Staples Inc Q1 Earnings Call Transcript

123jump.com Staff
08 Jun, 2009
New York City

The office supply chain first quarter sales grew 19% to $5.82 billion and earnings fell by 33% to $143 million due to one time costs and higher operating expenses. Earnings per share were 20 cents as against 30 cents a year ago.

Staples, Inc. ((SPLS))
Q1 2009 Earnings Call Transcript
May 27, 2009 8:00 a.m. ET

Executives

Laurel Lefebvre - Vice President Investor Relations
Ron Sargent - Chairman and Chief Executive Officer
Mike Miles - President and Chief Operating Officer
Peter Ventress - President International
John Mahoney - Vice Chairman and Chief Financial Officer
Demos Parneros - President U.S. Stores
Joe Doody - President North American Delivery

Analysts

Oliver Wintermantel – Morgan Stanley
Kate McShane – Citi Investment Research
Matthew Fassler – Goldman Sachs
Stephen Chick - FBR
Dan Binder – Jefferies & Co
Brian Nagel – Oppenheimer & Co
Chris Horvers – JP Morgan
Michael Baker – Deutsche Bank
Jack Murphy – William Blair
Alan Rifkin – Bank of America-Merrill Lynch
Joe Feldman – Telsey Advisory Group

Presentation

Operator

Good day ladies and gentlemen and welcome to the First Quarter 2009 Staples, Inc. Earnings Conference Call. My name is Mylalaia and I’ll be your coordinator for today. (Operator instructions) At this time all participants are in a listen-only mode. We’ll be facilitating a question-and-answer session at the end of this conference. If at any time during the call you require audio assistance please press * followed by 0 and a coordinator will be happy to assist you. As a reminder this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today’s call, Ms. Laurel Lefebvre, Vice President of Investor Relations. Please proceed.

Laurel Lefebvre – Vice President Investor Relations

Good morning everyone and thanks for joining us for our first quarter earnings announcement. During today’s call, we’ll discuss some non-GAAP metrics, to provide investors with useful information about our financial performance. Please see the financial measures and other data section of the investor information portion of Staples.com for an explanation and reconciliation of such measures and other calculations of financial measures that we use to analyze our business. I’d also like to remind you that certain information in this call constitutes forward-looking statements for purposes of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by such forward-looking statements as a result of various important factors, including those discussed or referenced under the heading risk factors and elsewhere in Staples latest 10-Q filed this morning

Here to discuss Staples Q1 performance and business outlook are Ron Sargent, Chairman and Chief Executive Officer, Mike Miles, President and Chief Operating Officer, Peter Ventress, President of International and John Mahoney, Vice Chairman and Chief Financial Officer. Also joining us are Demos Parneros, President of U.S. Stores, and Joe Doody, President of North American Delivery. Ron?

Ron Sargent – Chief Executive Officer

Thanks Laurel and good morning everybody and thanks for joining us today. I’m pleased to announce another quarter of solid performance in a pretty tough sales environment. At Staples, our plan for managing through this current recession is simple. We’re focused on just three things. First we’re taking good care of customers, second we’re working hard to tightly manage expenses given our expectation of soft sales all year long, and third we’re investing in growth ideas including integrating Corporate Express, opening new stores and expanding our services businesses, and I think that today’s results reflect this plan.

Sales for the first quarter including the results of Corporate Express were up 19% versus last year to $5.8 billion. Q1 earnings per share, excluding integration and restructuring cost declined 27% from last year to $0.22. Our investments in service and supply chain continue to pay off with our best ever customer service scores in North American Retail where the customer traffic trend improved and was just slightly negative for the quarter. This contributed to a strong sequential improvement in the top line. On the North American Delivery side, we’re very pleased with our customer acquisition activity across all three segments as well as our strong customer service levels which are driving strong retention.

Moving to the expense side, North American Retail team did a nice job on expenses during the quarter. They increased product margins, reduced distribution and delivery expense, tightened marketing spend and managed G&A very well. These efforts more than offset rent and labor de-leverage in North American Retail, as we expanded retail operating margins by 35 basis points despite a -8% comp for the quarter. In contrast North American Retail, the sales trends for both North American Delivery and International were slightly worse sequentially and strong expense management was not enough to offset the impact of fixed expenses. In terms of investing for the future, we’re right on track with the integration of Corporate Express. We got a lot done during the first quarter. In North America we completed vendor negotiations, began integrating our HR systems, developed our supply chain strategy, and continued to reduce small orders for Corporate Express customers. Customer retention remains very strong as we move through the integration process in Europe. We’re working through our reorganization plans and while we’re not as far along as we are in the US, we’re still making steady progress. We’ve also done a lot of work on re-branding and supply chain integration plans in Europe.

With a lot of efforts going into the integration, we continue to focus on growing the business in other areas as well. During the first quarter we opened 31 stores in North America including two new Copy & Print Shops. We drove rapid growth in our Easy Tech business which more than doubled in Q1 and we made investments in key categories like ink and paper and computing which paid off with positive comps in laptops, cartridges and cut sheet paper. Throughout this recession we’ve stuck to our plan and we’ve hunkered down on expenses while improving customer service. We’ve carefully managed our capital spend without sacrificing future growth potential, and we’ve generated record cash flows despite weakness in both the top and bottom lines. During the first quarter our team proved once again that we have the experience to manage through challenging times and I’m confident that we’ll continue to drive strong performance throughout 2009.

I’ll now turn the call over to Mike Miles to talk about our results in North America.

Mike Miles – Chief Operating Officer

Thanks Ron. Good morning. Including the results of Corporate Express, sales for the first quarter in North American Delivery were $2.4 billion, an increase of 41%. If you adjust last year’s Q1 sales to include $1.1 billion from Corporate Express, NAD sales declined 13% in US dollars or 12% in local currency. NAD operating margin declined 285 basis points to 6.64% as a result of absorbing the lower margin Corporate Express business, mix shift to lower margin products in contract, increased amortization expense, and de-leverage of fixed expenses on softer sales. Within North American Delivery, contract Staples business delivery and Quill, all experienced low double digit sales declines primarily reflecting lower sales for existing customers. This was somewhat offset by customer acquisition which remains healthy across each of our NAD businesses and particularly strong in contract.

Sales at Quill and SBD both improved somewhat compared to Q4, confirming the sense we’re getting at retail that the small business segment has stabilized. Contract was sequentially worse as job losses and bankruptcies have had an impact. During the first quarter adjusted to include Corporate Express in 2008, contract sales declined 13% or 12% in local currency. Sales from customers acquired within the past year contributed eight points of growth to the top line, offset by a 13 point decline in sales from existing customers. Our more discretionary lines of business like promotional products print and tech services were down about 25% and accounted for about four percentage points of the overall decline in contract. As was the case last year, we also saw a four point sales decline as the result of lost customers. We’ve seen no change in the historical trend for lost business even as we work with customers in our Corporate Express portfolio to implement our shared value model that drives the lowest total delivered cost.

For the past several months, opportunities to bid on new business in our contract segment have increased significantly. This behavior is typical in a recession when companies are looking to save money in every area of their business and our lowest cost to serve model resonates even more with prospective customers. In this depressed economy, customers have limited purchases to essential consumables and dramatically reduced spending on durables and discretionary items. So while we continue to make progress on our share of wallet initiatives including a recent $45 million win for promotional products, demand environment for these lines of business is very weak. And while the mix shift to consumables benefits the margin rate for most of our businesses, in contract it hurts our margin rate because these are the products in which our customers have negotiated the best prices. During the first quarter, this negatively impacted NAD gross margin by about 50 basis points.

To help offset the weak top line we’re closely managing expenses. During the first quarter the team drove efficiencies in our fulfillment centers, reduced trips per order and once again achieved strong customer service metrics. We also drove improvement in accounts receivable and managed inventory tightly, contributing to strong free cash flow. By reducing our costs, we’re able to maintain great prices in an environment where key categories like ink and toner are seeing price increases. We’re also making steady progress integrating Corporate Express North American operation, as we develop a leaner and much more efficient combined organization. During the first quarter we completed all of our vendor negotiations and the vast majority of our indirect procurement negotiations. We finalized our plans for Corporate Express and Staples Own Brand assortment rationalization. We’re making headway with our initiative to eliminate small orders to drive account profitability. We also made progress with our human resources systems integration, which will be key to getting all NAD associates on the same benefits plan. This is a major step forward as we become one company and will drive continued indirect procurement savings.

Moving on to North American Retail, sales for the first quarter were $2.2 billion down about 9% or 5% in local currency versus Q1 of 2008. Same store sales were down 8%, a five percentage point sequential improvement from the -13 comp in the fourth quarter 2008. Comps for both Q4 2007 and Q1 2008 in North American Retail were -6% so we’re also seeing a 500 basis point improvement in the two year trend. The team did an outstanding job managing every line on the P&L and drove operating margin improvement of 35 basis points to 7.33%. In fact, on a local currency basis NAR operating profit increased by about $6 million compared to Q1 2008. We benefited from the early purchasing synergies that we’ve realized, distribution controls, more efficient marketing spend, and tight G&A.

We’re very pleased to achieve all time high customer service scores particularly when we are managing labor so carefully. During the first quarter we also saw encouraging trends in customer traffic which was down 2% compared to Q1 of 2008. Lower average ticket which showed some moderation from the steep declines during the fourth quarter drove most of the negative comp. Just as in NAD, purchases of higher ticket furniture and technology hardware remained soft. Tech storage, business software, printers, and office machines were especially weak with durables comping down about 14%. Consumables performed much better with comps just slightly negative. We continue to see relative strength in our destination categories with ink and cut sheet copy paper comping positively during the first quarter.

Customers are responding to our “Save the Easy Way” value campaign. Our expanded $3.00 ink recycling program covers all brands of ink and we’re on track to recycle about 50 million empties this year. We had good response to some of our recent promotions including our 50% back in rewards on case copy paper. The higher mix of consumables helped retail product margin during the quarter. We’re also driving tremendous growth in our Easy Tech offering. Although Easy Tech is still a small portion of the overall business, we continue to invest in marketing to build awareness and trial with successful promotions like our free PC tune-up offer. We’re making investments in training, improving work flow on systems and increasing our physical capacity in store to ensure we continue to provide a great customer experience as we rapidly grow the business.

Customers continue to embrace Staples brand products particularly in the core supplies area. Staples brand group recently teamed up with OXO the innovative consumer products company, to bring customers across all channels, a co-branded line of office products. We continue to invest in store growth in Q1, opening 31 and closing two stores in North America and ended the quarter with a total 1,864 stores. This includes our first stores in Louisiana and Las Vegas, as well as two more stand alone Copy and Print shops in the US. We still expect to open 55 stores for the full year with five in Canada and 50 in the US, 10 of which will be stand alone Copy and Print shops.

With that I’ll turn it over to Peter to talk about International.

Peter Ventress – President International

Thanks very much Mike and good morning everybody. Including the impact of Corporate Express, Q1 sales were $1.2 billion, an increase of 60% in US dollars and 76% in local currency, compared to the same period last year. Including sales of about $950 million from Corporate Express for the first quarter of 2008, International sales declined approximately 11% in local currency. During the quarter we saw the trends in our International business weaken as the global economic downturn accelerated particularly in Europe. In our business we typically see the European economy lagging the US by about six months.

Operating margin came in at 1.66% of sales, a decrease of 149 basis points from the same period in 2008. The margin decline during the first quarter reflects a decrease in product margin rates primarily driven by the lower gross margin Corporate Express business, de-leverage of fixed expenses on lower sales volumes, as well as an increase in amortization expense compared to the prior year. In Contracts, sales were soft despite market share gains in our international accounts as large existing customers limited their purchases to core items. The Nordics and Benelux regions continued to perform well. The weak economic environment, however, weighed on our central Europe contract business particularly in Germany where we have a high penetration of furniture sales. In European retail, same store sales declined 14% with negative comps across all countries except Belgium which comped slightly positively. Germany, which has held up better than other countries over the past several quarters, began to experience the same trends as elsewhere in Europe. Our retail business in the Netherlands and Portugal which sell a much higher mix of technology products to consumers, continued to see sharp declines as well.

We’re tightly managing expenses to offset the lower sales volumes and are developing an improved labor model and customer loyalty program to drive efficiencies. We added two new stores in Portugal and one new store in Belgium, and closed five of the Corporate Express stores we acquired, ending the first quarter with 333 stores in Europe. For 2009 we’re on track to add between five and 10 new stores in Europe. On the Catalog side, sales remain soft. In France we gained share by refocusing our promotional efforts on everyday needs like ink and paper. Continued operational improvements drove a 90 basis point improvement in our perfect order metric. We remain committed to driving strong cash flow performance and despite the tough economic environment we saw good working capital improvement versus last year in the Catalog business. Moving on to our printing division in Europe, sales during the quarter were in line with expectations due to a well filled order book at the beginning of 2009. New order volumes during the first quarter were very weak, however, as customers deferred purchases of the multi-million dollar printing presses that this division sells.

Looking outside Europe, sales in our South American business grew at a modest rate compared to the prior year. Sales in our Asian businesses were negatively impacted by the weaker economy and comparisons to large furniture sales tied to our Olympic sponsorship last year and sales declined in the double digits. During the quarter we opened two stores and closed on store in China, ending the quarter with 27 stores in China and two stores in Argentina.

Turning to the Corporate Express integration, two weeks ago we started a consultation process with the European Work Council and local employee representatives across Europe, where we proposed a restructuring plan to streamline the business and build a new platform for success. If approved we expect these projects to drive efficiencies and profit improvements over the coming years. Similar to our progress in North America, our vendor negotiations are going very well and our efforts to rationalize the Corporate Express and Staples Own Brand assortment are well underway. We are working towards more centralized direct and indirect buying as well as more efficient human resources and finance models. And we’re on track with our pan-European branding strategy and have converted our contract websites already to have the Staples look and feel.

Now I’d like to turn it over to John Mahoney to review our financials.

John Mahoney – Chief Financial Officer

Thanks Peter. Our first quarter GAAP earnings per share on a fully diluted basis declined 33% to $0.20 versus the first quarter of 2008. Excluding integration and restructuring expense, our adjusted earnings per share declined 27% to $0.22 per share versus the first quarter of 2008. As a result of the Corporate Express acquisition, during Q1 we saw significant year-over-year increases to net interest expense which increased by $63 million and amortization expense which grew by $18 million. This reduced EPS by about $0.07 for the first quarter. The stronger US dollar continued to drag on both the top and bottom line during Q1. The negative impact of core sales was about 470 basis points during the quarter with the Canadian dollar accounting for about half of the decline, and EPS was reduced by about $0.02.

Gross profit margin decreased by 184 basis points to 26.2% during the quarter. This decline reflects the combination of the lower margin Corporate Express business, partially offset by purchasing synergies. SG&A leveraged 79 basis points versus last year’s first quarter to 20.6% of sales. The lower SG&A at Corporate Express as well as reduced marketing spend drove this change. This improvement was somewhat offset by labor expense de-leverage in our retail business. Including the impact of the lower margin Corporate Express business and excluding integration and restructuring expense, adjusted operating income declined 133 basis points for the quarter to $306 million or 5.3%. This includes $14 million of incremental amortization expense from Corporate Express.

Capital expenditures came in at $54 million for the first quarter down from the $74 million we spent in Q1 of 2008. We had strong operating cash flow of $438 million for the quarter and generated record first quarter free cash flow of $385 million versus free cash flow of $225 million in Q1 2008. We expect to spend about $350 million in capital for the full year. To update you on our capital structure, we reduced our gross debt by $221 million and ended the first quarter with about $3.2 billion in total debt. In the 10 months since we acquired Corporate Express, we’ve reduced our debt by more than $1.2 billion and we’ll continue to use free cash flow which we expect be in the $1 billion range for 2009 to de-lever our balance sheet. During the first quarter we successfully issued a $500 million two year note balancing our mix of long and short-term maturities. We continue to take advantage of the commercial paper market and ended the first quarter with about $670 million of commercial paper. At the end of Q1, Staples had approximately $1.7 billion in liquidity, including cash and cash equivalents of over $738 million and available lines of credit of $936 million.

After the end of the quarter we finalized a securitization program with our banks for $300 million of NAD receivables. We used the proceeds to repay the portion of our commercial paper that was back stopped by the 364 day bridge loan that we entered into last July which we then terminated. Availability under the company’s commercial paper program has therefore been reduced to $750 million from approximately $1.5 billion. We currently have liquidity in excess of $1 billion and we’ve now effectively addressed all of our refinancing needs. To help you out with a few of the line on our P&L, we expect depreciation expense to be $110 to $120 million in the second quarter and $430 to $440 million for the full year. We anticipate amortization expense to be $25 to $30 million in the second quarter and $100 to $110 million for the full year. Integration and restructuring expense is expected to be $15 to $20 million in the second quarter and $90 to $110 million for the year. And net interest expense is expected to be $60 to $65 million in the second quarter and $235 to $245 million for the full year, which is less than our previous estimate as was our finalized our long-term capital structure.

In addition, we expect foreign currency headwinds to continue to drag on both the top and bottom lines during Q2 until we anniversary the strengthening of the US dollar that began during Q3 of 2008. We anticipate that foreign currency will negatively impact earnings per share by about $0.01 in the second quarter, assuming rates stay at today’s levels. In terms of our share count, you should expect about 725 million shares outstanding for the second quarter and about 730 million for the full year as we’re not planning to repurchase shares to offset our equity compensation activity.

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

Question-and-Answer Session

Operator

(Operator Instructions) Ladies and gentlemen if you wish to ask a question please press * followed by 1 on your touchtone telephone. If your question has been answered or you wish to withdraw your question, press * followed by2. Questions will be taken in the order received. Please press “*1” to begin. Your first question comes from the line of Oliver Wintermantel with Morgan Stanley.

Ron Sargent

Hi Oliver.

Oliver Wintermantel – Morgan Stanley

Good morning. Some of the underlying macro trends in the US signal stabilization are maybe a signal to an improvement. Could you give us some more color on what trends you have seen within the different divisions in NAD over the last few months?

Ron Sargent

Sure. Oliver from my perspective I think the economy still looks pretty choppy out there but I do believe that we’re kind of slowly heading toward recovery mode. You look at our retail trend, it improved nicely during Q1. Customer counts which had been kind of mid single digit declines they were -2 for the quarter, I think they were even a little bit better than that in the US than they were in Canada for North American Retail. Delivery has stabilized from what we saw in Q3 and Q4 and I think the Delivery story is all wrapped around the job growth or job loss numbers that are reported every month. But I do think Delivery has stabilized. And Europe seems a lot like the United States and North America but six months behind. I think in some countries we’ve seen more severe downturns than what we’ve seen in North America but it does seem like Europe is trending later than the US. So I think for purposes of planning in running our business, we’re assuming that the slowdown continues throughout all of 2009 but in terms of our hopes is that things will certainly be looking better in the fourth quarter of 2009 and slightly later for Europe and the rest of the world.

Oliver Wintermantel – Morgan Stanley

Okay thank you and I have one follow up question. Corporate Express was known in the market as being more aggressive on price and now that you’ve acquired Corporate Express and changed the way CE sales reps go the market, have you experienced a change in behavior in how your competitors bid for contracts?

Ron Sargent

I’ll ask Joe Doody to answer that one.

Joe Doody

No, Oliver I don’t think we’ve seen any major change from our competitors in the marketplace. It’s a pretty aggressive marketplace especially in the Fortune 1000 accounts. We bring to the market our total lowest cost delivered model and we continue to drive that effectively and it may even be more effective given the tough economic times that customers or prospects today are looking at. So, our go to market strategy hasn’t changed. Our competitors are aggressive in the marketplace and continue to be so.

Oliver Wintermantel – Morgan Stanley

Great thank you very much.

Ron Sargent

Thank you, Oliver.

Operator

Your next question comes from the line of Kate McShane with Citi Investment Research

Ron Sargent

Hi Kate.

Kate McShane – Citi Investment Research

Hi good morning. You had stated on your last conference call that you had seen sequential improvements in your North American Retail business since December. Did this continue through April and May very steadily? I don’t believe your competitors have seen, or at least they’ve stated that they haven’t seen a stabilization in small business trends. So, how much do you think of the improvement in the retail business is the result of share gains?

Ron Sargent

In general we don’t plan on giving updates on trends during the quarter that we’re currently in. We did it last quarter, I agree, but we did it to try to bring some clarity to our retail results because they were very, very volatile in Q4. I can say that during Q1 there was not a lot of variation during the quarter. It was kind of flattish throughout the quarter when you adjust for the Easter shift that we saw. Easter tends to hurt your comp one to two comp points during the month. So, if you adjust for Easter this year versus last year I think it was kind of flattish throughout the quarter. How we’re getting that it’s a little hard in kind of real time to know whether its share gain or the economy. Either way we’ll take it.

Kate McShane – Citi Investment Research

Okay great and one other unrelated question, can you provide great detail on the European business but can you give us a little color as to what is happening in the competitive environment in Europe? What is that like? Were more of your customer acquisitions on the contract business from Europe or from North America?

Ron Sargent

Peter Ventress?

Peter Ventress

Hi Kate, Europe’s still very competitive market and rather a difficult place to get a real fix on market share. However, we do believe where we are able to get figures in France for example on the catalog business we are winning share. And we are certainly not losing share in the contract business across Europe. It remains very competitive but we feel that we are building customer acquisition particularly in the arena of international accounts. That’s continuing and appears to be continuing into the next quarter.

Kate McShane – Citi Investment Research

Okay great, thank you.

Peter Ventress

Thank you, Kate.

Operator

Your next question comes from the line of Matthew Fassler with Goldman Sachs

Matthew Fassler – Goldman Sachs

Thanks a lot and very good morning to you. Just a couple of questions, first of all can you put the European restructuring that you discussed in the press release into the context of your broader integration efforts? Is this essentially the next stage in your preconceived process or are you making some adjustments given the macro dynamics there?

Ron Sargent

I think this is exactly the plan that we set out over a year ago. We felt like the greatest synergies were North America and that’s where we wanted to start and that’s really where we’ve focused 80% of our effort I guess over the last year is getting those synergies in North America. Then our team has now kind of moved on to Europe and part of the Europe plan is to rationalize the business where I think in North America it was more kind of tucking into existing businesses. There we had a retail business and a catalog business at Staples and Corporate Express had a contract business. We’re really trying to create kind of the new Staples Europe all under the same brand, representing all three channels and reducing some of the overhead and G&A costs that are inherent when you have a business that’s smaller than the North America but you’re operating in 17 countries. So I think Peter has organized the business into a series of regions which will allow us to continue to be very close to customers because we’re trying to leave the sales and the marketing stuff in country and very close but at the same time will allow us to consolidate some of the back end functions like human resources and like finance and really some of the things that should be done in one place instead of multiple places we’re going to try to do that. So, I don’t know Peter if you have anything else you want to add about the restructuring?

Peter Ventress

I don’t think so. Other than the fact that we are on plan, the plans we set out. It takes time to make change in Europe because of the legislative environment and the need to consult with work councils. We’re on plan and we certainly feel that the regional structure is helping us to retain that focus on the customer locally.

Matthew Fassler – Goldman Sachs

Got it, the second quick question the Delivery business, it sounds like your customer wins are solid. Can you talk about what larger businesses are looking for and whether their criteria you think have changed either as the result of your competitive feel which has had some noise associated with it I guess or with regard to the environment is price becoming more of a factor as you think about new wins.

Ron Sargent

Joe?

Joe Doody

Yeah Matt I think price is always a factor with our large customers. And so that’s not changing. I think today what has changed is they’re just trying to buy more of the essentials and less of the discretionary. The mix of products that we’re selling to them has changed. And so we have to be careful in terms of our pricing because we’re getting less products purchased that are discretionary that are typically the more, higher margin products so the mix has changed and that’s the biggest change. As far as our go to market strategy continues to be our total lowest delivery costs and we continue to drive that overall with our customers and that message and strategy resonates well in this difficult economic times.

Matthew Fassler – Goldman Sachs

Got it and then finally just quickly you talked about your CapEx number for the quarter and then your plan for the year. It looks like the pace of investments started off a little slower than I guess what an evenly spread number would dictate. At what point would you expect CapEx rate to gain momentum to get to that annual guidance number?

John Mahoney

We typically would start off particularly in the systems area in NAD a little bit slower and picks up. I would say the third quarter is when you’ll start to see things pick up a little bit more.

Matthew Fassler – Goldman Sachs

Got it, thanks so much.

John Mahoney

Thanks Matt.

Operator

Your next question comes from the line of Stephen Chick with Friedman Billings and Ramsey.

Ron Sargent

Good morning, Steve.

Stephen Chick – FBR

Hi good morning, thanks. I guess two questions, the comments on the contract customers buying the essential consumable items, I’m wondering if you could give us a sense of what type of items those are and obviously your competitors have said similar things, is it something that I guess, I kind of refer to it maybe as a trade down if you will, are contract customers simply buying less than really what they will ultimately need and then will kind of trade up once they’re feeling better about the business? Is that kind of the thought process?

Ron Sargent

You’re talking about trading down from a broad selection to the on contract items and Joe?

Stephen Chick – FBR

Yeah exactly.

Joe Doody

Steve, first of all every customer looks at their top purchased items and typically they’re going out to bid on those that are their most popular items that they use within their operations. So it’s obviously paper, ink, toner, and various key office supplies. What’s affecting the customer is clearly what they’re driving towards as far as that elimination of discretionary items. In some cases there’s obviously far less headcount and when headcount comes out there is sometimes excess inventory left in people’s offices that they’re living off for a while. We’ve had customers that have certainly told us that is a function of their decrease spend. It’s a combination of obviously not allowing their people to go off contract items as well as a shrinking headcount that really is resulting in that one lower sales to existing customers and two some of the margin pressure that was noted as a result of that mix.

Ron Sargent

It’s safe to say that cupboard is bare. I think companies have been kind of raiding the supply cabinet for the last six months.

Joe Doody

Desks and drawers and empty office to use up what they can before they order.

Stephen Chick – FBR

Okay and then second question if I could, the numbers you sighted, I appreciate the numbers that you gave us within Delivery, the down 13% and down 12% on a local basis including Corporate Express in the prior year. Can we look at that as apples to apples with the numbers last quarter where I think they were down 10% and down 9% on a local basis? With your new customer acquisition I imagine that starts to build into the NAD business as the year goes on. Are we comfortable that the down 13% and down 12% local are kind of a bottom if you will?

Ron Sargent

Yeah I think they were down sequentially last quarter versus this quarter so I think it is apples to apples. Like I said, I think our Delivery business has stabilized during the quarter.

Joe Doody

Let me just make sure you are clear on this Steve like everybody else. First we did state that our Quill and SBD business was up somewhat from Q4 to Q1. Our contract business was not. It deteriorated and as we noted, we gave you the breakout of that -13%. That was a contract only breakout that you saw there that we gave you. And the other thing you have to keep in mind is that the plus 8% as far as new business is a very good number especially given that those new customers that we are bringing on in record numbers are ordering less just like our existing customers are ordering less than they normally would.

That number is normal times would be higher, driving more growth. The economy and the impact of the economy is not only affecting existing customers, it’s also affecting our new customers as we bring them on less purchasing than they normally would.

Stephen Chick – FBR

Okay great, thanks.

Joe Doody

Right, thanks Steve.

Operator

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

Ron Sargent

Hey Dan, we got your name right.

Dan Binder – Jefferies & Co

Good. Once every five years it is good. Couple of questions for you, just touching on an earlier question, perhaps coming out with a different angle, with regard to the Corporate Express accounts that you did acquire, I believe some of them were probably lower margin type of accounts given the kind of contracts they signed in the year or two before you acquired them. I’m just curious what kind of success you’re having in getting the profitability up on those accounts and relative to your expectations where you haven’t been able to get the profitability up how many have you had to jettison. Again I realize some of it was probably in your expectation, I’m just looking for an update in terms of how that looks.

Ron Sargent

It’s a major topic of discussion and focus for the contract team on an ongoing basis. Progress is good and it’s not just good in terms of discussions on pricing specifically but also elimination of small orders and driving average order size up and the progress is good, it’s not great but it is continual. It’s better today than it was yesterday and it continues to get better each and every day. We’re still facing some headwinds there as you look at some of those factors like average order size gets affected by less discretionary buying so that’s a headwind working against us but we are seeing that it is moving upward and we’re closing the gap between e-customer average order size and the Staples pre-acquisition so that’s good. You’re right, we’re continuing to work with many key customers and in some cases are providing ultimatums if we can’t come to agreeable terms. There is some loss of business in our last quarter that was the result of that. That’s not something unusual though too, Dan. That’s an ongoing thing that we do with our customer base regardless of whether it’s with CE in it or not.

Dan Binder – Jefferies & Co

Pretty much in line with your expectations, is that fair?

Ron Sargent

Yes and I think we said right in the script that the 4% loss of business in contract was consistent with what it was a year ago before we had CE in the space it was a 4% loss impact on contract.

Dan Binder – Jefferies & Co

What about on the European side? Is the loss rate higher in the European contract business in terms of customers there and what are you seeing out of Lyrica? Are they being more aggressive with you now that relationship has ended?

Ron Sargent

My guess is it’s probably less impacting us in Europe. Peter you want to add a little commentary about this thing.

Peter Ventress

Yeah I mean it is tentative but we certainly don’t feel that we’re losing share, particularly so in the contract business. One thing that’s been particularly encouraging is our success in winning business in international accounts and those tend to be the larger ones where we would only be competing with our larger competitors including Lyrica. The sense in Europe is that we’re more than holding our own in terms of market share in the larger accounts.

Dan Binder – Jefferies & Co

Okay thank you.

Ron Sargent

Thanks Dan.

Operator

Your next question comes from the line of Brian Nagel with Oppenheimer

Brian Nagel – Oppenheimer & Co

Hi good morning. Just wanted to ask a question on North American Retail, when you and I traveled on the West Coast a few months ago we talked about the competitive situation and now we’ve moved past some of the competitive store closings, maybe give us an update on how your stores that at one time competed with those stores are performing or if you’ve continued up sales up tick now the stores are gone?

Ron Sargent

We’ve seen not only the Circuit City closures but I think we’ve seen about 107 Depot closures and Demos?

Demos Parneros

Brian, sales transfer is pretty much in line with what we predicted it to be when the closures were announced. The only color on it is that it started out slowly. Customers I think went through the liquidation which normally works against us and now that the stores are officially closed and gone we’ve started to see some of the traffic come on over. It really varies by store greatly depending on the distance for each store. But I’d say that it’s right in line with expectations.

Ron Sargent

We had a stat that was 107 Office Depot stores closing which affected I think 170 Staples stores.

Demos Parneros

Right, at varying degrees right where we want it to be.

Brian Nagel – Oppenheimer & Co

Okay. Thank you very much.

Ron Sargent

Thanks Brian.

Operator

Your next question comes from the line of Chris Horvers with JP Morgan

Chris Horvers – JP Morgan

Good morning. Can you talk a little bit about the trends you’re seeing in the different industries that you serve on the contract side where maybe the pace of changes is moving in one direction or the other and also very curious if you have any data on the SBD side in light of your commentary on some stabilization there?

Ron Sargent

Joe?

Joe Doody

Yeah industry one in the contract area we’re not heavily concentrated in any one industry. That being said, we do have a big portion of our business in financial markets so that has taken a pretty big impact and many of those financial firms that have been affected the hardest happen to be either Staples or CE customers. So, when you think of the Bear Sterns, Lehman, Countrywide Financial, Washington Mutual, etc. those are all ones that impacted us quite significantly that we’re seeing. Outside of that Chris, I wouldn’t say there’s any other industry sector that is working one way or the other, other than Government. Government and healthcare continue to be our strongest performing sectors, both Federal as well as State and Local Government, and I think we’re clearly believing that we’re gaining share in those sectors today.

Ron Sargent

Maybe the one trend we are seeing is that our smaller customers in Delivery are performing better than the large corporate accounts and that is reflected in the fact that both Quill and SBD have had a little bit better quarter both sequentially compared to Q4 and relative to contract and those are our business units that tend to serve smaller business and to some extent, home offices.

Chris Horvers – JP Morgan

Quill is primarily medical professionals right?

Joe Doody

No, part of their business is geared in that way with the acquisition we made several years ago Medical Arts Press but their primary customer is about two to 100 employees true mid market catalog.com customer.

Chris Horvers – JP Morgan

You’re not able to track what their business is.

Joe Doody

In what way?

Chris Horvers – JP Morgan

In SBD, are you able to have that same view from an industry perspective in SBD?

Joe Doody

From an industry perspective in SBD its heavily, heavily small business customers SBD one to 20 employees, very small business and very much in concert with our retail business in terms of going after that cross channel small business customer. As Mike indicated and as we’ve indicated we have seen some bottoming of that business and saw a modest improvement sequentially Q4 to Q1 in terms of their sales performance.

Chris Horvers – JP Morgan

Okay. On the margin side, with average order size and the perfect order metric with legacy, Corporate Express, can you talk about where you are in getting them up to the Staples level? How long do you think it could take, and ultimately what do you think the margin lift from such an initiative could be?

Joe Doody

I’m going to stay away from your last part of the question. We have addressed that right up front. We have said before that originally the differential between our average order size and contract which is well above $200 and theirs was more down in the $160 range that our goal was to really bring those together over time. We expect that to take several years but we are making some improvement in that. We’re well above $170 average order size now so its moving in that direction. And as a result of that, that continues to take cost out. Fewer shipments are made and as a result of that it is a margin enhancement but I’m not going to quantify that for you.

Chris Horvers – JP Morgan

Thank you.

Operator

Your next question comes from the line of Michael Baker with Deutsche Bank

Michael Baker – Deutsche Bank

Hi thanks guys, couple of questions. One, on the retail business itself is it fair to take the currency impact of about 4.7 percentage point and apply that to the comp? In other words, US comps in local currency is that down more like 4% or so and I think it’s better than it’s been sometimes. Is that true?

Ron Sargent

I think we calculate comp in local currency only.

Michael Baker – Deutsche Bank

Okay my mistake.

John Mahoney

It’s the overall revenue growth in NAR that’s impacted by currency.

Michael Baker – Deutsche Bank

Okay got it. On the Delivery business the 8% customer acquisition how is that compared to previous quarters?

Mike Miles

Well for example, we looked at a year ago first quarter of ’08 comparing it to first quarter of ’07 and its down slightly from that but it’s not down because of number of accounts acquired. It is clearly down because of the accounts that are acquired are buying and purchasing less from us during that first year. So, we have increased total number of accounts acquired in contract year-over-year but the amount that they are purchasing from us is down. Again, bodes very well for the future Mike, but just right now its making it a little.

Michael Baker – Deutsche Bank

I understand. That increase in the number of accounts acquired regardless of how much they’re spending, is that accelerating or decelerating or about what it’s been?

Mike Miles

It’s been about flat. It varies quarter to quarter but it’s positively growing off a pretty large base.

Michael Baker – Deutsche Bank

Okay thanks. Last question is as we are talking both of your biggest competitors have talked about being less promotional, almost giving up share to hold on to margin. Are you seeing that, are you seeing a less promotional environment at retail?

Ron Sargent

The thing I think Michael that I’ve seen is less of a focus from both of them on selling laptop computers at low prices. And I think particularly Office Depot has pulled back on their assortment in that space which I think translates into less promotional and also translates into better margin given the margin rates on that stuff.

Michael Baker – Deutsche Bank

Is that an opportunity for you or are you still pursuing the same type of strategy?

Ron Sargent

Absolutely, we think that there’s an opportunity for us in the computing space and we’ve improved a lot. Demos and his team in the US have improved a lot on our ability to sell attachments and services along with the computer hardware. And as a result of not only the pull back and closures by some of our office superstore competitors but also Circuit City going away that’s been an opportunity for us to gain share in that space and one of the upsides that you’ve seen is the rapid growth of our tech services business as a result of our ability to sell more than just a piece of hardware to computer customers.

Michael Baker – Deutsche Bank

Okay thanks a lot.

Ron Sargent

Thanks Mike.

Operator

Your next question comes from the line of Jack Murphy with William Blair

Ron Sargent

Morning Jack.

Jack Murphy – William Blair

Morning. A couple of dollar questions, one for John I guess, the free cash flow number looking for, I think you said around $1 billion, compared to last year’s $1.3 billion. In the first quarter you were up year-over-year more than kind of offsetting the lower net income and even if you adjust for CapEx you’re up. As we think about the remaining quarters can you talk a little bit about the sustainability of how you did in working capital improvements and address if there’s any large items that would hold back free cash so obviously other than lower net income.

John Mahoney

The one factor is that in the second quarter we tend to build inventories for back to school. You really almost have to look at the first half of the year rather than just the first quarter. So, you may see some smoothing of the growth in the second quarter. But other than that we expect to see strong performance in working capital throughout the rest of the year.

Jack Murphy – William Blair

Okay and then just a follow up on Brian’s earlier question about consolidation in the retail generally, could you talk a little bit about any opportunity you might be seeing in occupancy costs on existing stores? Is there any that you can do on leases approaching the end of the lease term, anything material there over the next couple years?

Ron Sargent

Demos?

Demos Parneros

We do think there’s an opportunity for stores which are nearing the end of their term. Over the next four years we have roughly 400, about 100 a year, store leases that are up for renewal and that gives us a great opportunity to go in and really evaluate not only that store but how it fits into the network which it is part of. As you know, we’ve lowered the size of our prototype store from 20,000 to 18,000 square feet. One of the things that we are evaluating is whether to keep the remaining space, downsize, in some cases not renew. As you mentioned there might be opportunity for lower rent. So, I think it gives us a wide range of options at that point to go in and make the best decision for not only for that store, for that network and the P&L overall. We look forward to it. As I said its 400 decisions over the next year or so, it should make a nice impact for us.

Jack Murphy – William Blair

Okay thanks.

John Mahoney

Just overall in the market while rents are down so are new stores. We’re tending to have good luck in negotiating rents there but the vast majority of our stores are on leases that average 10 to 15 years and we are not going to have many cases where we’re able to reduce the rent on those stores. So, the impact overall of reduced rent is not going to be all that material.

Operator

Your next question comes from the line of Alan Rifkin with Bank of America-Merrill Lynch

Ron Sargent

Good morning, Alan.

Alan Rifkin – Bank of America-Merrill Lynch

Good morning. How are you doing? Ron, you mentioned that in the first quarter with respect to Corporate Express you completed your vendor negotiations. I was wondering if you can maybe provide some color on the average reduction in procurement costs you’re now seeing. How is this number relative to your expectations and would it be reasonable for us to assume that it should start to benefit the P&L soon after the anniversary date of the Corporate Express acquisition?

Ron Sargent

I’m certainly not going to quantify but I can tell you that the vendor negotiations were successful and I think it allowed us to not only kind of interact with our vendors in a different way than maybe we have in the past. It also allowed us to select the right vendors for us going forward. We’ve said of the $300 million in synergies we thought probably 35% to 40% of that could potentially come from buying better in one form or another. And we still feel real comfortable with that number. I think you’re already seeing a little of the impact in the first quarter with our retail business benefited from the acquisition of Corporate Express as did obviously our Delivery business as well. We’re feeling pretty good about that phase. Obviously we’ve got a lot further to go. We think the $300 million will come in over three years not in just one year. But when you look at the progress we’ve made so far we’re really pleased about this whole integration process that the integration team has been leading for us here.

Alan Rifkin – Bank of America-Merrill Lynch

You still believe 35% to 40% of the $300 million in total is a reasonable number.

Ron Sargent

Yes

Alan Rifkin – Bank of America-Merrill Lynch

Okay and then just one follow up for Mike if I could, Mike you said operating margins in NAD declined by 285 basis points. Would you be able to provide some color as to how much of that deterioration was due to Corporate Express as opposed to other factors including mix shift?

Mike Miles

I think the majority of that impact was Corporate Express business. That is a lower margin business than the Staples business. There was some impact from our mix shift to more contract items and I think we said that was 50 basis points and there was some de-leverage of fixed expenses, salaries etc. But the big chunk of that was in the fact that CE margins were less than the Staples margins for that big chunk of North American business that we added in.

Alan Rifkin – Bank of America-Merrill Lynch

Okay thank you very much.

Mike Miles

Thank you, Alan.

Operator

Your last question comes from the line of Joe Feldman with Telsey Advisory Group

Ron Sargent

Hi Joe.

Joe Feldman – Telsey Advisory Group

Hi guys how are you? Since this is the last question, just a couple of questions on retail a little bit, can you talk a little more on the Easy Tech business and some of the initiatives you have there as a way to maybe pick up some of the share that Circuit City going away is giving up.

Demos Parneros

Hi Joe, the main thing that we really focused on is increased awareness and trial and really become more trusted by customers. I’m happy to say that we’re seeing good results. We heard the numbers earlier. A lot of customers are coming in, in response to one of the key promotions that we’ve run over the past few months which is a free PC tune up if a customer comes in and gets a full diagnosis of their PC. That introduces them to our service, our reliable staff which spend a lot of time building out the capability and training our associates, expanding the space in the store so we can do a good job not only doing the work but securing customers PCs, a lot of the things that go into building the trust. I’m happy to say that we’re actually seeing a lot of repeat business. They’re now coming in for more complex work. It’s on track, its growing. I think we’re on pace to double that business this year. Our focus is on getting the work done right, building the trust, really making sure that we do it right 100%. It’s very sensitive topic for customers to bring their PC, and their data, and put it in somebody else’s hands. We’re really focused on the service and the overall experience.

Mike Miles

Just to piggy back on that, the Circuit City closures have helped but we have stores that obviously haven’t had a Circuit City in their trade area and they are up substantially in Easy Tech sales as well. So, it’s really a growth across the chain in that business for us.

Joe Feldman – Telsey Advisory Group

It is good to hear and one last one on the copy centers, any update on the stand alone performance of the copy centers, those new ones that you have?

Ron Sargent

Hi Joe.

Demos Parneros

Sure. A quick update there is that we are on plan; we continue to open those stores. We have plans to open 10 this year. We currently have 16 stores in a number of different markets. Our priority there is to learn as much as we can while making the P&L work. We’re encouraged that we probably open them at a little bit of a tough time but I think the team’s done a real nice job at building out the merchandise assortment as well as the services and the capability. Once again, we’re getting a lot of customers to switch, bigger customers into the copy shops and results have been good. We’re not in additional markets. We’ve opened in Los Angeles market, and we’re in New York, New Jersey, Boston. One of the nice big benefits also from the stand alone stores is that we’re taking a lot of the successes and lessons that we learned in those stores, in those incubated kind of environment and then rolling those back to the entire chain so we’re seeing additional benefits beyond just those stores. So, good news on the stand alone copy shops.

Joe Feldman – Telsey Advisory Group

Okay thanks and good luck with the next quarter guys.

Demos Parneros

Thanks Joe.

Operator

Ladies and Gentlemen, this concludes your question and answer session. I would now like to turn the call over to Mr. Ron Sargent for closing remarks.

Ron Sargent

Thanks everybody. Thanks for joining us on the call this morning. We look forward to speaking with all of your again very soon.

Operator

Thank you for your participation in today’s conference. This concludes your presentation and you may now disconnect. Have a great day.