10-Q 1 spls10-q110114.htm 10-Q SPLS 10-Q 110114
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
 
(Mark one)
 
x  Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the quarterly period ended:  November 1, 2014

or
 
o Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the transition period from                                to                              
 
Commission File Number:  0-17586
 
STAPLES, INC.
(Exact name of registrant as specified in its charter)
Delaware
04-2896127
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification No.)
 Five Hundred Staples Drive, Framingham, MA  01702
(Address of principal executive offices 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 x  No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
 
Accelerated filer o
 
 
 
Non-accelerated filer o
 
Smaller reporting company o
(Do not check if a smaller reporting company)
 
 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes o  No x
 
The registrant had 639,801,830 shares of common stock outstanding as of November 17, 2014.



STAPLES, INC. AND SUBSIDIARIES
FORM 10-Q
November 1, 2014
TABLE OF CONTENTS
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


1


PART I. FINANCIAL INFORMATION 
Item 1. Financial Statements 
STAPLES, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(Dollar Amounts in Thousands, Except Share Data)
(Unaudited)
 
November 1, 2014
 
February 1, 2014
ASSETS
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
770,007

 
$
492,532

Receivables, net
1,964,553

 
1,838,714

Merchandise inventories, net
2,349,721

 
2,328,299

Deferred income tax assets
195,464

 
179,566

Prepaid expenses and other current assets
318,890

 
400,447

Total current assets
5,598,635

 
5,239,558

 
 
 
 
Property and equipment:
 

 
 

Land and buildings
987,358

 
990,324

Leasehold improvements
1,255,663

 
1,306,987

Equipment
2,837,502

 
2,778,294

Furniture and fixtures
1,036,579

 
1,078,876

Total property and equipment
6,117,102

 
6,154,481

Less: Accumulated depreciation
4,387,009

 
4,283,762

Net property and equipment
1,730,093

 
1,870,719

 
 
 
 
Intangible assets, net of accumulated amortization
359,626

 
382,700

Goodwill
3,181,981

 
3,233,597

Other assets
434,068

 
448,302

Total assets
$
11,304,403

 
$
11,174,876

LIABILITIES AND STOCKHOLDERS’ EQUITY
 

 
 

Current liabilities:
 

 
 

Accounts payable
$
2,201,050

 
$
1,997,494

Accrued expenses and other current liabilities
1,327,146

 
1,266,974

Debt maturing within one year
92,526

 
103,982

Total current liabilities
3,620,722

 
3,368,450

 
 
 
 
Long-term debt, net of current maturities
1,025,740

 
1,000,205

Other long-term obligations
625,351

 
665,386

 
 
 
 
Stockholders’ equity:
 

 
 

Preferred stock, $.01 par value, 5,000,000 shares authorized; no shares issued

 

Common stock, $.0006 par value, 2,100,000,000 shares authorized; issued and outstanding 939,733,799 and 640,099,237 shares at November 1, 2014 and 938,722,858 shares and 652,860,207 shares at February 1, 2014, respectively
564

 
563

Additional paid-in capital
4,896,381

 
4,866,467

Accumulated other comprehensive loss
(643,764
)
 
(507,154
)
Retained earnings
7,166,108

 
7,001,755

Less: Treasury stock at cost, 299,634,562 shares at November 1, 2014 and 285,862,651 shares at February 1, 2014
(5,395,200
)
 
(5,229,368
)
Total Staples, Inc. stockholders’ equity
6,024,089

 
6,132,263

Noncontrolling interests
8,501

 
8,572

Total stockholders’ equity
6,032,590

 
6,140,835

Total liabilities and stockholders’ equity
$
11,304,403

 
$
11,174,876

 
See notes to condensed consolidated financial statements.

2


STAPLES, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Comprehensive Income
(Dollar Amounts in Thousands, Except Per Share Data)
(Unaudited)
 
 
13 Weeks Ended
 
39 Weeks Ended
 
November 1,
2014
 
November 2,
2013
 
November 1,
2014
 
November 2,
2013
Sales
$
5,961,531

 
$
6,111,695

 
$
16,835,893

 
$
17,240,990

Cost of goods sold and occupancy costs
4,365,255

 
4,456,969

 
12,521,280

 
12,715,758

Gross profit
1,596,276

 
1,654,726

 
4,314,613

 
4,525,232

Operating expenses:
 

 
 

 
 
 
 
Selling, general and administrative
1,224,049

 
1,210,251

 
3,627,438

 
3,581,206

Impairment of long-lived assets
8,970

 

 
35,974

 

Restructuring charges
24,565

 
64,085

 
126,467

 
64,085

Amortization of intangibles
16,139

 
13,794

 
45,844

 
40,551

Total operating expenses
1,273,723

 
1,288,130

 
3,835,723

 
3,685,842

 
 
 
 
 
 
 
 
Gain on sale of businesses, net
5,690

 

 
27,495

 

 
 
 
 
 
 
 
 
Operating income
328,243


366,596


506,385


839,390

 
 
 
 
 
 
 
 
Other income (expense):
 

 
 

 
 
 
 
Interest income
632

 
1,319

 
2,175

 
4,289

Interest expense
(12,566
)
 
(30,446
)
 
(37,527
)
 
(91,682
)
Other income (expense), net
(2,538
)
 
3,975

 
2,913

 
(3,834
)
Income from continuing operations before income taxes
313,771

 
341,444

 
473,946

 
748,163

Income tax expense
96,979

 
121,359

 
79,069

 
253,542

Income from continuing operations
216,792

 
220,085

 
394,877

 
494,621

Discontinued Operations:
 
 
 
 
 
 
 
Loss from discontinued operations, net of income taxes

 
(84,857
)
 

 
(86,935
)
Net income
$
216,792

 
$
135,228


$
394,877


$
407,686

 
 
 
 
 
 
 
 
Basic Earnings Per Common Share:
 

 
 

 
 
 
 
Continuing operations
$
0.34

 
$
0.34

 
$
0.62

 
$
0.76

Discontinued operations

 
(0.13
)
 

 
(0.13
)
Net income
$
0.34

 
$
0.21

 
$
0.62

 
$
0.63

Diluted Earnings Per Common Share:
 
 
 
 
 
 
 
Continuing operations
$
0.34

 
$
0.34

 
$
0.61

 
$
0.75

Discontinued operations

 
(0.13
)
 

 
(0.13
)
Net income
$
0.34

 
$
0.21

 
$
0.61

 
$
0.62

 
 
 
 
 
 
 
 
Dividends declared per common share
$
0.12

 
$
0.12

 
$
0.36

 
$
0.36

 









3


STAPLES, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Comprehensive Income
(Amounts in Thousands)
(Unaudited)
 
13 Weeks Ended
 
39 Weeks Ended
 
November 1,
2014
 
November 2,
2013
 
November 1,
2014
 
November 2,
2013
Comprehensive income from consolidated operations
$
80,036

 
$
191,130

 
$
258,196

 
$
352,528

Comprehensive income (loss) attributed to noncontrolling interests
89

 
52

 
(71
)
 
185

Comprehensive income attributed to Staples, Inc.
$
79,947

 
$
191,078

 
$
258,267

 
$
352,343


See notes to condensed consolidated financial statements.

4


STAPLES, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Dollar Amounts in Thousands)
(Unaudited)
 
39 Weeks Ended
 
November 1, 2014
 
November 2, 2013
Operating Activities:
 

 
 

Consolidated net income
$
394,877

 
$
407,686

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation
300,348

 
301,348

Amortization of intangibles
45,844

 
40,551

(Gain) loss on sale of businesses, net
(27,495
)
 
80,887

Impairment of long-lived assets
35,974

 

Inventory write-downs related to restructuring activities
26,307

 

Stock-based compensation
51,051

 
62,113

Excess tax benefits from stock-based compensation arrangements
(404
)
 
(2,164
)
Deferred income tax (benefit) expense
(20,670
)
 
41,856

Other
15,489

 
(1,481
)
Changes in assets and liabilities:
 
 
 
Increase in receivables
(150,703
)
 
(81,505
)
Increase in merchandise inventories
(72,090
)
 
(138,399
)
Decrease in prepaid expenses and other assets
47,924

 
17,359

Increase in accounts payable
221,364

 
203,200

Increase in accrued expenses and other liabilities
71,048

 
52

Decrease in other long-term obligations
(30,686
)
 
(56,364
)
Net cash provided by operating activities
908,178

 
875,139

 
 
 
 
Investing Activities:
 

 
 

Acquisition of property and equipment
(201,076
)
 
(204,212
)
Cash paid for termination of joint venture

 
(34,298
)
Proceeds from the sale of property and equipment
3,160

 
12,849

Sale of businesses, net
58,639

 
(12,736
)
Acquisition of businesses, net of cash acquired
(67,888
)
 
(74,632
)
Net cash used in investing activities
(207,165
)
 
(313,029
)
 
 
 
 
Financing Activities:
 

 
 

Proceeds from the exercise of stock options and sale of stock under employee stock purchase plans
19,689

 
56,146

Proceeds from borrowings
19,488

 
31,614

Payments on borrowings and capital lease obligations
(44,721
)
 
(39,863
)
Purchase of noncontrolling interest

 
(96
)
Cash dividends paid
(230,524
)
 
(234,939
)
Excess tax benefits from stock-based compensation arrangements
404

 
2,164

Repurchase of common stock
(182,940
)
 
(303,254
)
Net cash used in financing activities
(418,604
)
 
(488,228
)
Effect of exchange rate changes on cash and cash equivalents
(12,802
)
 
(16,308
)
Net increase in cash and cash equivalents
269,607

 
57,574

Cash and cash equivalents at beginning of period
492,532

 
1,334,302

Cash and cash equivalents at end of period
762,139

 
1,391,876

Less: Change in cash and cash equivalents attributed to discontinued operations

 
(705
)
Add: Cash and cash equivalents attributed to disposal group held for sale at February 1, 2014
7,868

 

Cash and cash equivalents at the end of the period
$
770,007

 
$
1,391,171

 See notes to condensed consolidated financial statements.

5


STAPLES, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 
Note A — Basis of Presentation
 
The accompanying interim unaudited condensed consolidated financial statements include the accounts of Staples, Inc. and its subsidiaries (“Staples” or “the Company”). All intercompany accounts and transactions have been eliminated in consolidation.  These financial statements are for the period covering the 13 and 39 weeks ended November 1, 2014 (also referred to as the “third quarter of 2014" and "year-to-date 2014") and the period covering the 13 and 39 weeks ended November 2, 2013 (also referred to as the “third quarter of 2013” and "year-to-date 2013").

On July 11, 2014, Staples completed its acquisition of PNI Digital Media, Inc. ("PNI") for $67.9 million. PNI's results of operations are included in the Company's consolidated results from that date forward.

The Company's former European Printing Systems Division business ("PSD") was presented as a discontinued operation in the condensed consolidated statement of comprehensive income during the third quarter of 2013 and year-to-date 2013. The Company completed the sale of PSD on October 5, 2013. Unless otherwise stated, any reference to the condensed consolidated statement of comprehensive income in the notes to the condensed consolidated financial statements for that period refers to results from continuing operations.
 
These financial statements have been prepared based upon Securities and Exchange Commission (“SEC”) rules that permit reduced disclosure for interim periods.  In the opinion of management, these 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.  For a more complete discussion of significant accounting policies and certain other information, these financial statements should be read in conjunction with the audited consolidated financial statements and the related notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended February 1, 2014 ("Annual Report"). 

The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full fiscal year. Our business is somewhat seasonal, with sales and profitability historically higher during the second half of our fiscal year due to the back-to-school, holiday and January back-to-business seasons.

Note BRecent Accounting Pronouncements

In May 2014, a pronouncement was issued that creates common revenue recognition guidance for U.S. GAAP and International Financial Reporting Standards. The new guidance supersedes most preexisting revenue recognition guidance. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The new standard will be effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period, and early adoption is not permitted. The standard shall be applied either retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption. For Staples, the standard will be effective in the first quarter of fiscal 2017. The Company is currently evaluating the impact of the new pronouncement on the Company's condensed consolidated financial statements.

In April 2014, a pronouncement was issued that changes the requirements for reporting discontinued operations. The new pronouncement stipulates that the disposal of a component of an entity is to be reported in discontinued operations only if the disposal represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results. The pronouncement also removed the conditions that a) the operations and cash flows of the component have been (or will be) eliminated from the ongoing operations of the entity as a result of the disposal transaction and b) the entity will not have any significant continuing involvement in the operations of the component after the disposal transaction. The Company adopted this guidance as of the beginning of its fiscal year 2014. The guidance will apply to components of the Company that are disposed or classified as held for sale after the effective date. The adoption of this guidance had no impact on the Company's condensed consolidated financial statements for year-to-date 2014.


6

STAPLES, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)



Note CRestructuring Charges
2014 Restructuring Plan

The performance of the Company’s North American retail stores has fallen short of management’s expectations over the past few years, and the Company continues to see customer demand shifting to online channels, which has led the Company to increase its focus on growing its online businesses.  As a result, in March 2014 the Company announced that its Board of Directors (the “Board”) had approved the closure of up to 225 retail stores in North America by the end of fiscal year 2015 (the “Store Closure Plan”).
In addition, as part of the Company’s continuing efforts to transform its business, the Company initiated a cost savings plan to generate annualized pre-tax savings of approximately $500 million by the end of fiscal 2015.  The Company expects the savings to come from global supply chain, retail store closures and labor optimization, non-product related costs, IT hardware and services, marketing, sales force, and customer service.  The Company plans to reinvest some of the savings in its strategic initiatives. The actions to be taken related to the $500 million cost savings plan, together with the actions to be taken related to the Store Closure Plan, are herein referred to as the "2014 Plan". The Company expects to substantially complete the actions required under the 2014 Plan by the end of 2015.
In the first half of 2014, the Company approved the closure of 137 specific retail stores. Also in the first half of 2014, pursuant to the Company's efforts to improve efficiencies in its delivery fulfillment operations, the Company approved the closure of two fulfillment centers.
In the third quarter of 2014, the Company approved the closure of an additional 53 retail stores, which includes the planned closure of 36 stores in the fourth quarter of 2014 and 17 stores in the first quarter of 2015. Also in the third quarter of 2014, the Company approved the closure of certain facilities and the outsourcing of certain logistics functions that currently support its North American delivery businesses.
As a result of these actions, the Company recorded pre-tax charges of $48.4 million and $192.3 million in the third quarter and year-to-date 2014, respectively. The table below provides a summary of the charges recorded in the third quarter and year-to-date 2014 for each major type of cost associated with the 2014 Plan, as well as the Company's current estimates of the amount of charges expected to be incurred during the fourth quarter of 2014 in connection with the 2014 Plan. The table also summarizes the costs incurred and expected to be incurred by reportable segment (in millions).
 
 
2014 Plan
 
 
Actual costs incurred
 
Estimated costs to be incurred
 
 
Third quarter of 2014
 
Year-to-Date 2014
 
Fourth quarter of 2014
Employee related costs
 
$
8.6

 
$
20.8

 
 $15M - 25M
Contractual obligations
 
15.8

 
92.4

 
 25M - 35M
Other associated costs
 
2.1

 
12.5

 
Less than 5M
Total restructuring charges
 
26.6

 
125.7

 
 40M - 65M
Impairment of long-lived assets and accelerated depreciation
 
11.2

 
40.3

 
 5M - 10M
Inventory write-downs
 
10.6

 
26.3

 
Less than 5M
Total charges
 
$
48.4

 
$
192.3

 
 $45M - 80M
 
 
 
 
 
 
 
North American Stores & Online
 
$
29.4

 
$
153.7

 
 $20M - 30M
North American Commercial
 
15.9

 
33.2

 
 10M - 20M
International Operations
 
3.1

 
5.4

 
15M - 30M
Total charges
 
$
48.4

 
$
192.3

 
 $45M - 80M

The Company's estimates of future charges could change as the Company's plans evolve and become finalized. The actual amount of charges recognized during the fourth quarter of 2014 will depend on which specific additional retail stores, if

7

STAPLES, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)



any, are approved for closure during the remainder of the fiscal year, as well as the timing of such closures. The actual amount of charges recognized during the remainder of 2014 will also depend on the nature and timing of other specific actions to be taken related to the $500 million costs savings plan. At this time the Company cannot reliably estimate the costs to be incurred in fiscal 2015 related to the 2014 Plan, given the degree of uncertainty related to the timing and nature of the specific actions to be taken next year. The Company continues to evaluate the scope and nature of its restructuring plans.
See Note D - Impairment of Long-Lived Assets for additional information related to the $9.0 million and $36.0 million of fixed asset impairment charges recorded during the third quarter and year-to-date 2014, respectively. The Company also recorded accelerated depreciation of $2.2 million and $4.3 million in the third quarter and year-to-date of 2014, respectively, primarily related to the planned closure of facilities supporting the Company's North American delivery operations.

During the third quarter and year-to-date 2014, the Company recognized inventory write-downs of $10.6 million and $26.3 million, respectively, primarily related to the rationalization of certain SKU's pursuant to the Company's efforts to improve efficiencies in its delivery fulfillment operations, as well as the retail store closures. The inventory write-downs are included in Cost of goods sold and occupancy costs in the condensed consolidated statement of comprehensive income.

The table below shows the restructuring charges recorded during the year-to-date 2014 and the related liability balances as of November 1, 2014 for each major type of cost associated with the 2014 Plan (in thousands):
 
 
2014 Plan
 
 
Employee Related
 
Contractual Obligations
 
Other
 
Total
Accrued restructuring balance as of February 1, 2014
 
$

 
$

 
$

 
$

Charges
 
20,836

 
92,365

 
12,479

 
125,680

Cash payments
 
(6,857
)
 
(20,837
)
 
(5,551
)
 
(33,245
)
Foreign currency translations
 
(87
)
 
(236
)
 
(9
)
 
(332
)
Accrued restructuring balance as of November 1, 2014
 
$
13,892

 
$
71,292

 
$
6,919

 
$
92,103


Of the $125.7 million of restructuring charges incurred during year-to-date 2014 related to the 2014 Plan, approximately $111.9 million relates to North American Stores & Online, $10.1 million relates to North American Commercial and $6.5 million relates to International Operations. For the restructuring liabilities associated with the 2014 Plan, $53.8 million of contractual obligations costs are included within Other long-term obligations and the remaining balances are included within Accrued expenses and other current liabilities in the Company's condensed consolidated balance sheet as of November 1, 2014. The Company expects that payments related to employee related liabilities associated with the 2014 Plan will be substantially completed by the end of fiscal 2015. The Company anticipates that payments related to facility lease obligations will be completed by fiscal year 2025.
    
The restructuring charges related to the 2014 Plan are presented within Restructuring charges in the Company's condensed consolidated statement of comprehensive income. The table below shows how the $125.7 million of restructuring charges would have been allocated if the Company had recorded the expenses within the functional departments of the restructured activities (in thousands):
 
 
13 Weeks Ended
 
39 Weeks Ended
 
 
November 1, 2014
Cost of goods sold and occupancy costs
 
$
14,270

 
$
90,656

Selling, general and administrative
 
12,335

 
35,024

Total
 
$
26,605

 
$
125,680


2013 Restructuring Plan
In the third quarter of 2013, as part of the Company's continuing efforts to cut costs, the Company initiated a restructuring plan (the "2013 Plan”) to streamline its operations and general and administrative functions. Pursuant to the 2013 Plan, certain distributed general and administrative functions are being centralized, which the Company believes will help drive additional synergies across business units. In addition, certain operational resources are being consolidated, which the Company believes will result in increased efficiencies, without negatively impacting customer service.

8

STAPLES, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)



As a result of actions initiated under the 2013 Plan, during 2013 the Company recorded pre-tax restructuring charges of $78.3 million, including $75.5 million for employee severance costs related to the elimination of positions throughout the organization and $2.8 million for other associated costs. Of these amounts, $62.7 million related to the Company's International Operations segment and $15.6 million related to the Company’s corporate headquarters and North American operations. The Company does not expect to incur material costs in future periods related to the 2013 Plan. The Company expects to substantially complete the actions required under the 2013 Plan by the first half of fiscal 2015.

During the first three quarters of 2014, the Company recorded adjustments to increase the employee-related liability associated with the 2013 Plan by $5.5 million and to decrease the liability for other associated costs by $1.2 million. The adjustment to the employee-related liability stemmed from changes in estimates regarding the number of headcount reductions and the amount of severance benefits per associate, primarily related to the closure of a distribution center in Europe and the Company's restructuring of its European marketing and merchandising organizations. The adjustment to the liability for other associated costs resulted from changes in estimates related to professional fees incurred in connection with the 2013 Plan.

The table below shows a reconciliation of the beginning and ending liability balances related to each major type of cost incurred under the 2013 Plan (in thousands):
 
 
2013 Plan
 
 
Employee Related
 
Other
 
Total
Accrued restructuring balance as of February 1, 2014
 
$
62,489

 
$
2,532

 
$
65,021

Cash payments
 
(15,603
)
 
(1,327
)
 
(16,930
)
Adjustments
 
5,477

 
(1,243
)
 
4,234

Foreign currency translations
 
(3,927
)
 
38

 
(3,889
)
Accrued restructuring balance as of November 1, 2014
 
$
48,436

 
$

 
$
48,436

    
For the restructuring liabilities associated with the 2013 Plan, all of the balances are included within Accrued expenses and other current liabilities in the Company's condensed consolidated balance sheet as of November 1, 2014. The Company expects that the payments related to the employee related liabilities will be substantially completed by the third quarter of fiscal 2015.

2012 Restructuring Plan
In 2012, the Company initiated a strategic plan (the “2012 Plan”) aimed at accelerating growth, particularly in the Company's online businesses. Elements of the 2012 Plan included more fully integrating the Company's retail and online offerings, restructuring its International Operations segment and improving the productivity of its stores in North America. Pursuant to the 2012 Plan, the Company took the following actions:
closed 46 retail stores in Europe and accelerated the closure of 15 retail stores in the United States;
closed and consolidated certain sub-scale delivery businesses in Europe;
disposed of PSD;
reorganized certain general and administrative functions in Europe; and
rebranded its business in Australia from the Corporate Express tradename to the Staples tradename.

As a result of the actions taken under the 2012 Plan, during 2012 the Company recorded pre-tax restructuring charges of $207.0 million related to continuing operations. Of this amount, approximately $177 million related to the Company's International Operations segment and $30 million related to the North American Stores & Online segment. The Company does not expect to incur material costs in the future in connection with the 2012 Plan. The actions required under the 2012 Plan were substantially complete by the end of fiscal 2013.

9

STAPLES, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)



The table below shows a reconciliation of the beginning and ending liability balances related to each major type of cost incurred under the 2012 Plan (in thousands):
 
 
2012 Plan
 
 
Contractual Obligation
 
Employee Related
 
Other
 
Total
Accrued restructuring balance as of February 1, 2014
 
$
28,681

 
$
13,787

 
$
179

 
$
42,647

Cash payments
 
(12,460
)
 
(6,835
)
 

 
(19,295
)
Adjustments
 
(428
)
 
(2,839
)
 
(179
)
 
(3,446
)
Foreign currency translations
 
(406
)
 
442

 

 
36

Accrued restructuring balance as of November 1, 2014
 
$
15,387

 
$
4,555

 
$

 
$
19,942

The Company expects that payments related to employee related liabilities associated with the 2012 Plan will be substantially completed by the first quarter of 2015. The Company anticipates that payments related to facility lease obligations will be completed by fiscal year 2024. During the third quarter of 2014 the Company recorded an adjustment to reduce the severance liability related to the 2012 restructuring plan by $2.0 million due to changes in estimates for the amount of severance benefits to be paid under this plan (primarily related to the Company's North American Stores & Online segment).

For the restructuring liabilities associated with the 2012 Plan, $6.2 million of the contractual obligations are included in Other long-term obligations and the remaining balances are included within Accrued expenses and other current liabilities in the Company's condensed consolidated balance sheet as of November 1, 2014.

Note DImpairment of Long-Lived Assets

During the first nine months of 2014, the Company approved the closure of 190 retail stores pursuant to its plan to close up to 225 retail stores in North America by the end of 2015 (see Note C - Restructuring Charges). As a result, in the third quarter of 2014 and year-to-date 2014, the Company recorded long-lived asset impairment charges of $9.0 million and $36.0 million, respectively, primarily relating to leasehold improvements, fixtures, equipment and other fixed assets at the store locations. These charges relate to the Company's North American Stores & Online segment.

These charges were based on measurements of the fair value of the impaired assets derived using the income approach, specifically the discounted cash flow method, which incorporated Level 3 inputs as defined in Accounting Standards Codification ("ASC") Topic 820, “Fair Value Measurements and Disclosures” ("ASC Topic 820"). The Company considered the expected net cash flows to be generated by the use of the assets through the store closure dates, as well as the expected cash proceeds from the disposition of the assets, if any. The Company determined that the fair value of the impaired assets was not material.

Note EDivestitures

During the fourth quarter of 2013, the Company classified certain assets and liabilities of its Smilemakers, Inc. business unit as a disposal group and accounted for the group as held-for-sale in the consolidated balance sheet as of February 1, 2014. On May 2, 2014, the Company completed the sale of this business unit, recognizing a gain of $23.4 million. A working capital adjustment finalized in the second quarter of 2014 was not material. The results of operations for Smilemakers, Inc. had not been material to the Company's consolidated results of operations nor to its segment reporting, and therefore this business has not been presented as a discontinued operation in the Company's consolidated financial statements. Smilemakers, Inc. was a component of the Company's North American Commercial segment.

The Company also completed the sale of a small business in Europe in the first quarter of 2014 and the sale of a small U.S. business that was a component of the Company's North American Commercial segment in the third quarter of 2014, recognizing a $1.6 million loss and a $5.7 million gain on the sales, respectively.

On October 5, 2013, the Company completed the sale of PSD, recognizing a preliminary loss on disposal of $80.9 million in the third quarter of 2013 that is subject to the impact of a working capital adjustment to the purchase price. The loss is included in Loss from discontinued operations, net of income taxes in the condensed consolidated statements of comprehensive income. The amount of the working capital adjustment is currently in dispute between the parties to the transaction. The parties are currently pursuing dispute resolution procedures to attempt to resolve the issue.


10

STAPLES, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)



The following table details PSD's results of operations during the nine and thirty-five weeks ended October 5, 2013, which were reported in discontinued operations (in thousands):
 
 
9 Weeks Ended
 
35 Weeks Ended
 
 
October 5, 2013
Sales
 
$
37,641

 
$
199,224

 
 
 
 
 
Loss from discontinued operations, before income taxes (including loss on disposal of $80.9 million in the 9 and 35 weeks ended October 5, 2013)
 
(86,070
)
 
(88,301
)
Income tax benefit
 
(1,213
)
 
(1,366
)
Loss from discontinued operations, net of income taxes
 
$
(84,857
)
 
$
(86,935
)

Note F Income Taxes

As of November 1, 2014, the Company's liability for unrecognized tax benefits decreased by a net $43.8 million compared with February 1, 2014. The following table summarizes the activity related to the Company's unrecognized tax benefits during the first nine months of 2014 (in thousands):

 
 
Unrecognized tax benefits
Balance at February 1, 2014
 
$
280,959

    Additions for tax positions related to the current year
 
15,317

    Additions for tax positions related to prior years
 
36,022

    Reductions for tax positions related to prior years
 
(78,214
)
    Settlements
 
(16,899
)
Balance at November 1, 2014
 
$
237,185


The decline in the liability for unrecognized tax benefits during year-to-date 2014 reflects, in part, a $63.3 million net reduction in the liability in the second quarter of 2014 for discrete items that impacted the Company's income tax rate. The primary driver of this net reduction was the resolution of federal and foreign audits during the second quarter of 2014.  The federal audit primarily pertained to the utilization of certain net operating loss carryforwards that the Company acquired by virtue of its acquisition of Corporate Express, while the foreign audits primarily pertained to France. The $63.3 million net reduction also reflects certain increases to the reserve as a result of recent state and foreign court decisions in certain jurisdictions in which the Company operates.

As of November 1, 2014, the Company had $237.2 million of gross unrecognized tax benefits, of which $220.2 million, if recognized, would affect the Company's tax rate. The Company does not reasonably expect any material changes to the estimated amount of the liability associated with its uncertain tax positions during the next twelve months.

The Company had $43.3 million and $46.7 million accrued for gross interest and penalties as of November 1, 2014 and February 1, 2014, respectively.
 
During the first quarter of 2014, the Company repatriated $127.3 million of cash held by a foreign subsidiary.  As a result, during the first quarter of 2014 the Company recorded income tax expense of $11.2 million related to taxable income generated in the U.S. stemming from this repatriation.  For the undistributed earnings remaining in the Company’s foreign subsidiaries after the repatriation that have not been previously taxed in the U.S., the Company’s intention remains to indefinitely reinvest those funds outside of the U.S., and accordingly deferred taxes have not been provided for these funds. The determination of the amounts of the unrecognized deferred tax liability related to the undistributed earnings is not practicable because of the complexities associated with its hypothetical calculation.

Note GFair Value Measurements

ASC Topic 820 establishes a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1 measurement), then priority

11

STAPLES, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)



to quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market (Level 2 measurement), then the lowest priority to unobservable inputs (Level 3 measurement).
 
The fair values of cash and cash equivalents, receivables, accounts payable, accrued expenses, other current liabilities and short-term debt approximate their carrying values because of their short-term nature. 

 The following table shows the difference between the financial statement carrying value and fair value of the Company's debt obligations (see Note H - Debt and Credit Agreements) as of November 1, 2014 and February 1, 2014 (in thousands). The fair values of these notes were determined based on quoted market prices and are classified as Level 1 measurements.
 
November 1, 2014
 
February 1, 2014
 
Carrying Value
 
Fair Value
 
Carrying Value
 
Fair Value
January 2018 Notes
$
499,124

 
$
505,150

 
$
498,919

 
$
505,189

January 2023 Notes
499,212

 
499,600

 
499,140

 
486,947

 
The following table shows the Company’s assets and liabilities as of November 1, 2014 and February 1, 2014 that are measured and recorded in the financial statements at fair value on a recurring basis (in thousands): 
 
November 1, 2014
 
Quoted Prices in Active Markets for Identical Assets or Liabilities
 
Significant Other Observable Inputs
 
Unobservable Inputs
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
Money market funds
$
14,574

 
$

 
$

Non-designated derivative asset

 
544

 


 
February 1, 2014
 
Quoted Prices in Active Markets for Identical Assets or Liabilities
 
Significant Other Observable Inputs
 
Unobservable Inputs
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
Money market funds
$
37,288

 
$

 
$

Liabilities
 
 
 
 
 
Non-designated derivative liabilities

 
(4,688
)
 


     The derivatives shown in the tables above have not been designated as hedges pursuant to the guidelines of ASC 815, "Derivatives and Hedging."

The fair values of the Company’s money market funds are based on quotes received from third-party banks.  The fair values of the Company’s derivative assets and liabilities are based on quotes received from third-party banks and represent the estimated amount the Company would receive or pay to terminate the agreements taking into consideration current interest and forward exchange rates as well as the creditworthiness of the counterparty.

Note HDebt and Credit Agreements

On May 31, 2013, the Company entered into a new credit agreement (the "May 2018 Revolving Credit Facility") with Bank of America, N.A., as Administrative Agent and other lending institutions named therein. The May 2018 Revolving Credit Facility provides for a maximum borrowing of $1.0 billion, which pursuant to an accordion feature may be increased to $1.5 billion upon our request and the agreement of the lenders participating in the increase. Borrowings may be syndicated loans, swing line loans, multicurrency loans, or letters of credit, the combined sum of which may not exceed the maximum borrowing amount. Amounts borrowed may be repaid and reborrowed from time to time until May 31, 2018. Borrowings will bear interest at various interest rates depending on the type of borrowing, and will reflect a percentage spread based on the Company's credit rating and fixed charge coverage ratio. The Company will pay a facility fee at rates that range from 0.08% to 0.225% per annum depending on our credit rating and fixed charge coverage ratio. The May 2018 Revolving Credit Facility is unsecured and ranks pari passu

12

STAPLES, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)



with the Company's public notes and other indebtedness and contains customary affirmative and negative covenants for credit facilities of this type. The May 2018 Revolving Credit Facility also contains financial covenants that require the Company to maintain a minimum fixed charge coverage ratio and a maximum adjusted funded debt to total capitalization ratio.

The Company has a commercial paper program ("Commercial Paper Program") that allows it to issue up to $1.0 billion of unsecured commercial paper notes ("Commercial Paper Notes") from time to time. The May 2018 Revolving Credit Facility serves as a back-up to the Commercial Paper Program. The Company typically uses proceeds from the Commercial Paper Notes for general purposes, including working capital, capital expenditures, acquisitions and share repurchases. Maturities of the Commercial Paper Notes vary, but may not exceed 397 days from the date of issue. During year-to-date 2014, the Company borrowed under the Commercial Paper Program to support its seasonal working capital requirements. As of November 1, 2014, no Commercial Paper Notes were outstanding. The maximum amount outstanding under the Commercial Paper Program during year-to-date 2014 was $150.0 million.

The Company has various other lines of credit under which it may borrow a maximum of $144.9 million. At November 1, 2014, the Company had outstanding borrowings of $79.8 million and outstanding letters of credit of $0.2 million related to these lines of credit, leaving $64.9 million of available credit at that date.    
    
The major components of the Company’s outstanding debt as of November 1, 2014 and February 1, 2014 are as follows (in thousands):
 
November 1, 2014
 
February 1, 2014
January 2018 Notes
$
499,124

 
$
498,919

January 2023 Notes
499,212

 
499,140

Other lines of credit
79,760

 
100,100

Capital lease obligations and other notes payable
40,170

 
6,028

 
1,118,266

 
1,104,187

Less: current portion
(92,526
)
 
(103,982
)
Net long-term debt
$
1,025,740

 
$
1,000,205


The Company entered into $37.7 million of new capital lease obligations during year-to-date 2014. Staples did not incur any new capital lease obligations in 2013.
 
Note IDerivatives Instruments and Hedging Activities
 
From time to time, Staples uses interest rate swaps, foreign currency swaps and foreign currency forward agreements to offset certain operational and balance sheet exposures related to changes in interest or foreign exchange rates.  These agreements are entered into to support transactions made in the normal course of business and, accordingly, are not speculative in nature.  The derivatives qualify for hedge accounting treatment if they are highly effective in offsetting the underlying exposures related to the hedged items.
 
All derivatives are recorded at fair value and the changes in fair value are immediately included in earnings if the derivatives do not qualify as effective hedges. If a derivative is designated as a fair value hedge, then changes in the fair value of the derivative are offset against the changes in the fair value of the underlying hedged item in earnings.  If a derivative is designated as a cash flow hedge, then the effective portion of the changes in the fair value of the derivative is recognized as a component of accumulated other comprehensive income (loss) until the underlying hedged item is recognized in earnings or the forecasted transaction is no longer probable of occurring. If a derivative or a non-derivative financial instrument is designated as a hedge of the Company’s net investment in a foreign subsidiary, then changes in the fair value of the financial instrument are recognized as a component of accumulated other comprehensive income (loss) to offset a portion of the change in the translated value of the net investment being hedged, until the investment is sold or liquidated. The Company formally documents all hedging relationships for all derivatives, non-derivative hedges and the underlying hedged items, as well as its risk management objectives and strategies for undertaking the hedge transactions.  There are no amounts excluded from the assessment of hedge effectiveness.
 
The Company classifies the fair value of all derivative contracts and the fair value of its hedged firm commitments as either current or long-term depending on whether the maturity date of the derivative contract is within or beyond one year from the balance sheet date. The cash flows from derivatives are classified in the Company's condensed consolidated statement of cash flows in the same category as the item being hedged.

13

STAPLES, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)




Foreign Currency Forwards and Swaps:

In December 2011, the Company entered into foreign currency forwards designed to convert a series of intercompany loans denominated in Canadian dollars into a fixed U.S. dollar amount. The loans totaled 750 million Canadian dollars in the aggregate and matured at various dates between October 2012 and October 2013. Staples, upon full maturity of the agreements in October 2013, had collected $720 million and paid 750 million Canadian dollars per the terms of the contracts. The forward agreements were accounted for as a fair value hedge. In 2012, the Company settled 500 million Canadian dollars of the notional amount relating to this forward, realizing a loss of $24.2 million, which was recorded within Other income (expense), net. In 2013, the Company settled 150 million Canadian dollars of notional amount in its second fiscal quarter and the final 100 million Canadian dollars of notional amount in the third quarter, realizing losses of $1.0 million and $4.2 million in the third quarter and year-to-date 2013, respectively which were recorded within Other income (expense), net. Unrealized gains of $5.8 million were recognized in Other expense, net during year-to-date 2013 related to the outstanding portions of this fair value hedge.

Note JEquity Based Employee Benefit Plans
 
Under the 2014 Stock Incentive Plan, the Company may grant restricted stock and restricted stock units (collectively, “Restricted Shares”) and non-qualified stock options to associates.  Prior to June 2014, Restricted Shares and non-qualified stock options were granted under the Company's Amended and Restated 2004 Stock Incentive Plan. Shares issued pursuant to restricted stock awards are restricted in that they are not transferable until they vest. Shares underlying awards of restricted stock units are not issued until the units vest. Non-qualified stock options cannot be exercised until they vest.  For stock awards with service conditions only, vesting occurs over different periods, depending on the terms of the individual award, but expenses relating to these awards are recognized on a straight line basis over the applicable vesting period. For awards that include performance conditions, the Company recognizes compensation expense during the performance period to the extent achievement of the performance condition is deemed probable relative to targeted performance. A change in the Company's estimate of the probable outcome of a performance condition is accounted for in the period of the change by recording a cumulative catch-up adjustment.

    The following table summarizes the activity during year-to-date 2014 related to non-qualified stock options and Restricted Shares:
 
 
Non-qualified Stock Options
 
Restricted Shares (1)
 
 
Number of Shares
 
Weighted Average Exercise Price per Share
 
Number of Shares
 
Weighted Average Grant Date Fair Value per Share
Outstanding at February 1, 2014
 
36,252,522

 
$
20.35

 
10,174,432

 
$
14.66

Granted
 

 

 
4,712,557

 
11.18

Exercised (2)
 

 

 
(4,739,282
)
 
14.65

Canceled
 
(128,328
)
 
15.29

 
(868,903
)
 
14.29

Expired
 
(8,239,502
)
 
20.26

 

 

Outstanding at November 1, 2014
 
27,884,692

 
$
20.40

 
9,278,804

 
$
12.93

 
 
 
 
 
 
 
 
 
Exercisable at November 1, 2014
 
25,819,787

 
$
20.90

 
 
 
 
Vested or expected to vest at November 1, 2014
 
27,675,079

 
$
20.45

 
 
 
 

(1)
Excludes outstanding performance shares
(2)
Represents exercise of stock options or vesting of Restricted Shares

In connection with its equity-based employee compensation and benefit plans, Staples recognized $14.2 million and $51.1 million in compensation expense for the third quarter and year-to-date 2014, respectively, and $15.1 million and $62.1 million in compensation expense for the third quarter and year-to-date 2013, respectively. As of November 1, 2014, Staples had $87.5 million of unamortized stock compensation expense associated with these plans which will be expensed over the period through September 2017


14

STAPLES, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)



Performance shares
In April 2013 and March 2014, the Company entered into long-term performance share agreements with certain executives. Payout under these arrangements may range from 25% to 200% of target, depending on actual performance. Vesting is based on performance in each fiscal year, not cumulative performance, with metrics established at the beginning of each year. Any award earned based on performance will be increased or decreased by 25% if the Company's cumulative total shareholder return ("TSR") over the three year performance period is in the top or bottom one-third of the S&P 500 TSR, respectively. Shares earned, if any, will be issued on a fully-vested basis at the conclusion of the three-year performance period only if the grantee is still actively employed by or serving as a consultant to the Company at that time, with certain exceptions for retirement, death, disability, and termination without cause.
The agreements entered into in March 2014 pertain to fiscal years 2014, 2015 and 2016. The aggregate target number of shares for each year is 0.6 million. Vesting for the 2014 tranche is 50% based on satisfaction of certain sales growth metrics and 50% based on achievement of certain return on net assets percentage targets in 2014. The 2014 tranche had an aggregate grant-date fair value of $7.2 million.
The agreements entered into in April 2013 pertained to fiscal years 2013, 2014 and 2015, with an aggregate targeted number of shares for each year of 0.5 million. For the tranche relating to fiscal year 2013, 49.74% of the target shares were earned based on the extent to which the performance targets were achieved, subject to adjustment based on TSR at the end of the three year performance period. In March 2014, the performance metrics and corresponding targets were established for the tranche relating to fiscal 2014. Vesting for this tranche is 50% based on satisfaction of certain sales growth metrics and 50% based on achievement of certain return on net assets percentage targets in 2014. The 2014 tranche had an aggregate grant-date fair value of $6.0 million.
Employee stock purchase plan

Staples offers its associates the opportunity for share ownership pursuant to the 2012 Employee Stock Purchase Plan. Historically, including the first half of 2014, U.S. and International associates were able to purchase shares of Staples common stock at 85% of the lower of the market price of the common stock at the beginning or end of an offering period through payroll deductions in an amount not to exceed 10% of an employee’s annual base compensation. Effective beginning in the third quarter of 2014, the 2012 Employee Stock Purchase Plan was amended such that the purchase price will be based on 85% of the market price of the common stock at the end of the offering period. During year-to-date 2014 and 2013, the Company issued 2.1 million shares and 2.2 million shares, respectively, pursuant to the 2012 Employee Stock Purchase Plan.

Note KPension and Other Post-Retirement Benefit Plans
 
The Company sponsors pension plans that cover certain employees in Europe and the U.S.  The benefits due to U.S. plan participants are frozen.  A number of the defined benefit plans outside the U.S. are funded with plan assets that have been segregated in trusts.  Contributions are made to these trusts, as necessary, to meet legal and other requirements.
 
In August 2010, the Company began sponsoring an unfunded post-retirement life insurance benefit plan, which provides benefits to eligible U.S. executives based on earnings, years of service and age at termination of employment.
 

15

STAPLES, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)



The total net cost recognized for the third quarter and year-to-date 2014 and 2013 associated with the pension and other post-retirement benefit plans is based on unaudited actuarial estimates of such costs. The following tables present a summary of the total net periodic cost recorded in the condensed consolidated statement of comprehensive income for the third quarter and year-to-date 2014 and 2013 related to the plans (in thousands):
 
13 Weeks Ended November 1, 2014
 
Pension Plans
 
 Other
Post-Retirement Benefit Plan
Total
 
U.S. Plans
 
International Plans
 
Total
 
Service cost
$

 
$
3,265

 
$
3,265

 
$
445

Interest cost
454

 
9,414

 
9,868

 
447

Expected return on plan assets
(484
)
 
(15,637
)
 
(16,121
)
 

Amortization of unrecognized losses and prior service costs
3

 
3,435

 
3,438

 
608

Total (benefit) cost
$
(27
)
 
$
477

 
$
450

 
$
1,500

 
13 Weeks Ended November 2, 2013
 
Pension Plans
 
 Other
Post-Retirement Benefit Plan
Total
 
U.S. Plans
 
International Plans
 
Total
 
Service cost
$

 
$
3,994

 
$
3,994

 
$
798

Interest cost
410

 
7,886

 
8,296

 
633

Expected return on plan assets
(468
)
 
(15,372
)
 
(15,840
)
 

Amortization of unrecognized losses and prior service costs
155

 
3,360

 
3,515

 
534

Total cost (benefit)
$
97

 
$
(132
)
 
$
(35
)
 
$
1,965

 
39 Weeks Ended November 1, 2014
 
Pension Plans
 
 Other
Post-Retirement Benefit Plan Total
 
U.S. Plans
 
International Plans
 
Total
 
Service cost
$

 
$
10,144

 
$
10,144

 
$
1,335

Interest cost
1,362

 
29,223

 
30,585

 
1,341

Expected return on plan assets
(1,452
)
 
(48,553
)
 
(50,005
)
 

Amortization of unrecognized losses and prior service costs
11

 
10,672

 
10,683

 
1,824

Total (benefit) cost
$
(79
)
 
$
1,486

 
$
1,407

 
$
4,500

 
39 Weeks Ended November 2, 2013
 
Pension Plans
 
 Other
Post-Retirement Benefit Plan Total
 
U.S. Plans
 
International Plans
 
Total
 
Service cost
$

 
$
11,834

 
$
11,834

 
$
2,394

Interest cost
1,229

 
23,360

 
24,589

 
1,899

Expected return on plan assets
(1,403
)
 
(45,525
)
 
(46,928
)
 

Amortization of unrecognized losses and prior service costs
465

 
9,955

 
10,420

 
1,602

Total cost (benefit)
$
291

 
$
(376
)
 
$
(85
)
 
$
5,895

    

16

STAPLES, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)



Note LStockholders' Equity

The following table details the changes in accumulated other comprehensive loss ("AOCL") for year-to-date 2014 (in thousands):
 
 
Foreign Currency Translation Adjustment
 
Deferred Benefit Costs
 
Accumulated Other Comprehensive Loss
Balance at February 1, 2014
 
$
(255,404
)
 
$
(251,750
)
 
$
(507,154
)
Foreign currency translation adjustment
 
(144,655
)
 

 
(144,655
)
Reclassification adjustments:
 
 
 
 
 


Release of cumulative translation adjustments to earnings upon disposal of foreign businesses
 
(1,335
)
 

 
(1,335
)
Amortization of deferred benefit costs (net of taxes of $3.1 million)
 

 
9,380

 
9,380

Balance at November 1, 2014
 
$
(401,394
)
 
$
(242,370
)
 
$
(643,764
)

The following table details the line items in the condensed consolidated statements of comprehensive income affected by the reclassification adjustments during the third quarter and year-to-date 2014 and 2013 (in thousands):
 
 
Amount reclassified from AOCL
 
 
13 Weeks Ended
 
39 Weeks Ended
 
 
November 1, 2014
 
November 2, 2013
 
November 1, 2014
 
November 2, 2013
Selling, general and administrative
 
$
4,046

 
$
4,049

 
$
12,507

 
$
12,022

Gain on sale of businesses, net
 

 

 
(1,335
)
 

Income before tax
 
(4,046
)
 
(4,049
)
 
(11,172
)
 
(12,022
)
Income tax expense
 
(1,012
)
 
(1,425
)
 
(3,127
)
 
(3,940
)
Income from continuing operations
 
(3,034
)
 
(2,624
)
 
(8,045
)
 
(8,082
)
Loss from discontinued operations
 

 
3,265

 

 
3,265

Net income from continuing operations
 
$
(3,034
)
 
$
641

 
$
(8,045
)
 
$
(4,817
)

     The changes in the amounts of stockholders' equity attributable to noncontrolling interests during year-to-date 2014 and 2013 related solely to foreign currency translation adjustments.        
    

17

STAPLES, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)



Note MComputation of Earnings per Common Share
 
The computation of basic and diluted earnings per share for the third quarter and year-to-date 2014 and 2013 is as follows (in thousands, except per share data):
 
13 Weeks Ended
 
39 Weeks Ended
 
November 1, 2014
 
November 2, 2013
 
November 1, 2014
 
November 2, 2013
Numerator:
 

 
 

 
 

 
 

Income from continuing operations
$
216,792

 
$
220,085

 
$
394,877

 
$
494,621

Loss from discontinued operations

 
(84,857
)
 

 
(86,935
)
Net income
216,792

 
135,228

 
394,877

 
407,686

 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
Weighted-average common shares outstanding
640,301

 
650,967

 
641,709

 
653,536

Effect of dilutive securities:
 
 
 
 
 
 
 
Employee stock options and restricted shares
3,778

 
4,071

 
5,037

 
6,978

Weighted-average common shares outstanding assuming dilution
644,079

 
655,038

 
646,746

 
660,514

 
 
 
 
 
 
 
 
Basic Earnings Per Common Share
 
 
 
 
 
 
 
Continuing operations
$
0.34

 
$
0.34

 
$
0.62

 
$
0.76

Discontinued operations

 
(0.13
)
 

 
(0.13
)
Net income
$
0.34

 
$
0.21

 
$
0.62

 
$
0.63

 
 
 
 
 
 
 
 
Diluted Earnings Per Common Share
 
 
 
 
 
 
 
Continuing operations
$
0.34

 
$
0.34

 
$
0.61

 
$
0.75

Discontinued operations

 
(0.13
)
 

 
(0.13
)
Net income
$
0.34

 
$
0.21

 
$
0.61

 
$
0.62

 
For the third quarter and year-to-date 2014, approximately 28.5 million and 30.9 million of potentially dilutive equity instruments, respectively, were excluded from the calculation of diluted earnings per share as their inclusion would have been anti-dilutive. For the third quarter and year-to-date 2013, approximately 34.5 million and 36.3 million of potentially dilutive equity instruments, respectively, were excluded from the calculation of diluted earnings per share as their inclusion would have been anti-dilutive.

Note NSegment Reporting
     
Staples has three reportable segments: North American Stores & Online, North American Commercial and International Operations. North American Stores and Online sells products and services to customers in the U.S. and Canada. North American Commercial consists of the U.S. and Canadian businesses that sell and deliver products and services directly to businesses and includes Staples Advantage and Quill.com. The International Operations segment consists of businesses that sell and deliver products and services directly to consumers and businesses in 23 countries in Europe, Australia, South America and Asia.

Staples' North American Stores & Online and North American Commercial segments are managed separately because the way they sell and market products is different and the classes of customers they service are different. International Operations is considered a separate reportable segment because of the significant differences in the operating environment from the North American operations.

Staples evaluates performance and allocates resources based on profit or loss from operations before goodwill and long-lived asset impairment charges, restructuring costs, stock-based compensation, interest and other expense, non-recurring items and the impact of changes in accounting principles ("business unit income"). Beginning in the first quarter of 2014, business unit income also excludes accelerated depreciation and amortization and inventory write-downs associated with exit or disposal activities, including restructurings. In the third quarter of 2014, business unit income for North American Stores & Online and

18

STAPLES, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (continued)



North American Commercial excludes $1.2 million and $9.4 million, respectively, of inventory write-downs related to restructuring activities. In year-to-date 2014, business unit income for North American Stores & Online and North American Commercial excludes $6.3 million and $19.9 million, respectively, of inventory write-downs related to restructuring activities. In the third quarter of 2014, business unit income for North American Stores & Online, North American Commercial and International Operations excludes $0.2 million, $1.8 million and $0.2 million, respectively, of accelerated depreciation related to restructuring activities. In year-to-date 2014, business unit income for North American Stores & Online, North American Commercial and International Operations excludes $0.4 million, $3.2 million and $0.7 million, respectively, of accelerated depreciation related to restructuring activities. In the third quarter and year-to-date 2013, we did not recognize any inventory write-downs nor any accelerated depreciation or amortization related to exit and disposal activities.
    
Intersegment sales and transfers are recorded at Staples' cost; therefore, there is no intercompany profit or loss recognized on these transactions.

The following is a summary of sales and business unit income by reportable segment and a reconciliation of business unit income to income from continuing operations before income taxes for the third quarter and year-to-date 2014 and 2013 (in thousands):
 
13 Weeks Ended
 
39 Weeks Ended
 
November 1, 2014
 
November 2, 2013
 
November 1, 2014
 
November 2, 2013
 
Sales
North American Stores & Online
$
2,833,971

 
$
3,012,860

 
$
7,749,944

 
$
8,203,638

North American Commercial
2,157,933

 
2,088,955

 
6,211,311

 
6,078,232

International Operations
969,627

 
1,009,880

 
2,874,638

 
2,959,120

Total segment sales
$
5,961,531

 
$
6,111,695

 
$
16,835,893

 
$
17,240,990

 
 
 
 
 
 
 
 
 
Business Unit Income (Loss)
North American Stores & Online
$
217,962

 
$
285,435

 
$
338,432

 
$
557,541

North American Commercial
159,117

 
158,709

 
425,384

 
436,803

International Operations
6,053

 
1,617

 
(40,790
)
 
(28,756
)
Business unit income
383,132

 
445,761

 
723,026

 
965,588

Stock-based compensation
(14,187
)
 
(15,080
)
 
(51,051
)
 
(62,113
)
Impairment of long-lived assets
(8,970
)
 

 
(35,974
)
 

Restructuring charges
(24,565
)
 
(64,085
)
 
(126,467
)
 
(64,085
)
Gain on sale of businesses, net
5,690

 

 
27,495

 

Inventory write-downs related to restructuring activities
(10,610
)
 

 
(26,307
)
 

Accelerated depreciation related to restructuring activities
(2,247
)
 

 
(4,337
)
 

Interest and other expense, net
(14,472
)
 
(25,152
)
 
(32,439
)
 
(91,227
)
Income from continuing operations before income taxes
$
313,771

 
$
341,444

 
$
473,946

 
$
748,163


Note OCommitments and Contingencies

The Company is currently in the process of investigating a data security incident involving an intrusion into certain of the Company's retail point of sale and computer systems.  The Company has taken steps to address the intrusion and believe that we have identified and eradicated the malware used in the intrusion.  The Company is working with law enforcement and is continuing to investigate the nature and scope of the incident, including whether and to what extent retail transaction data may have been compromised.  It is reasonably possible that the Company may incur losses in connection with the incident; however, the Company is still in the early stages of the investigation and at this time the Company is unable to reasonably estimate the amount of any losses or the amount of expenses the Company will incur in addressing this incident.  The Company maintains network-security insurance coverage, which the Company expects would help mitigate any material financial impact.


19


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
 
Forward Looking Statements
 
This Quarterly Report on Form 10-Q and, in particular, this management’s 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 (the “Exchange Act”).  Any statements contained in or incorporated by reference into this report that are not statements of historical fact should be considered forward-looking statements.  You can identify these forward-looking statements by the use of the words “believes”, “expects”, “anticipates”, “plans”, “may”, “will”, “would”, “intends”, “estimates” and other similar expressions, whether in the negative or affirmative, although not all forward looking statements include such words. 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, and should be read in conjunction with our condensed consolidated financial statements and related notes included in this report.  Staples, Inc. and its subsidiaries ("we", "our" or "us") cannot guarantee that we actually will achieve the plans, intentions or expectations disclosed in the forward-looking statements made.  There are a number of important risks and uncertainties that could cause our actual results to differ materially from those indicated by such forward-looking statements.  These risks and uncertainties include, without limitation, those set forth under the heading “Risk Factors” of this Quarterly Report on Form 10-Q.  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

Major contributors to our third quarter of 2014 results, as compared to the results for the third quarter of 2013, are reviewed in detail in the Consolidated Performance and Segment Performance discussions and are summarized below:
 
We generated $5.96 billion in sales, a decrease of 2.5%;
 
North American Stores & Online sales decreased 5.9% and business unit income rate decreased to 7.7% from 9.5%;
 
North American Commercial sales increased 3.3% and business unit income rate decreased to 7.4% from 7.6%;
 
International Operations sales decreased 4.0% and business unit income rate was 0.6% compared to 0.2%;

Income from continuing operations for the third quarter of 2014 was $216.8 million compared with $220.1 million for the third quarter of 2013. Non-GAAP income from continuing operations was $235.7 million for the third quarter of 2014 compared with $273.7 million for the third quarter of 2013; and

Earnings per diluted share from continuing operations was $0.34 in the third quarter of 2014 compared to $0.34 in the third quarter of 2013. Non-GAAP earnings per diluted share from continuing operations was $0.37 in the third quarter of 2014 compared with $0.42 in the third quarter of 2013.

See the non-GAAP reconciliations in the "Non-GAAP Measures" section further below.

Outlook

For the fourth quarter of 2014, we expect sales to decrease versus the fourth quarter of 2013. We expect to achieve fully diluted non-GAAP earnings per share in the range of $0.27 to $0.32 for the fourth quarter of 2014. This guidance excludes any potential impact on earnings per share related to restructuring and other related activities.

We expect to record pre-tax charges in the range of $45 million to $80 million associated with restructuring and other related activities during the fourth quarter of 2014. For the full year, we expect to generate more than $800 million of free cash flow, an increase from our previous guidance of more than $600 million.


20


2014 Restructuring Plan

In March 2014, we announced that our Board of Directors had approved the closure of up to 225 retail stores in North America by the end of fiscal year 2015. In addition, as part of our continuing efforts to transform our business, in March 2014 we announced a cost savings plan to generate annualized pre-tax savings of approximately $500 million by the end of fiscal 2015. We expect the savings to come from global supply chain, retail store closures and labor optimization, non-product related costs, IT hardware and services, marketing, sales force, and customer service.  We plan to reinvest some of the savings in our strategic initiatives. See Note C - Restructuring Charges in the Notes to the Condensed Consolidated Financial Statements for additional information related to this plan.
    
Non-GAAP Measures

In our analysis of the results of operations and in our outlook, we have referred to certain non-GAAP financial measures for gross profit rate, income from continuing operations, earnings per share, effective tax rate, and free cash flow (which we define as net cash provided by operating activities less capital expenditures). The presentation of these results should be considered in addition to, and should not be considered superior to, or as a substitute for, the presentation of results determined in accordance with GAAP. We believe that these non-GAAP financial measures better enable management and investors to understand and analyze our performance by providing meaningful information that facilitates the comparability of underlying business results from period to period. We use these non-GAAP financial measures to evaluate the operating results of our business against prior year results and our operating plan, and to forecast and analyze future periods. We recognize there are limitations associated with the use of non-GAAP financial measures as they may reduce comparability with other companies that use different methods to calculate similar non-GAAP measures. We generally compensate for these limitations by considering GAAP as well as non-GAAP results. In addition, management provides a reconciliation to the most comparable GAAP financial measure. With respect to our earnings per share and free cash flow guidance, we have not provided guidance on a GAAP basis given that our current estimates for charges to be incurred related to our restructuring initiatives and the potential related impact on cash flow represent broad ranges which are based on our preliminary analysis and are subject to change as our plans become finalized.


21


For the non-GAAP measures related to results of operations, reconciliations to the most directly comparable GAAP measures are shown below (amounts in thousands, except per share data):
 
 
13 Weeks Ended
 
 
November 1, 2014
 
 
GAAP
 
Inventory write-downs
 
Restructuring charges
 
Impairment of long lived assets & accelerated depreciation
 
Gain on sale of business
 
Non-GAAP
Sales
 
$
5,961,531

 
 
 
 
 
 
 
 
 
$
5,961,531

Gross profit
 
1,596,276

 
10,610

 

 

 

 
1,606,886

Gross profit rate
 
26.8
%
 
 
 
 
 
 
 
 
 
27.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating income
 
328,243

 
10,610

 
24,565

 
11,217

 
(5,690
)
 
368,945

Interest and other expense, net
 
14,472

 
 
 
 
 
 
 
 
 
14,472

Income from continuing operations before income taxes
 
313,771

 
 
 
 
 
 
 
 
 
354,473

 
 
 
 
 
 
 
 
 
 
 
 
 
Income tax expense
 
96,979

 
 
 
 
 
 
 
 
 
96,979

Reduction of liability for unrecognized tax benefits
 

 
 
 
 
 
 
 
 
 
5,818

Tax benefit on charges related to restructuring activities
 

 
 
 
 
 
 
 
 
 
15,951

Adjusted income tax expense
 
96,979

 
 
 
 
 
 
 
 
 
118,748

 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 
$
216,792

 
 
 
 
 
 
 
 
 
$
235,725

 
 
 
 
 
 
 
 
 
 
 
 
 
Effective tax rate
 
30.9
%
 
 
 
 
 
 
 
 
 
33.5
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Diluted earnings per common share
 
$
0.34

 
 
 
 
 
 
 
 
 
$
0.37


22


 
 
39 Weeks Ended
 
 
November 1, 2014
 
 
GAAP
 
Inventory write-downs
 
Restructuring charges
 
Impairment of long lived assets & accelerated depreciation
 
Gain on sale of businesses, net
 
Non-GAAP
Sales
 
$
16,835,893

 
 
 
 
 
 
 
 
 
$
16,835,893

Gross profit
 
4,314,613

 
26,307

 

 

 

 
4,340,920

Gross profit rate
 
25.6
%
 
 
 
 
 
 
 
 
 
25.8
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating income
 
506,385

 
26,307

 
126,467

 
40,311

 
(27,495
)
 
671,975

Interest and other expense, net
 
32,439

 
 
 
 
 
 
 
 
 
32,439

Income from continuing operations before income taxes
 
473,946

 
 
 
 
 
 
 
 
 
639,536

 
 
 
 
 
 
 
 
 
 
 
 
 
Income tax expense
 
79,069

 
 
 
 
 
 
 
 
 
79,069

Reduction of liability for unrecognized tax benefits & discrete tax items
 

 
 
 
 
 
 
 
 
 
63,421

Tax benefit on restructuring-related charges
 

 
 
 
 
 
 
 
 
 
71,753

Adjusted income tax expense
 
79,069

 
 
 
 
 
 
 
 
 
214,243

 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 
$
394,877

 
 
 
 
 
 
 
 
 
$
425,293

 
 
 
 
 
 
 
 
 
 
 
 
 
Effective tax rate
 
16.7
%
 
 
 
 
 
 
 
 
 
33.5
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Diluted earnings per common share
 
$
0.61

 
 
 
 
 
 
 
 
 
$
0.66

 
 
13 Weeks Ended
 
 
November 2, 2013
 
 
GAAP
 
Restructuring Charges
 
Non-GAAP
 
 
 
 
 
 
 
Operating income
 
$
366,596

 
$
64,085

 
$
430,681

Interest and other expense, net
 
(25,152
)
 

 
(25,152
)
Income from continuing operations before income taxes
 
341,444

 
64,085

 
405,529

 
 
 
 
 
 
 
Income tax expense
 
121,359

 
10,481

 
131,840

 
 
 
 
 
 
 
Income from continuing operations
 
$
220,085

 
$
53,604

 
$
273,689

 
 
 
 
 
 
 
Diluted per share income from continuing operations
 
$
0.34

 
$
0.08

 
$
0.42

 
 
 
 
 
 
 
Effective tax rate
 
35.5
%
 
 
 
32.5
%


23


 
 
39 Weeks Ended
 
 
November 2, 2013
 
 
GAAP
 
Restructuring Charges
 
Non-GAAP
 
 
 
 
 
 
 
Operating income
 
$
839,390

 
$
64,085

 
$
903,475

Interest and other expense, net
 
(91,227
)
 

 
(91,227
)
Income from continuing operations before income taxes
 
748,163

 
64,085

 
812,248

 
 
 
 
 
 
 
Income tax expense
 
253,542

 
10,481

 
264,023