. 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 third quarter of 2003 was $165.8 million or $0.33 per diluted share compared to $128.0 million or $0.27 per diluted share for the third quarter of 2002, an increase in net income of 29%. This increase reflects our continued focus on customer service, solid execution, expense management and our improved product mix directed at more profitable small business customers and power users.

 

Net income for year-to-date 2003 was $278.3 million or $0.57 per diluted share compared to $281.4 million or $0.60 per diluted share for year-to-date 2002.  Year-to-date 2003 results include a $62 million adjustment, net of taxes, related to the change in accounting for vendor consideration required by Issue 02-16. Our results for year-to-date 2002 included the impact of a $29 million non-recurring tax benefit (see Note H to the Consolidated Financial Statements).  On a pro forma basis to reflect the retroactive application of Issue 02-16, net income for year-to-date 2003 was $340.0 million or $0.70 per diluted share.  Excluding the tax benefit, net income for year-to-date 2002 was $252.4 million or $0.53 per diluted share.  On a pro forma basis for year-to-date 2003 reflecting the retroactive application of Issue 02-16 and excluding the tax benefit in year-to-date 2002, net income increased 35% for year-to-date 2003 compared to year-to-date 2002.

 

Sales:  Sales for the third quarter of 2003 were $3.48 billion, an increase of 12.8% from the third quarter of 2002.   Sales for year-to-date 2003 were $9.50 billion, an increase of 15.0% from year-to-date 2002. Excluding non-comparative sales for the 2002 acquisitions of $101.7 million for the third quarter of 2003 and $446.1 million for year-to-date 2003, sales increased 9.5% for the third quarter and 9.6% for year-to-date 2003. Comparable sales for our North American retail locations increased 4% for the third quarter and year-to-date 2003 and comparable sales for our European retail operations increased 1% for the third quarter and year-to-date 2003.  We had 1,531 open stores as of November 1, 2003 compared to 1,471 stores as of November 2, 2002 and 1,488 stores as of February 1, 2003.  This includes 22 stores opened and 1 store closed during the third quarter of 2003 and 53 stores opened and 10 stores closed during year-to-date 2003. North American Delivery sales increased 6.7% for the third quarter of 2003 and, excluding non-comparable sales of $85.5 million for year-to-date 2003 for MAP, 7.8% for year-to-date 2003.  The increase in total sales also reflects a positive impact of foreign currency rates of $85.4 million for the third quarter of 2003 and $208.1 million for year-to-date 2003.

 

Gross Profit:   Gross profit as a percentage of sales was 28.3% for the third quarter of 2003 and 26.5% for year-to-date 2003 compared to 26.0% and 24.9% for the corresponding periods in 2002. On a pro forma basis to reflect the retroactive application of Issue 02-16, gross profit was 28.3% for the third quarter of 2003 and 27.5% for year-to-date 2003 compared to 28.1% and 27.0% for the corresponding periods in 2002. The increase in pro forma gross profit for both the third quarter and year-to-date 2003 is due in large part to the impact of the 2002 acquisitions, which have significantly higher gross margins as a percentage of sales than our other businesses.  The increase also reflects continued improvements

 

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in shrink and leveraging of rent and occupancy expenses, our improved product mix directed at more profitable business customers and power users, our continued focus on higher margin Staples brand 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 16.8% of sales for the third quarter of 2003 and 17.5% for year-to-date 2003 compared to 15.3% and 15.9% for the corresponding periods in 2002. On a pro forma basis to reflect the reclassification of cooperative advertising rebates under Issue 02-16, operating expenses were 17.4% of sales for the third quarter of 2002 and 18.0% of sales for year-to-date 2002. The decrease in pro forma operating expenses for both the third quarter and year-to-date 2003 reflects more efficient investments in marketing across all business units, our focus on expense management, and leveraging of fixed expenses on higher sales.  This decrease was partially offset by the impact of the 2002 acquisitions, 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, number and location of new store openings.  Pre-opening expenses decreased to $2.3 million in the third quarter of 2003 from $2.4 million in the third quarter of 2002 and decreased to $6.0 million for year-to-date 2003 from $6.6 million for year-to-date 2002.  Pre-opening expenses for the third quarter and year-to-date 2003 reflect 22 stores opened in the third quarter of 2003 compared to 25 stores opened in the third quarter of 2002 and 53 stores opened during year-to-date 2003 compared to 68 stores opened during year-to-date 2002.

 

General and Administrative Expenses:  General and administrative expenses as a percentage of sales decreased to 3.7% for the third quarter of 2003 and increased to 4.0% for year-to-date 2003 compared to 3.9% for the third quarter and year-to-date 2002.  The decrease for the third quarter of 2003 reflects our ability to increase sales without proportionately increasing overhead expenses. Our current year investments in our supply chain and procurement initiatives as well as the impact of the 2002 acquisitions which have higher general and administrative costs as a percentage of sales than our other businesses slightly offset the decrease in the third quarter of 2003 and resulted in the increase for year-to-date 2003.

 

Amortization of Intangibles: Amortization of intangibles was $2.1 million for the third quarter of 2003 and $6.0 million for year-to-date 2003, reflecting the amortization of customer-related intangible assets and noncompetition agreements associated with the 2002 acquisitions.  Prior to the third quarter of 2002, we had no amortization of intangible assets.

 

Interest and Other Expense, Net:   Net interest and other expense totaled $3.9 million for the third quarter of 2003 and $15.7 million for year-to-date 2003 compared to $5.4 million for the third quarter of 2002 and $10.2 million for year-to-date 2002.  Interest and other expense relate primarily to existing borrowings.  In the third quarter of 2002, we completed an offering of $325 million senior notes and borrowed $325 million under a 364-day Term Loan Agreement (the “Term Loan”), which was repaid in May 2003.  As a result of these debt agreements, interest expense increased in the third quarter of 2002 and throughout the first quarter of 2003.  Subsequent to the repayment of the Term Loan at the end of the first quarter of 2003, interest expense decreased, resulting in a decrease in interest expense for the third quarter of 2003 compared to the third quarter of 2002.  For year-to-date 2003, the outstanding borrowings early in the year resulted in an increase in interest expense over year-to-date 2002.

 

Income Taxes: Our effective tax rate was 37.0% for the third quarter and year-to-date 2003 and 37.0% for the third quarter of 2002 and 29.8% for year-to-date 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. 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 the tax benefit, our effective tax rate was 37.0% for year-to-date 2002.

 

17

 

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 J to our Consolidated Financial Statements):

 

		(Amounts in thousands) 13 Weeks Ended						November 1, 2003		November 2, 2002
		November 1, 2003			November 2, 2002			Increase From Prior Year		Increase From Prior Year
Sales:
North American Retail		$	2,120,176		$	1,927,445		10.0	%	4.1	%
North American Delivery		971,277			910,573			6.7	%	17.1	%
European Operations		393,331			251,707			56.3	%	23.0	%
Total sales		$	3,484,784		$	3,089,725		12.8	%	9.0	%
		(Amounts in thousands) 13 Weeks Ended						November 1, 2003 % of Sales		November 2, 2002 % of Sales
		November 1, 2003			November 2, 2002
Business Unit Income/(Loss):
North American Retail		$	160,732		$	136,257		7.6	%	7.1	%
North American Delivery		86,595			74,714			8.9	%	8.2	%
European Operations		19,661			(2,361		)	5.0	%	(0.9	)%
Total business unit income		$	266,988		$	208,610		7.7	%	6.8	%
		(Amounts in thousands) 39 Weeks Ended						November 1, 2003 Increase From Prior Year		November 2, 2002 Increase From Prior Year
		November 1, 2003			November 2, 2002
Sales:
North American Retail		$	5,581,548		$	5,110,467		9.2	%	2.5	%
North American Delivery		2,783,844			2,503,276			11.2	%	11.6	%
European Operations		1,134,676			647,223			75.3	%	15.4	%
Total sales		$	9,500,068		$	8,260,966		15.0	%	5.7	%
		(Amounts in thousands) 39 Weeks Ended						November 1, 2003 % of Sales		November 2, 2002 % of Sales
		November 1, 2003			November 2, 2002
Business Unit Income/(Loss):
North American Retail		$	303,304		$	241,265		5.4	%	4.7	%
North American Delivery		217,999			179,593			7.8	%	7.2	%
European Operations		34,133			(9,998		)	3.0	%	(1.5	)%
Total business unit income		$	555,436		$	410,860		5.8	%	5.0	%

 

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North American Retail: Sales for North American Retail increased 10.0% for the third quarter of 2003 and 9.2% for year-to-date 2003 compared to the third quarter and year-to-date 2002.  The growth for both the third quarter and year-to-date 2003 primarily reflects an increase in comparable store sales of 4%, as well as non-comparable store sales for stores opened in the prior year and throughout the first three quarters of 2003.  We added a net of 16 stores to the North American store base in the third quarter, and a net of 36 stores for year-to-date 2003.  At November 1, 2003, the North American store base included 1,336 open stores compared to 1,286 stores as of November 2, 2002 and 1,300 stores at February 1, 2003. The increase in sales also reflects the positive impact of Canadian exchange rates to the U.S. dollar of $53.9 million for the third quarter of 2003 and $104.1 million for year-to-date 2003. Our strong sales growth reflects solid execution in key categories, including ink and toner, paper, business machines and our copy center businesses, combined with continued improvements in furniture, driven by improved layout and in-store selling. This sales growth was also positively impacted by a strong back-to-school season. Business unit income as a percentage of sales increased to 7.6% for the third quarter of 2003 and 5.4% for year-to-date 2003 from 7.1% for the third quarter of 2002 and 4.7% for year-to-date 2002. The increase in business unit income for both the third quarter and year-to-date 2003 primarily reflects our improved product mix and more focused marketing spend directed at more profitable business customers and power users, leveraging of fixed expenses on higher sales, our focus on expense management and continued improvements in shrink. This increase also reflects our continued focus on higher margin Staples brand products and better buying as a result of our procurement initiatives.

 

North American Delivery: Sales for North American Delivery increased 6.7% for the third quarter of 2003 and 11.2% for year-to-date 2003 compared to the third quarter and year-to-date 2002. Excluding the non-comparable impact of our MAP acquisition, sales grew 7.8% for year-to-date 2003.  The sales growth for both the third quarter and year-to-date 2003 reflects the positive results of marketing among our catalog, websites and retail stores, as well as the continued success of our customer acquisition efforts and improved service levels across all of our delivery businesses.  Business unit income increased to 8.9% of sales for the third quarter of 2003 and 7.8% for year-to-date 2003 from 8.2% in the third quarter of 2002 and 7.2% for year-to-date 2002.  The increase in business unit income for the third quarter of 2003 reflects improved gross margins in our Staples Business Delivery business resulting from our investments in service improvement and customer retention, more efficient marketing spend in our Staples Business Delivery and Quill businesses, and continued market share gains in our Contract business. The increase for year-to-date 2003 was driven in large part by the acquisition of MAP, as well as the results of our existing businesses reflecting our investments in service improvement, customer acquisition and retention and more efficient marketing spend.

 

European Operations: Sales for European Operations increased 56.3% for the third quarter of 2003 and 75.3% for year-to-date 2003 compared to the third quarter and year-to-date 2002. Excluding non-comparable sales for the European mail order acquisition of $101.7 million for the third quarter of 2003 and $360.6 million for year-to-date 2003, sales grew 15.9% for the third quarter of 2003 and 19.6% for year-to-date 2003. The sales growth primarily reflects the positive impact of European exchange rates to the U.S. dollar of $26.4 million for the third quarter of 2003 and $92.7 million for year-to-date 2003. This increase also reflects non-comparable store sales for stores opened in the prior year and throughout the first three quarters of 2003.  A net of five stores were opened in the third quarter of 2003, and a net of seven stores were added for year-to-date 2003. At November 1, 2003, the European store base included 195 open stores compared to 185 stores as of November 2, 2002 and 188 stores at February 1, 2003. The increase also reflects an increase in comparable store sales of 1% for the third quarter and year-to-date 2003.  Business unit income improved to $19.7 million for the third quarter of 2003 and $34.1 million for year-to-date 2003 from a loss of $2.4 million for the third quarter of 2002 and a loss of $10.0 million for year-to-date 2002. This improvement primarily reflects the results of the European mail order acquisition as well as a $5 million integration charge recorded in the third quarter of 2002. In addition, our European retail business unit income continued to improve over the prior year primarily as a result of our focus on expense management.

 

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.

 

19

 

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 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.

 

New Accounting Pronouncements

 

In January 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46, “Consolidation of Variable Interest Entities,” (“Interpretation 46”) to clarify the conditions under which assets, liabilities and activities of another entity should be consolidated into the financial statements of a company. Interpretation 46 requires the consolidation of a variable interest entity (including a special purpose entity such as that utilized in an accounts receivable securitization transaction) by a company that bears the majority of the risk of loss from the variable interest entity’s activities, is entitled to receive a majority of the variable interest entity’s residual returns or both. We are required to adopt the provisions of Interpretation 46 in fiscal 2003. We do not believe the adoption of Interpretation 46 will have a material impact on our overall financial position or results of operations.

 

In April 2003, the FASB issued Statement No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities”. This Statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities”. The provisions of this Statement are effective for us for all derivatives and hedging activity entered into after June 30, 2003.  The adoption of this Statement had no impact on our overall financial position and results of operations.

 

In May 2003, the FASB issued Statement No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”. This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. The provisions of this Statement

 

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are effective for financial instruments entered into or modified after May 31, 2003. The adoption of this Statement had no impact on our overall financial position and results of operations.

 

Liquidity and Capital Resources

 

Cash Flows

 

Cash provided by operations was $614.9 million for year-to-date 2003 compared to $501.1 million for year-to-date 2002.  The increase in operating cash flow was primarily due to the increase in pro forma net income as well as an increase in accounts payable. The increase in accounts payable reflects our focus on improving working capital and effectively utilizing cash and cash equivalents.

 

Cash used in investing activities was $193.7 million for year-to-date 2003 compared to $1.36 billion for year-to-date 2002. This change is primarily due to the 2002 acquisitions as well as reductions in the number of stores opened, from 68 in year-to-date 2002 to 53 in year-to-date 2003, and in store remodels from 122 in year-to-date 2002 to 36 in year-to-date 2003.

 

Cash provided by financing activities was $16.6 million for year-to-date 2003 compared to $690.5 million for year-to-date 2002. The change in 2003 is primarily due to the early repayment of our $325 million 364–Day Term Loan Agreement on May 2, 2003 (see Note G to the Consolidated Financial Statements), offset by $252.9 million of net proceeds received from our issuance of 13,800,000 shares of our common stock in a public offering on June 4, 2003 (see Note B to Consolidated Financial Statements) and $96.8 million received in connection with the exercise of stock options.

 

Sources of Liquidity

 

We utilize cash generated from operations and our main revolving credit facility to cover seasonal fluctuations in cash flows and to support our various growth initiatives. When necessary, we have traditionally supplemented this with debt or equity offerings.

 

We had $1.85 billion in total cash and available funds through credit agreements at November 1, 2003, which consisted of $695.8 million of available credit, $1.05 billion of cash and cash equivalents and $105.5 million available under a receivables securitization agreement.

 

A summary, as of November 1, 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		—			174,570
Senior Notes due August  2007		—			200,000
Uncommitted lines of credit		70,000			—
Other lines of credit		80,622			—
Capital leases and other notes payable		—			10,527
Total		$	695,751		$	710,097

 

We issue letters of credit under our revolving credit facility in the ordinary course of business.  At November 1, 2003, we had $54.9 million of open letters of credit, thus reducing the available credit under our revolving credit facility from $600 million to $545.1 million.

 

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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 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.

 

Uses of Capital

 

We expect to open up to 33 new stores during the fourth quarter 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 $110 million on capital expenditures during the fourth quarter of 2003.  We may also expend additional funds to purchase lease rights from tenants occupying retail space that is suitable for a Staples store.

 

We may also use capital to engage in strategic acquisitions.  Throughout our history, we have primarily grown organically, and we do not expect this to change.  We do not rely on acquisitions to achieve our target growth plans, and we anticipate that future acquisitions will be strategic “tuck-in” or “bolt-on” acquisitions that are aligned with our existing businesses.  We plan to exercise the same discipline for acquisitions as we use for other investments, thereby only pursuing acquisitions that earn a return above our internal return on net assets hurdle rate within a two or three year time frame.  We do not expect this strategy to result in large acquisitions and anticipate that future acquisition activity will be financed from our operating cash flow.

 

We believe that we will need to spend approximately $325 million a year on capital expenditures for the next few years to fund organic growth.  The combination of capital spending in this range and an acquisition strategy that is not projected to require significant amounts of capital means that we will likely generate operating cash flow in excess of our expected needs, thereby strengthening our credit profile.  In addition, we anticipate that we will return some capital to our stockholders and are considering both a stock repurchase program and cash dividend in the future.

 

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

 

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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 53 stores during year-to-date 2003 and currently plan to open up to 33 new stores in the fourth quarter of 2003. For our growth strategy to be successful, we must identify and lease or buy 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 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 our 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 disproportionately negative effect on our net income for the quarter.

 

Our operating results may be impacted by changes in the economy. Our operating results are directly impacted by the health of the North American and European economies.  Current economic conditions 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 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

 

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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.

 

Our debt level could impact our ability to obtain future financing and continue our growth strategy.  Our consolidated outstanding debt at November 1, 2003 was $738.8 million. Our consolidated debt, along with our operating lease obligations, 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 previously disclosed on May 20, 2003 in our quarterly report on Form 10-Q for the quarter ended May 3, 2003, in connection with 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 have not communicated with the SEC on this matter since June 2003 and 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 discovery stage.   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 November 1, 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

 

The Company’s management, with the participation of the Company’s chief executive officer and chief financial officer, evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act) as of November 1, 2003.  Based on this evaluation, the Company’s chief executive officer and chief financial officer concluded that, as of November 1, 2003, the Company’s disclosure controls and procedures were (1) designed to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to the Company’s chief executive officer and chief financial officer by others within those entities, particularly during the period in which this report was being prepared and (2) effective, in that they provide reasonable assurance that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

 

No change in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act) occurred during the fiscal quarter ended November 1, 2003 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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STAPLES, INC. AND SUBSIDIARIES

 

PART II  —  OTHER INFORMATION

 

Item 1 – Not Applicable

 

Item 2 – Not Applicable

 

Item 3 – Not Applicable

 

Item 4 – Not Applicable

 

Item 5 – Not Applicable

 

Item 6 – Exhibits and Reports on Form 8-K

 

(a)          Exhibits

 

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

 

(b)         Reports on Form 8-K

 

On August 19, 2003, we furnished a Current Report on Form 8-K under Item 12 containing a press release announcing our financial results for the fiscal quarter ended August 2, 2003.

 

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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:	November 18, 2003		By:	/s/ John J. Mahoney
				John J. Mahoney
				Executive Vice President,
				Chief Administrative Officer
				and Chief Financial Officer
				(Principal Financial Officer)
			By:	/s/ Jeffrey Nachbor
				Jeffrey Nachbor
				Senior Vice President, Corporate Controller
				(Principal Accounting Officer)

 

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EXHIBIT INDEX

 

Exhibit Number		Description
10.1		Offer letter, dated July 30, 2003, by and between the Company and Michael Miles
10.2		Amendment No. 2, dated as of October 22, 2003, to the Receivables Purchase Agreement, by and among Lincolnshire Funding, LLC, the Company, Corporate Receivables Corporation and Citicorp North America, Inc.
31.1		Principal Executive Officer – Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Principal Financial Officer – Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1		Principal Executive Officer – Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2		Principal Financial Officer – Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

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