-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Sox8a5pgWVRctbrx7IZCTSTrjHsoO6tZe9i18jM5Sj+54bpnHSBDL5R9qVdWO05+ JhUJrWhJYoFPhXwSZkJQmg== 0000927016-99-003419.txt : 19991018 0000927016-99-003419.hdr.sgml : 19991018 ACCESSION NUMBER: 0000927016-99-003419 CONFORMED SUBMISSION TYPE: DEFS14A PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19991109 FILED AS OF DATE: 19991012 FILER: COMPANY DATA: COMPANY CONFORMED NAME: STAPLES INC CENTRAL INDEX KEY: 0000791519 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-MISCELLANEOUS SHOPPING GOODS STORES [5940] IRS NUMBER: 042896127 STATE OF INCORPORATION: DE FISCAL YEAR END: 0127 FILING VALUES: FORM TYPE: DEFS14A SEC ACT: SEC FILE NUMBER: 000-17586 FILM NUMBER: 99726970 BUSINESS ADDRESS: STREET 1: 500 STAPLES DRIVE STREET 2: P O BOX 9328 CITY: FRAMINGHAM STATE: MA ZIP: 01702 BUSINESS PHONE: 508-253-5000 DEFS14A 1 NOTICE & PROXY SCHEDULE 14A (Rule 14a-101) INFORMATION REQUIRED IN PROXY STATEMENT SCHEDULE 14A INFORMATION Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Act of 1934 Filed by the Registrant [X] Filed by a Party other than the Registrant [_] Check the appropriate box: [_] Preliminary Proxy Statement [_] Confidential, for Use of the Commission Only (as permitted by Rule 14a- 6(e)(2)) [X] Definitive Proxy Statement [_] Definitive Additional Materials [_] Soliciting Material Pursuant to Rule 14a-11(c) or Rule 14a-12 STAPLES, INC. (Name of Registrant as Specified in Its Charter) Payment of Filing Fee (Check the appropriate box): [X] No fee required. [_] Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and 0-11. (1) Title of each class of securities to which transaction applies: (2) Aggregate number of securities to which transaction applies: (3) Per unit price or other underlying value of transaction computed pursuant to Exchange Act Rule 0-11 (Set forth the amount on which the filing fee is calculated and state how it was determined): (4) Proposed maximum aggregate value of transaction: $ (5) Total fee paid: $ [_] Fee paid previously with preliminary materials. [_] Check box if any part of the fee is offset as provided by Exchange Act Rule 0-11(a)(2) and identify the filing for which the offsetting fee was paid previously. Identify the previous filing by registration statement number, or the Form or Schedule and the date of its filing. (1) Amount Previously Paid: (2) Form, Schedule or Registration Statement No.: (3) Filing Party: (4) Date Filed: STAPLES, INC. STAPLES LOGO APPEARS HERE ---------------- PROXY STATEMENT ---------------- SPECIAL MEETING OF STOCKHOLDERS TO BE HELD ON NOVEMBER 9, 1999 Dear Stockholder: We invite you to attend a Special Meeting of Stockholders of Staples, Inc. to be held at 2:00 p.m., Eastern Standard Time, on November 9, 1999, at Hale and Dorr LLP, 60 State Street, Boston, Massachusetts. At this Special Meeting we will ask you to consider and approve the Tracking Stock Proposal and the Stock Plan Proposals as described in this Proxy Statement. The Tracking Stock Proposal would allow us to issue a new series of common stock intended to reflect the performance of our e-commerce business, which is principally comprised of Staples.com, Quillcorp.com and StaplesLink.com and operates under the name Staples.com. Before we first issue the new series of common stock, Staples' existing common stock will be reclassified as Staples Retail and Delivery common stock ("Staples Stock"), intended to reflect the performance of our other businesses and a retained interest in Staples.com ("Staples Retail and Delivery" or "Staples RD"). Specifically, the Tracking Stock Proposal seeks approval of an amendment to our certificate of incorporation that would (i) authorize a new series of common stock called Staples.com common stock ("Staples.com Stock"), intended to reflect the performance of Staples.com, (ii) increase the aggregate number of shares of common stock that we may issue from 1,500,000,000 to 2,100,000,000, initially comprised of 1,500,000,000 shares of Staples Stock and 600,000,000 shares of Staples.com Stock, and (iii) reclassify Staples' existing common stock as Staples Stock. We believe the Tracking Stock Proposal is in the best interests of Staples and its stockholders because the authorization of Staples.com Stock would: . enable investors to review separate information about Staples.com and separately value Staples.com Stock. This should encourage investors to focus more attention on Staples.com and result in greater market recognition of the value of Staples.com to Staples. . enable us to issue Staples.com Stock in one or more private or public financings, thus raising capital for Staples Retail and Delivery and/or Staples.com and perhaps creating a public trading market for Staples.com Stock. . enable us to grant stock options or restricted stock tied to Staples.com Stock, thereby providing more focused incentives to Staples.com management and employees. . provide us with greater flexibility in responding to strategic opportunities, such as acquisitions, by allowing us to issue either Staples Stock or Staples.com Stock as appropriate under the circumstances. . enable us to realize more of the value of Staples.com without losing the financial, tax, operational, strategic and other benefits of being a single consolidated entity. Our reasons for proceeding with the Tracking Stock Proposal are outlined more fully elsewhere in this Proxy Statement. In addition to the Tracking Stock Proposal, we are asking you to consider and approve amendments to our 1992 Equity Incentive Plan, Amended and Restated 1990 Director Stock Option Plan and 1998 Employee Stock Purchase Plan that would permit us to issue Staples.com Stock under those plans. The Staples board of directors has carefully considered and unanimously approved the Tracking Stock Proposal and the Stock Plan Proposals and recommends that you vote for them. We describe the proposals in more detail in this Proxy Statement, which you should carefully read in its entirety before voting. Thank you for your continued support and interest in Staples. Sincerely yours, /s/ Thomas G. Stemberg Thomas G. Stemberg Chairman and CEO See "Risk Factors" beginning on page 20 for certain information relating to an evaluation of these proposals. The date of this Proxy Statement is October 12, 1999. We are first sending this Proxy Statement to stockholders on or about that date. STAPLES, INC. 500 Staples Drive Framingham, Massachusetts 01702 Notice of Special Meeting of Stockholders To Be Held on November 9, 1999 TO THE STOCKHOLDERS OF STAPLES: A Special Meeting of Stockholders of Staples, Inc. will be held at 2:00 p.m., Eastern Standard Time, on November 9, 1999, at Hale and Dorr LLP, 60 State Street, Boston, Massachusetts, to consider and act upon the following matters: 1. The approval of an amendment to our certificate of incorporation to authorize a new series of common stock called Staples.com Stock, to increase the aggregate number of shares of common stock that may be issued and to reclassify the existing Staples common stock into Staples Stock (the "Tracking Stock Proposal"). 2. The approval of amendments to our 1992 Equity Incentive Plan, Amended and Restated 1990 Director Stock Option Plan and 1998 Employee Stock Purchase Plan (the "Stock Plan Proposals"). 3. Such other business as may properly come before the meeting. We describe the proposals in more detail in this Proxy Statement, which you should read in its entirety before voting. Stockholders of record at the close of business on October 5, 1999 will be entitled to notice of and to vote at the meeting or any adjournment thereof. The stock transfer books will remain open. By order of the board of directors, /s/ Jack A. VanWoerkom Jack A. VanWoerkom Secretary Framingham, Massachusetts October 12, 1999 WHETHER OR NOT YOU EXPECT TO ATTEND THE MEETING, PLEASE COMPLETE, DATE AND SIGN THE ENCLOSED PROXY AND MAIL IT PROMPTLY IN THE ENCLOSED ENVELOPE IN ORDER TO ENSURE REPRESENTATION OF YOUR SHARES. NO POSTAGE NEED BE AFFIXED IF THE PROXY IS MAILED IN THE UNITED STATES. "STREET NAME" HOLDERS WHO PLAN TO ATTEND THE MEETING WILL NEED TO BRING A COPY OF A BROKERAGE STATEMENT REFLECTING STOCK OWNERSHIP AS OF THE RECORD DATE. TABLE OF CONTENTS
Page ---- QUESTIONS AND ANSWERS ABOUT THE SPECIAL MEETING........................... 1 PROXY STATEMENT SUMMARY................................................... 4 GENERAL................................................................... 19 RISK FACTORS.............................................................. 20 CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION................ 25 PROPOSAL 1--THE TRACKING STOCK PROPOSAL................................... 26 General................................................................. 26 Background and Reasons for the Tracking Stock Proposal.................. 26 Description of Staples Stock and Staples.com Stock...................... 27 General............................................................... 27 Dividends............................................................. 28 Mandatory Dividend, Redemption or Exchange on Disposition of All or Substantially All of the Assets of a Business........................ 30 Optional Exchange of One Series of Common Stock for the Other Series.. 33 Exchange for Stock of a Subsidiary at Staples' Option................. 34 General Dividend, Redemption and Exchange Provisions.................. 35 Voting Rights......................................................... 36 Liquidation........................................................... 37 Staples RD's Retained Interest In Staples.com......................... 38 Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com.............................................. 38 Effectiveness of Certain Terms........................................ 40 Determinations by the Board of Directors.............................. 41 Preemptive Rights..................................................... 41 Certain Other Provisions of Our Certificate of Incorporation, By-laws and Delaware Law....................................................... 41 Preferred Stock....................................................... 41 Rights Plan........................................................... 41 Delaware Law and Certain Charter Provisions........................... 42 Limitation of Liability and Indemnification........................... 43 Cash Management and Allocation Policies................................. 43 Finance Activities.................................................... 43 Shared Services and Support Activities................................ 45 Taxes................................................................. 45 Carrying Charge....................................................... 45 Employee Benefits..................................................... 46 No Appraisal Rights..................................................... 46 Stock Transfer Agent and Registrar...................................... 46 Certain Federal Income Tax Considerations............................... 46 Tax Implications of the Tracking Stock Proposal to Stockholders....... 46 Tax Implications of a Conversion into Different Series of Tracking Stock................................................................ 47 No Internal Revenue Service Ruling.................................... 47 Clinton Administration Proposal....................................... 47 Back-up Withholding................................................... 47
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Page ----- PROPOSALS 2, 3 and 4--THE STOCK PLAN PROPOSALS........................... 49 General................................................................ 49 Description of Amendments to Incentive Plan (Proposal 2)............... 49 Description of Amendments to Director Plan (Proposal 3)................ 50 Description of Amendments to Stock Purchase Plan (Proposal 4).......... 52 EXECUTIVE COMPENSATION................................................... 54 Summary Compensation................................................... 54 Performance Accelerated Restricted Stock ("PARS") Awards............... 56 Option Grants.......................................................... 56 Option Exercises and Holdings.......................................... 57 Employment Contracts, Termination of Employment and Change-in-Control Agreements with Senior Executives..................................... 58 Director Compensation.................................................. 58 Compliance with Section 16(a) of the Securities Exchange Act of 1934... 59 Compensation Committee Interlocks and Insider Participation............ 59 Compensation Committee Report on Executive Compensation................ 60 Stock Performance Graph................................................ 63 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT........... 64 WHERE YOU CAN FIND MORE INFORMATION...................................... 65 OTHER MATTERS............................................................ 65 INDEX OF CERTAIN TERMS................................................... 67 ANNEX I llustration of Certain Terms........................................... I-1 ANNEX II Certificate of Amendment to Certificate of Incorporation of Staples, Inc................................................................... II-1 ANNEX III Amended and Restated 1992 Equity Incentive Plan........................ III-1 ANNEX IV Amended and Restated 1990 Director Stock Option Plan................... IV-1 ANNEX V Amended and Restated 1998 Employee Stock Purchase Plan................. V-1 ANNEX VI Staples Retail and Delivery Combined Financial Information............. VI-1 ANNEX VII Staples.com Combined Financial Information............................. VII-1
ii QUESTIONS AND ANSWERS ABOUT THE SPECIAL MEETING Q: WHAT PROPOSALS ARE COVERED BY THIS PROXY STATEMENT? A: We are sending you this Proxy Statement in connection with a Special Meeting of Stockholders to be held at 2:00 p.m., Eastern Standard Time, on November 9, 1999, at Hale and Dorr LLP, 60 State Street, Boston, Massachusetts. At this Special Meeting we will ask you to consider and approve the Tracking Stock Proposal and the Stock Plan Proposals described in this Proxy Statement. The Tracking Stock Proposal would allow us to amend our certificate of incorporation to: . Create a new series of common stock called Staples.com Stock that could be issued from time to time by the board of directors. . Increase the aggregate number of shares of common stock that we may issue from 1,500,000,000 to 2,100,000,000, initially comprised of 1,500,000,000 shares of Staples Stock and 600,000,000 shares of Staples.com Stock. . Reclassify each outstanding share of existing common stock into a share of Staples Stock. We intend Staples.com Stock to reflect the performance of Staples.com, our e-commerce business. We intend Staples Stock to reflect the performance of Staples Retail and Delivery, which consists of our other businesses and a retained interest in Staples.com. In this Proxy Statement, we also refer to Staples Retail and Delivery as "Staples RD." We have allocated, for financial reporting purposes, all of Staples' consolidated assets, liabilities, revenue, expenses and cash flow between Staples Retail and Delivery and Staples.com. If the Tracking Stock Proposal is approved by stockholders, we will publish combined financial statements of Staples Retail and Delivery, combined financial statements of Staples.com, and consolidated financial statements of Staples covering both Staples Retail and Delivery and Staples.com. The Stock Plan Proposals ask you to approve amendments to our 1992 Equity Incentive Plan, Amended and Restated 1990 Director Stock Option Plan and 1998 Employee Stock Purchase Plan that would provide for the issuance of Staples.com Stock under those Plans. Q: WHAT WILL COMPRISE THE STAPLES E-COMMERCE BUSINESS? A: Staples' electronic commerce business, or e-commerce business, sells office products and services over the Internet to Staples' entire spectrum of business customers, including small, medium and large businesses, as well as consumers. Our e-commerce business operates under the name Staples.com and is comprised of three principal business units: Staples.com, Quillcorp.com and StaplesLink.com (formerly Staples Network Advantage Plus, or SNAP), each of which has its own web site and is specifically designed to serve a target customer base. We launched our Staples.com web site, the e-commerce business portal of our traditional retail superstore, in November 1998. Staples.com markets over 6,000 products primarily to home office and small business customers through its web-based superstore. We sold our first products through the Quillcorp.com web site, the e-business portal of our Quill catalog business, in November 1996. Quillcorp.com markets products from our direct mail catalog to small to medium sized business customers such as legal and medical offices. Quill's private label products are among the products we sell on our Quillcorp.com web site. We established the StaplesLink.com web site, the e-business portal of our Staples Network Advantage contract stationer business, in August 1997. Our StaplesLink.com web site focuses on meeting the needs of medium to large sized business customers by offering simple order entry and contract pricing. 1 Q: WHAT IS "TRACKING STOCK"? A: "Tracking stock", which people sometimes call "alphabet stock", "letter stock" or "targeted stock", is a type of common stock that the issuing company intends to reflect (or "track") the performance of a particular business. As mentioned above, we propose creating a new series of tracking stock, to be designated as Staples.com Stock, and reclassifying our existing common stock into a new series of common stock to be designated Staples Stock. We cannot assure you that the values of Staples Stock and Staples.com Stock will in fact reflect the performance of Staples Retail and Delivery and Staples.com as we intend. Holders of Staples Stock and Staples.com Stock will continue to be common stockholders of Staples and, as such, will be subject to all risks associated with an investment in Staples. Q: HOW AND WHEN WILL YOU INITIALLY ISSUE STAPLES.COM STOCK? A: We currently plan to grant options for Staples.com Stock under the 1992 Equity Incentive Plan to all Staples employees who currently receive options under the Plan shortly following stockholder approval of the proposed amendment to the Plan. We expect to issue additional shares of Staples.com Stock in one or more private or public financings within 12 months of stockholder approval of the Tracking Stock Proposal. The specific terms of the financings, including whether they are private or public, the amount of Staples.com Stock we issue, and the timing of the financings, will depend upon factors such as stock market conditions and the performance of Staples.com. Q: WHEN WILL YOU IMPLEMENT THE TRACKING STOCK PROPOSAL? WHEN WILL YOU RECLASSIFY MY COMMON STOCK INTO STAPLES STOCK? A: We expect to file the charter amendment to implement the Tracking Stock Proposal and reclassify your common stock shortly following the Special Meeting, assuming the Tracking Stock Proposal is approved. Q: WHAT HAPPENS TO MY COMMON STOCK WHEN YOU IMPLEMENT THE TRACKING STOCK PROPOSAL? DO I NEED TO SEND IN MY STOCK CERTIFICATES? A: The filing of the amendment to our certificate of incorporation implementing the Tracking Stock Proposal will automatically reclassify your shares into Staples Stock, and your existing stock certificates will automatically represent that Staples Stock. Since the reclassification is automatic, you do not need to send in your stock certificates or make any notations reflecting the change. Q: WHY ARE YOU AUTHORIZING STAPLES.COM STOCK? A: Primarily for the following reasons: . to enable investors to review separate information about Staples.com and separately value Staples.com Stock. This should encourage investors to focus more attention on Staples.com and result in greater market recognition of the value of Staples.com to Staples. . to enable us to issue Staples.com Stock in one or more private or public financings, thus raising capital for Staples Retail and Delivery and/or Staples.com and perhaps creating a public trading market for Staples.com Stock. . to enable us to grant stock options or restricted stock tied to Staples.com Stock, thereby providing more focused incentives to Staples.com management and employees. . to provide us with greater flexibility in responding to strategic opportunities, such as acquisitions, by allowing us to issue either Staples Stock or Staples.com Stock as appropriate under the circumstances. 2 . to enable us to realize some of the value of Staples.com without losing the financial, tax, operational, strategic and other benefits of being a single consolidated entity. Q: WILL STAPLES STOCK BE LISTED ON NASDAQ? HOW ABOUT STAPLES.COM STOCK? A: When we reclassify our common stock as Staples Stock, it will continue to trade on the Nasdaq National Market under the symbol "SPLS." If and when we decide to issue Staples.com Stock in a public offering, we would expect to apply for listing of Staples.com Stock on the Nasdaq National Market. Q: WHAT VOTING RIGHTS WILL I HAVE? A: Holders of Staples Stock and Staples.com Stock will vote together as a single class, except in certain limited circumstances. Each share of Staples Stock will entitle the holder to one vote. Likewise, each share of Staples.com Stock will entitle the holder to one vote. Q: DO YOU INTEND TO PAY DIVIDENDS? A: We currently intend to retain all of our earnings for use in the operation and expansion of our business. We therefore do not expect to pay any cash dividends on Staples Stock or Staples.com Stock in the foreseeable future. Q: WHAT IS THE PURPOSE OF THE STOCK PLAN PROPOSALS? A: The Stock Plan Proposals are intended to advance the interests of our stockholders by enabling us to provide management and employees of both Staples.com and Staples Retail and Delivery with the opportunity to own an equity interest in Staples.com. Because the value of this equity interest is tied to the performance of Staples.com, we believe these equity awards will help align the interests of our employees with the holders of Staples.com Stock. We intend to issue Staples.com Stock under these plans both to Staples.com employees, to provide them with incentives directly tied to their business, and to Staples RD employees, to promote cooperation between these businesses and help ensure that all of our employees are motivated by the best interests of all of our stockholders. Q: WHAT DOES THE BOARD OF DIRECTORS RECOMMEND? A: The Staples board of directors has carefully considered and unanimously approved the Tracking Stock Proposal and the Stock Plan Proposals described in this Proxy Statement and recommends that you vote for them. Q: WHAT VOTE IS REQUIRED TO APPROVE THE PROPOSALS? A: The Tracking Stock Proposal requires the affirmative vote of the holders of a majority of the outstanding shares of Staples common stock. Each of the Stock Plan Proposals requires the affirmative vote of the holders of a majority of the shares of Staples common stock voting on the proposal. Q: WHO DO I CONTACT IF I HAVE ADDITIONAL QUESTIONS? A: If you have any questions prior to the Special Meeting, please call Staples Investor Relations at (508) 253-0879. 3 PROXY STATEMENT SUMMARY This summary highlights key aspects of the Tracking Stock Proposal and the Stock Plan Proposals described in more detail elsewhere in this Proxy Statement. This summary is not a substitute for the more detailed information contained in the rest of this Proxy Statement. For a more comprehensive description of the Tracking Stock Proposal and the Stock Plan Proposals, you should read the rest of this Proxy Statement. Capitalized terms used in this summary have the meanings given them elsewhere in this Proxy Statement. See "Index of Certain Terms" on page 67. STAPLES, STAPLES RETAIL AND DELIVERY AND STAPLES.COM Staples Staples pioneered the office products superstore concept and is a leading office products distributor, with a total of 1,088 retail stores located in the United States, Canada, the United Kingdom, Germany, the Netherlands and Portugal as of October 6, 1999. In addition, Staples has a catalog business, an e-commerce business and contract stationer operations. From an accounting standpoint, we have separated Staples.com, our e-commerce business, from Staples Retail and Delivery, which includes the rest of our businesses and a retained interest in Staples.com. We have allocated all of our consolidated assets, liabilities, revenue, expenses and cash flow between Staples.com and Staples Retail and Delivery. These two businesses are each sometimes referred to in this Proxy Statement as a "Business" and collectively as "Businesses." Staples Retail and Delivery is also referred to herein as "Staples RD." The Tracking Stock Proposal would allow us to issue Staples.com Stock, intended to reflect the performance of Staples.com, and Staples Stock, intended to reflect the performance of Staples RD. We briefly describe Staples RD and Staples.com below. Our principal executive offices are located at 500 Staples Drive, Framingham, Massachusetts 01702. Our telephone number is (508) 253-5000. Staples Retail and Delivery Staples Retail and Delivery, which we also call Staples RD, includes Staples' retail stores, catalog business and contract stationer business and a retained interest in Staples.com. This retained interest is currently 100%, but will decline to reflect issuances of Staples.com Stock under either our stock plans or in one or more private or public financings. Staples.com Staples' electronic commerce business, or e-commerce business, sells office products and services over the Internet to Staples' entire spectrum of business customers, including small, medium and large businesses, as well as consumers. Our e-commerce business operates under the name Staples.com and is comprised of three principal business units: Staples.com, Quillcorp.com and StaplesLink.com (formerly Staples Network Advantage Plus, or SNAP), each of which has its own web site and is specifically designed to serve a target customer base. All of our web sites leverage existing resources wherever possible such as offline advertising, call centers, distribution centers and delivery hubs. Online marketing for our e-commerce business is currently done primarily through major relationships with leading Internet properties. Each of our web portals has many innovative features and offers functionality which allows Staples to better serve existing customers as well as attract a large number of new customers. 4 SPECIAL MEETING Time, Date and Place........ 2:00 p.m., Eastern Standard Time, on November 9, 1999, at Hale and Dorr LLP, 60 State Street, Boston, Massachusetts. Record Date................. October 5, 1999. Proposals to be Vote Required for Approval Considered.................. . Proposal 1--The Proposal 1 requires the affirmative vote of the Tracking Stock Proposal holders of a majority of the outstanding shares of existing common stock. . Proposals 2, 3 and 4 -- Each of Proposals 2, 3 and 4 requires the The Stock Plan affirmative vote of the holders of a majority of Proposals the shares of existing common stock voting on the matter. Questions If you have any questions prior to the Special Meeting, please call Staples Investor Relations at (508) 253-0879. The board of directors has carefully considered and unanimously approved these proposals and recommends that you vote for them. 5 PROPOSAL 1--THE TRACKING STOCK PROPOSAL General At the Special Meeting, we will ask you to consider and approve the Tracking Stock Proposal described in this Proxy Statement. The Tracking Stock Proposal would allow us to amend our certificate of incorporation to: . Create a new series of common stock called Staples.com Stock that could be issued from time to time by the board of directors. . Increase the aggregate number of shares of common stock that we may issue from 1,500,000,000 to 2,100,000,000, initially comprised of 1,500,000,000 shares of Staples Stock and 600,000,000 shares of Staples.com Stock. . Reclassify each outstanding share of existing common stock into a share of Staples Stock. We intend Staples.com Stock to reflect the performance of Staples.com, our e-commerce business division. We intend Staples Stock to reflect the performance of Staples RD, which consists of our other businesses and a retained interest in Staples.com. We have allocated, for financial reporting purposes, all of Staples' consolidated assets, liabilities, revenue, expenses and cash flow between Staples RD and Staples.com. If the Tracking Stock Proposal is approved by stockholders, we will publish combined financial statements of Staples RD, combined financial statements of Staples.com, and consolidated financial statements of Staples covering both Staples RD and Staples.com. We currently plan to grant options for Staples.com Stock under the 1992 Equity Incentive Plan to all Staples employees who currently receive options under the Plan shortly following stockholder approval of the proposed amendment to the Plan. We expect to issue additional shares of Staples.com Stock in one or more private or public financings within 12 months of stockholder approval of the Tracking Stock Proposal. The specific terms of the financings, including whether they are private or public, the amount of Staples.com Stock we issue, and the timing of the financings, will depend upon factors such as stock market conditions and the performance of Staples.com. We expect to file the amendment to our certificate of incorporation implementing the Tracking Stock Proposal and reclassify your common stock shortly following the Special Meeting, assuming the Tracking Stock Proposal is approved. Reasons for the Tracking Stock Proposal We believe the Tracking Stock Proposal is in the best interests of Staples and its stockholders because the authorization of Staples.com Stock would: . enable investors to review separate information about Staples.com and separately value Staples.com Stock. This should encourage investors to focus more attention on Staples.com and result in greater market recognition of the value of Staples.com to Staples. . enable us to issue Staples.com Stock in one or more private or public financings, thus raising capital for Staples RD and/or Staples.com and perhaps creating a public trading market for Staples.com Stock. . enable us to grant stock options or restricted stock tied to Staples.com, thereby providing more focused incentives to Staples.com management and employees. . provide us with greater flexibility in responding to strategic opportunities (including acquisitions), because it would allow us to issue either Staples Stock or Staples.com Stock as appropriate under the circumstances. 6 . enable us to realize some of the value of Staples.com without losing the financial, tax, operational, strategic and other benefits of being a single consolidated entity. If you vote "FOR" the Tracking Stock Proposal at the Special Meeting you may be forfeiting your right to challenge the Tracking Stock Proposal in the future. Summary Comparison of Terms of Existing Common Stock with Terms of Staples Stock and Staples.com Stock The following compares certain terms of our existing common stock to the proposed terms of Staples Stock and Staples.com Stock. This comparison is not complete and should be read together with the more detailed information contained in the rest of this Proxy Statement. In particular, see "Proposal 1-- The Tracking Stock Proposal--Description of Staples Stock and Staples.com Stock."
Tracking Stock Proposal -------------------------------------------- Existing Common Stock Staples Stock Staples.com Stock --------------------- --------------------- --------------------- Basic Investment Our existing common We intend Staples We intend Staples.com Characteristics: stock reflects the Stock to reflect the Stock to reflect the performance of all of performance of performance of our businesses, Staples RD. Staples Staples.com, our e- including: RD currently commerce business. includes: . North American . North American Staples.com sells superstores superstores office products and services over the Internet to Staples' entire spectrum of customers, including small, medium and large businesses. Staples.com is comprised of three principal business units: Staples.com, Quillcorp.com and StaplesLink.com (formerly Staples Network Advantage Plus, or SNAP), each of which has its own web site and is specifically designed to serve a target customer base. . Delivery . Delivery operations, operations, including our including our catalog, contract catalog and stationer and e- contract stationer commerce businesses, but businesses excluding our e-commerce businesses . International . International stores stores . A Retained Interest in Staples.com, which is currently 100% but will decline over time as we issue Staples.com Stock. We cannot assure you We cannot assure you that the market value that the market value of Staples Stock will of Staples.com Stock in fact reflect the will in fact reflect performance of the performance of Staples RD as we Staples.com as we intend. Holders of intend. Holders of Staples Stock will be Staples.com Stock common stockholders will continue to be of Staples and, as common stockholders such, will be subject of Staples and, as to all of the risks such, will be subject associated with an to all of the risks investment in Staples associated with an and all of our investment in Staples businesses, assets and all of our and liabilities. businesses, assets and liabilities.
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Tracking Stock Proposal -------------------------------------------- Existing Common Stock Staples Stock Staples.com Stock --------------------- --------------------- --------------------- Issuance: Our existing common The amendment to the We currently plan to stock is already certificate of grant options for outstanding incorporation Staples.com Stock authorizing under the 1992 Equity Staples.com Stock Incentive Plan to all would reclassify each Staples employees who outstanding share of currently receive existing common stock options under the into a share of Plan shortly Staples Stock. following stockholder approval of the proposed amendment to the Plan. We expect to issue additional shares of Staples.com Stock in one or more private or public financings within 12 months of stockholder approval of the Tracking Stock Proposal. The specific terms of the financings, including whether they are private or public, the amount of Staples.com Stock we issue, and the timing of the financings, will depend upon factors such as stock market conditions and the performance of Staples.com. Retained Interest: N/A We would adjust the N/A Retained Interest of Staples RD (which would initially be 100%) as appropriate to reflect issuances or repurchases of Staples.com Stock; capital contributions to, or returns of capital from, Staples.com; and certain other events. Authorized and We are currently The Tracking Stock The Tracking Stock Outstanding Common authorized to issue Proposal will Proposal will Stock: only one series of authorize us to issue authorize us to issue common stock. two series of common two series of common stock--Staples Stock stock -- Staples and Staples.com Stock and Staples.com Stock. Stock. We are currently The Tracking Stock The Tracking Stock authorized to issue Proposal will Proposal will up to 1,500,000,000 authorize us to authorize us to shares of common increase the number increase the number stock. of authorized shares of authorized shares to 2,100,000,000 to 2,100,000,000 shares of common shares of common stock, initially stock, initially comprised of comprised of 1,500,000,000 shares 1,500,000,000 shares of Staples Stock and of Staples Stock and 600,000,000 shares of 600,000,000 shares of Staples.com Stock. Staples.com Stock.
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Tracking Stock Proposal -------------------------------------------- Existing Common Stock Staples Stock Staples.com Stock --------------------- --------------------- --------------------- 462,138,859 shares of Immediately following After the Tracking existing common stock the implementation of Stock Proposal is were outstanding on the Tracking Stock implemented, we October 5, 1999. Proposal, 462,138,859 expect to issue from These shares count shares of Staples time to time shares against the total Stock will be of Staples.com Stock. number of shares we outstanding, based on Any shares issued, are authorized to the number of shares and the shares of issue. of existing common Staples Stock then stock outstanding on outstanding, will October 5, 1999. count against the These shares, and any total number of shares of Staples.com shares of common Stock outstanding stock we are from time to time, authorized to issue. will count against the total number of shares of common stock we are authorized to issue. Dividends: We currently intend We currently intend We currently intend to retain all of our to retain all of our to retain all of our earnings for use in earnings for use in earnings for use in the operation and the operation and the operation and expansion of our expansion of our expansion of our business. We do not business. We do not business. We do not expect to pay any expect to pay any expect to pay any cash dividends on our cash dividends on cash dividends on existing common stock Staples Stock in the Staples.com Stock in in the foreseeable foreseeable future. the foreseeable future. future. Although our Although our Although our revolving credit revolving credit revolving credit agreement restricts agreement restricts agreement restricts the payment of cash the payment of cash the payment of cash dividends, we are dividends, we will dividends, we will otherwise permitted otherwise be otherwise be to pay dividends out permitted to pay permitted to pay of the assets of dividends on Staples dividends on Staples legally Stock out of the Staples.com Stock out available for the assets of Staples of the assets of payment of dividends legally available for Staples legally under Delaware law. the payment of available for the dividends under payment of dividends Delaware law, but the under Delaware law total of the amounts (and transfer paid as dividends on corresponding amounts Staples Stock cannot to Staples RD in exceed the Available respect of its Dividend Amount for Retained Interest), Staples RD. The but the total of the Available Dividend amounts paid as Amount for Staples RD dividends on is based on the Staples.com Stock amount that would be (and the legally available for corresponding amounts the payment of transferred to dividends under Staples RD in respect Delaware law if of its Retained Staples RD were a Interest) cannot separate Delaware exceed the Available corporation and Dividend Amount for certain other Staples.com. The assumptions were Available Dividend applied. Amount for Staples.com is based on the amount that would be legally available for the payment of dividends under Delaware law if Staples.com were a separate Delaware corporation and Staples RD's Retained Interest in Staples.com were represented by outstanding shares.
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Tracking Stock Proposal -------------------------------------------- Existing Common Stock Staples Stock Staples.com Stock --------------------- --------------------- --------------------- Mandatory Dividend, None. If we dispose of All If we dispose of All Redemption or or Substantially All or Substantially All Exchange on of the Assets of of the Assets of Disposition of Staples RD and the Staples.com and the Assets: disposition is not an disposition is not an Exempt Disposition, Exempt Disposition, we would be required we would be required to choose one of the to choose one of the following three following three alternatives: alternatives: . pay a dividend to . pay a dividend to holders of Staples holders of Stock in an amount Staples.com Stock equal to their in an amount equal Proportionate to their Interest in the Proportionate Net Proceeds of Interest in the such disposition; Net Proceeds of such disposition; . redeem from . redeem from holders of Staples holders of Stock, for an Staples.com Stock, amount equal to for an amount their equal to their Proportionate Proportionate Interest in the Interest in the Net Proceeds of Net Proceeds of such disposition, such disposition, outstanding shares outstanding shares of Staples Stock; of Staples.com or Stock; or . issue Staples.com . issue Staples Stock in exchange Stock in exchange for outstanding for outstanding Staples Stock at a Staples.com Stock 10% premium (based at a 10% premium on the average (based on the Market Value of average Market Staples Stock as Value of compared to the Staples.com Stock average Market as compared to the Value of average Market Staples.com Stock Value of Staples over a specified Stock over a 20-Trading Day specified 20- period prior to Trading Day period the exchange). prior to the exchange). At any time within At any time within one year after one year after completing a special completing a special dividend or partial dividend or partial redemption referred redemption referred to above, we will to above, we will have the right to have the right to issue Staples.com issue Staples Stock Stock in exchange for in exchange for outstanding Staples outstanding Stock at a 10% Staples.com Stock at premium (based on the a 10% premium (based average Market Value on the average Market of Staples Stock as Value of Staples.com compared to the Stock as compared to average Market Value the average Market of Staples.com Stock Value of Staples over a specified 20- Stock over a Trading Day period specified 20-Trading prior to the Day period prior to exchange). the exchange).
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Tracking Stock Proposal -------------------------------------------- Existing Common Stock Staples Stock Staples.com Stock --------------------- --------------------- --------------------- Optional Exchange of None. We will have the We will have the One Series of Common right, at any time, right, at any time, Stock for the Other to issue shares of to issue shares of Series: Staples.com Stock in Staples Stock in exchange for exchange for outstanding shares of outstanding shares of Staples Stock at a Staples.com Stock at premium that will a premium that will initially be 25% (for initially be 25% (for exchanges occurring exchanges occurring in the first quarter in the first quarter after the original after the original issuance of issuance of Staples.com Stock or Staples.com or options for options for Staples.com Stock) Staples.com Stock) and will decline and will decline ratably each quarter ratably each quarter over a period of over a period of three years to 15%. three years to 15%. Notwithstanding the Notwithstanding the exchange provisions exchange provisions outlined above, in outlined above, in the event that the event that certain adverse tax certain adverse tax law changes were to law changes were to take place, we will take place, we will have the right to have the right to issue shares of issue shares of either series of either series of common stock in common stock in exchange for exchange for outstanding shares of outstanding shares of the other series of the other series of common stock at a 10% common stock at a 10% premium, regardless premium, regardless of when such adverse of when such adverse tax law changes take tax law changes take place. place. The exchange ratio The exchange ratio that will result in that will result in the specified premium the specified premium will be calculated will be calculated based on the average based on the average Market Value of Market Value of Staples Stock as Staples Stock as compared to the compared to the average Market Value average Market Value of Staples.com Stock of Staples.com Stock during the 20 during the 20 consecutive Trading consecutive Trading Day period ending on, Day period ending on, and including, the and including, the 5th Trading Day 5th Trading Day immediately preceding immediately preceding the date on which we the date on which we mail the notice of mail the notice of exchange to holders exchange to holders of the outstanding of the outstanding shares being shares being exchanged. exchanged. In addition, we will In addition, we will have the right, at have the right, at any time Staples.com any time Staples.com Stock exceeds the 40% Stock exceeds the 40% of Total Market of Total Market Capitalization Capitalization Threshold but is Threshold but is below the 60% of below the 60% of Total Market Total Market Capitalization Capitalization Threshold, to issue Threshold, to issue shares of either shares of either series of common series of common stock in exchange for stock in exchange for outstanding shares of outstanding shares of the other series of the other series of common stock on a common stock on a value for value value for value basis. basis.
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Tracking Stock Proposal -------------------------------------------- Existing Common Stock Staples Stock Staples.com Stock --------------------- --------------------- --------------------- The exchange ratio The exchange ratio that will result in a that will result in a value for value value for value exchange will be exchange will be based on the average based on the average Market Value of the Market Value of the series of the common series of the common stock being exchanged stock being exchanged as compared to the as compared to the average Market Value average Market Value of the other series of the other series of common stock of common stock during the 20 during the 20 consecutive Trading consecutive Trading Day period ending on, Day period ending on, and including, the and including, the 5th Trading Day 5th Trading Day immediately preceding immediately preceding the date on which we the date on which we mail the notice of mail the notice of exchange to holders exchange to holders of the outstanding of the outstanding shares being shares being exchanged. exchanged. Exchange for Stock of None. We will have the We will have the a Subsidiary at right at any time to right at any time to Staples' Option: transfer all of the transfer all of the assets and assets and liabilities of liabilities of Staples RD to a Staples.com to a subsidiary and subsidiary and deliver all of the deliver all of the stock of that stock of that subsidiary in subsidiary in exchange for all of exchange for all of the outstanding the outstanding Staples Stock. Staples.com Stock. Voting Rights: One vote per share. One vote per share. One vote per share. Holders of Staples Holders of Staples Stock and Staples.com Stock and Staples.com Stock will vote Stock will vote together as a single together as a single class, except in class, except in limited limited circumstances. circumstances.
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Tracking Stock Proposal -------------------------------------------- Existing Common Stock Staples Stock Staples.com Stock --------------------- --------------------- --------------------- Liquidation: Upon liquidation of Upon liquidation of Upon liquidation of Staples, holders of Staples, holders of Staples, holders of existing common stock Staples Stock and Staples Stock and are entitled to Staples.com Stock Staples.com Stock receive the net will be entitled to will be entitled to assets of Staples, if receive the net receive the net any, available for assets of Staples, if assets of Staples, if distribution to any, available for any, available for stockholders (after distribution to distribution to payment or provision stockholders (after stockholders (after for all liabilities payment or provision payment or provision of Staples and for all liabilities for all liabilities payment of the of Staples and of Staples and liquidation payment of the payment of the preference payable to liquidation liquidation any holders of preference payable to preference payable to Preferred Stock). any holders of any holders of Preferred Stock). Preferred Stock). Amounts due upon Amounts due upon liquidation in liquidation in respect of shares of respect of shares of Staples Stock and Staples Stock and shares of Staples.com shares of Staples.com Stock will be Stock will be distributed pro rata distributed pro rata in accordance with in accordance with the average Market the average Market Value of Staples Value of Staples Stock and the average Stock and the average Market Value of Market Value of Staples.com Stock Staples.com Stock over a 20-Trading Day over a 20-Trading Day period ending 300 period ending 300 days after the days after the implementation of the implementation of the Tracking Stock Tracking Stock Proposal (or if the Proposal (or if the liquidation occurs liquidation occurs prior to that date, prior to that date, the 20-Trading Day the 20-Trading Day period prior to the period prior to the liquidation.) In the liquidation.) In the absence of a public absence of a public trading market for trading market for Staples.com Stock, Staples.com Stock, market value would be market value would be determined in good determined in good faith by the board of faith by the board of directors. directors. Stock Exchange Nasdaq National Nasdaq National If and when we issue Listings: Market under the Market under the Staples.com Stock in symbol "SPLS." symbol "SPLS." a public offering, we would expect to apply for listing of Staples.com Stock on the Nasdaq National Market.
Cash Management and Allocation Policies Because Staples RD and Staples.com are part of a single company, we have established policies relating to cash management and allocations between Staples RD and Staples.com. For a more complete description of these policies, see "Proposal 1--The Tracking Stock Proposal--Cash Management and Allocation Policies." No Appraisal Rights Under the Delaware General Corporation Law, you will not have appraisal rights in connection with the Tracking Stock Proposal. Certain Federal Income Tax Considerations We have been advised by Ernst & Young LLP that no gain or loss will be recognized by you for federal income tax purposes as a result of the implementation of the Tracking Stock Proposal. However, the Internal 13 Revenue Service could disagree. There are no court decisions or other authorities bearing directly on transactions similar to the Tracking Stock Proposal. In addition, the Internal Revenue Service has announced that it will not issue rulings on the characterization of stock with characteristics similar to Staples Stock or Staples.com Stock. Therefore, the tax treatment of the Tracking Stock Proposal is subject to some uncertainty under current law. In addition, a recent proposal by the Clinton Administration would impose a corporate level tax on the issuance of stock similar to Staples Stock or Staples.com Stock. If this proposal were enacted, we could be subject to tax on an issuance of Staples Stock or Staples.com Stock after the date of enactment. If our stockholders approve the Tracking Stock Proposal, our board of directors currently intends to implement the proposal, subject to further legislative developments relating to the Clinton Administration tax proposal (or similar proposals). In light of the foregoing, you should consult your own tax advisor regarding the tax consequences of the Tracking Stock Proposal, including the state, local and any foreign tax consequences. 14 PROPOSALS 2, 3 and 4--THE STOCK PLAN PROPOSALS At the Special Meeting, we will also ask you to consider and approve amendments to our 1992 Equity Incentive Plan, Amended and Restated 1990 Director Stock Option Plan and 1998 Employee Stock Purchase Plan that would permit us to issue Staples.com Stock under those Plans. For a more detailed description of these proposals, see "Proposals 2, 3 and 4--The Stock Plan Proposals." 15 STAPLES SUMMARY HISTORICAL CONSOLIDATED FINANCIAL DATA
Six Months Ended Fiscal Year --------------------- -------------------------------- July 31, August 1, 1999 1998(1) 1998(1)(2) 1997(3) 1996 ---------- ---------- ---------- ---------- ---------- (in thousands, except per share and selected operating data) Statement of Income Data: Sales................... $3,912,176 $3,146,316 $7,123,189 $5,732,145 $4,493,589 Gross profit............ 949,312 728,805 1,726,266 1,354,455 1,060,245 Net income.............. 103,058 44,924 185,370 167,914 144,742 Pro forma net income(4).............. -- 43,110 183,556 153,128 129,413 Historical basic earnings per common share(5)............... $0.22 $0.11 $0.43 $0.41 $0.36 Historical diluted earnings per common share(5)............... $0.22 $0.10 $0.41 $0.39 $0.35 Pro forma basic earnings per common share(4)(5)............ $ -- $0.10 $0.43 $0.38 $0.32 Pro forma diluted earnings per common share(4)(5)............ $ -- $0.10 $0.41 $0.36 $0.31 Selected Operating Data: Stores open (at period end)................... 1,009 830 913 742 557
As of --------------------- July 31, Jan. 30, 1999 1999 ---------- ---------- (in thousands) Balance Sheet Data: Working capital.......................................... $ 677,132 $ 798,768 Total assets............................................. 3,405,246 3,179,266 Total long-term debt, less current portion............... 263,560 205,015 Stockholders' equity..................................... 1,733,678 1,656,886
- -------- (1) Results of operations for this period include a $41,000,000 charge relating to costs incurred in connection with the merger with Quill. (2) Results of operations for this period include a $49,706,000 charge relating to store closure costs. (3) Results of operations for this period include a pre-tax charge of $29,665,000 relating to costs incurred for the then proposed merger with Office Depot, Inc. (4) Pro forma net income and pro forma earnings per share include a provision for income taxes on the previously untaxed earnings of Quill, which had been taxed as an S corporation prior to its acquisition by Staples. (5) Earnings per common share have been restated to reflect 3-for-2 stock splits effective January 1999, January 1998 and March 1996. 16 STAPLES RETAIL AND DELIVERY SUMMARY HISTORICAL COMBINED FINANCIAL DATA
Six Months Ended Fiscal Year --------------------- -------------------------------- July 31, August 1, 1999 1998(1) 1998(1)(2) 1997(3) 1996 ---------- ---------- ---------- ---------- ---------- (in thousands, except selected operating data) Statement of Income Data: Sales................... $3,884,874 $3,141,258 $7,106,303 $5,728,439 $4,493,554 Gross profit............ 943,007 727,353 1,722,101 1,353,524 1,060,236 Net income.............. 103,058 44,924 185,370 167,914 144,742 Pro forma net income(4).............. 103,058 43,110 183,556 153,128 129,413 Dividends............... -- -- -- -- -- Selected Operating Data: Stores open (at period end)................... 1,009 830 913 742 557 As of --------------------- January July 31, 30, 1999 1999 ---------- ---------- (in thousands) Balance Sheet Data: Working capital......... $ 680,723 $ 797,820 Total assets............ 3,404,019 3,179,181 Total long-term debt, less current portion... 263,560 205,015 Group equity............ 1,733,678 1,656,886
- -------- (1) Results of operations for this period include a $41,000,000 charge relating to costs incurred in connection with the merger with Quill. (2) Results of operations for this period include a $49,706,000 charge relating to store closure costs. (3) Results of operations for this period include a $29,665,000 charge relating to costs incurred for the then proposed merger with Office Depot, Inc. (4) Pro forma net income includes a provision for income taxes on the previously untaxed earnings of Quill, which had been taxed as an S corporation prior to its acquisition by Staples. 17 STAPLES.COM SUMMARY HISTORICAL COMBINED FINANCIAL DATA
Six Months Ended Fiscal Year ------------------ ----------------------------- July 31, August 1, 1999 1998 1998 1997 1996 ------- --------- ------- ------- ----------- (in thousands) Statement of Income Data: Sales........................ $27,302 $5,058 $16,886 $3,706 $ 35 Gross profit................. 6,305 1,352 4,165 931 26 Net loss..................... (3,706) (104) (487) (300) (207) Pro forma net loss(1)........ (3,706) (92) (475) (180) (124) Dividends.................... -- -- -- -- -- As of -------------------- July 31, January 30, 1999 1999 ------- ----------- (in thousands) Balance Sheet Data: Working capital.............. $(2,591) $ 948 Total assets................. 23,976 2,047 Total long-term debt, less current portion -- -- Group equity................. 21,052 1,962
- -------- (1) Pro forma net loss includes a benefit for income taxes on the previously untaxed earnings of Quill, which had been taxed as an S corporation prior to its acquisition by Staples. 18 GENERAL Staples' board of directors is furnishing this Proxy Statement to solicit proxies in connection with a Special Meeting of Stockholders to be held at 2:00 p.m., Eastern Standard Time, on November 9, 1999, at Hale and Dorr LLP, 60 State Street, Boston, Massachusetts, and at any adjournments or postponements thereof. We will vote shares represented by the proxies received and not properly revoked in accordance with the instructions contained therein. If no choice is specified on an executed form of proxy, the shares will be voted "FOR" the approval of each of Proposals 1, 2, 3 and 4 described in this Proxy Statement. A stockholder who has given a proxy may revoke it at any time before it is exercised by filing with the Secretary of Staples a written revocation or a duly executed proxy bearing a later date or by voting in person at the Special Meeting. If you vote "FOR" the Tracking Stock Proposal at the Special Meeting, you may be forfeiting your right to challenge the Tracking Stock Proposal in the future. Stockholders of record at the close of business on October 5, 1999 (the "Record Date") are entitled to notice of and to vote at the Special Meeting. As of the close of business on the Record Date, a total of 462,138,859 shares of common stock (constituting all of the voting stock of Staples) were outstanding. Holders of common stock are entitled to one vote per share. The holders of a majority of the shares of common stock outstanding and entitled to vote at the Special Meeting will constitute a quorum for the transaction of business at the Special Meeting. Shares of common stock represented in person or by proxy (including shares which abstain or do not vote with respect to one or more of the matters presented for stockholder approval) will be counted for purposes of determining whether a quorum is present at the Special Meeting. The affirmative vote of the holders of a majority of the shares of common stock outstanding as of the Record Date is required to approve the Tracking Stock Proposal and the affirmative vote of the holders of a majority of the shares of Common Stock voting on the matter is required to approve each of the Stock Plan Proposals. Shares which abstain from voting as to a particular matter, and shares held in "street name" by brokers or nominees who indicate on their proxies that they do not have discretionary authority to vote such shares as to a particular matter, will not be counted as votes in favor of such matter, and will also not be counted as shares voting on such matter. Accordingly, abstentions and "broker non-votes" will have the same effect on the Tracking Stock Proposal as a vote against such proposal, but will have no effect on the voting on the Stock Plan Proposals. 19 RISK FACTORS You should carefully consider the risk factors described below, as well as the other information included in this Proxy Statement, before you decide how to vote on the proposals. We cannot predict how the issuance of Staples.com Stock will affect the market price of Staples Stock We cannot predict the price at which Staples Stock will trade following the issuance of Staples.com Stock. The market price of Staples Stock may not equal or exceed the market price of our existing common stock. Some of the terms of Staples Stock and Staples.com Stock may adversely affect the trading price of Staples Stock (or Staples.com Stock, in the event we decide to undertake an initial public offering of Staples.com Stock in the future). Examples include: . the right of the Staples board of directors to issue Staples Stock in exchange for Staples.com Stock, and . the discretion of Staples' board of directors in making various determinations relating to (1) a variety of matters affecting the rights of the holders of Staples Stock and Staples.com Stock, such as dividends and the allocation of merger proceeds, and (2) a variety of cash management and allocation matters. Holders of Staples Stock and Staples.com Stock will be common stockholders of Staples and will not have any legal rights relating to specific assets of Staples Even though we have allocated, for financial reporting purposes, all of our consolidated assets, liabilities, revenue, expenses and cash flow between the two Businesses in order to prepare their financial statements, the Tracking Stock Proposal will not change the legal title to any assets or responsibility for any liabilities and will not affect the rights of any of our creditors. Holders of Staples Stock and Staples.com Stock will not have any legal rights related to specific assets of either Business, and, in any liquidation, will receive a share of the net assets of Staples based on the relative trading prices of Staples Stock and Staples.com Stock rather than on any assessment of the actual value of Staples RD or Staples.com. Holders of Staples Stock and Staples.com Stock will be common stockholders of Staples and, as such, will be subject to all of the risks associated with an investment in Staples and all of our businesses, assets and liabilities. If Staples encounters financial difficulty, the value of either Business's stock may suffer for reasons unrelated to the prospects of that Business. Financial results of either Business will affect Staples' consolidated results of operations, financial position and borrowing costs. This could affect the results of operations or financial position of the other Business or the market price of shares issued with respect to the other Business. Existing stockholders of Staples will have a reduced interest in Staples.com Holders of Staples Stock will participate in the ownership of Staples.com through Staples RD's retained interest in Staples.com. Staples RD's interest in Staples.com will decrease as a result of the issuance of Staples.com Stock. After any issuance of Staples.com Stock, the existing stockholders of Staples will no longer share in the gains or losses attributable to the portion of Staples.com that is represented by the outstanding shares of Staples.com Stock. The price at which any shares of Staples.com Stock may be sold in the future may not reflect accurately the value of Staples.com Stock and thus holders of Staples Stock may not appropriately benefit from such issuances. Existing stockholders of Staples will not have any special rights to subscribe for Staples.com Stock. 20 The cost of maintaining separate businesses will likely exceed the costs associated with operating Staples as a single entity The costs associated with implementing the Tracking Stock Proposal and the ongoing costs of operating separate Businesses will likely exceed the costs associated with operating Staples as it currently exists. In particular, the issuance of the Staples.com Stock will result in a complex capital structure and additional reporting requirements with respect to each Business. Having two series of common stock could create potential conflicts of interest and the Staples board of directors could make decisions that adversely affect stockholders of either Business Having two series of common stock could give rise to occasions when the interests of holders of one series might diverge or appear to diverge from the interests of holders of the other series. In addition, due to the extensive relationships between, and the similarity of the businesses of, Staples RD and Staples.com, there will likely be inherent conflicts of interest between the two Businesses. The Staples board of directors, in its sole discretion, will make operational and financial decisions and implement policies that may affect the businesses of Staples RD and Staples.com differently, potentially favoring one Business at the expense of the other. Examples include decisions as to: . whether to allocate the proceeds of issuances (or the costs of repurchases) of Staples.com Stock to Staples RD in respect of its retained interest in Staples.com or to the equity of Staples.com, . how to allocate consideration received in connection with a merger involving Staples between holders of Staples Stock and Staples.com Stock, . whether and when to issue Staples Stock in exchange for Staples.com Stock, . whether and when to approve dispositions of assets of either Business, . how to allocate available cash between Staples RD and Staples.com and decisions as to whether and how to make transfers of funds from one Business to another, . how to allocate assets and resources, such as inventory, distribution and fulfillment services and management time, between the two Businesses, and . whether and to what extent the two Businesses compete with each other and how corporate opportunities are allocated between the two Businesses. If directors own disproportionate interests (in percentage or value terms) in Staples Stock and Staples.com Stock, that disparity could create or appear to create potential conflicts of interest when they are faced with decisions that could have different implications for the stockholders of either Business. The Staples board of directors has sole discretion to change cash management and allocation policies and this makes it riskier to be a holder of Staples Stock or Staples.com Stock than a holder of ordinary common stock The Staples board of directors has adopted certain policies relating to cash management and allocations between Staples RD and Staples.com. Although it has no present intention to do so, the board of directors may, in its sole discretion, modify, rescind or add to any of these policies. The board of directors' discretion to change these policies makes it riskier to be a holder of Staples Stock or Staples.com Stock than a holder of ordinary common stock. For a more comprehensive description of these policies, see "Proposal 1--The Tracking Stock Proposal--Cash Management and Allocation Policies." 21 Principles of Delaware law may protect decisions of the Staples board of directors that have a disparate impact upon holders of Staples Stock and Staples.com Stock Delaware law provides that a board of directors owes an equal duty to all stockholders regardless of class or series and does not have separate or additional duties to the holders of any particular class or series of stock. Recent cases in Delaware involving tracking stocks have established that decisions by directors or officers involving differing treatment of tracking stocks may be judged under the "business judgment rule." Under these principles of Delaware law and the "business judgment rule," you may not be able to challenge board of directors' decisions that have a disparate impact upon holders of Staples Stock and Staples.com Stock if the board of directors is adequately informed with respect to such decisions and acts in good faith and in the honest belief that it is acting in the best interests of Staples' stockholders and does not have a conflict of interest. Stockholders will not vote on how to allocate consideration received in connection with a merger among holders of Staples Stock and holders of Staples.com Stock Our certificate of incorporation will not contain any provisions governing how consideration received in connection with a merger or consolidation involving Staples is to be allocated between holders of Staples Stock and holders of Staples.com Stock. Neither holders of Staples Stock nor holders of Staples.com Stock will have a separate class vote in any merger or consolidation so long as we divide the type and amount of consideration between holders of Staples Stock and holders of Staples.com Stock in a manner we determine, in our sole discretion, to be fair. In any such merger or consolidation, the different ways we may divide the consideration might have materially different results. As a result, the consideration to be received by holders of Staples Stock or Staples.com Stock in any such merger or consolidation may be materially less valuable than the consideration they would have received if that business had been sold separately or if they had a separate class vote on such merger or consolidation. We have the option to exchange one series of common stock for the other series and this may be disadvantageous to holders of Staples Stock or holders of Staples.com Stock We will have the right to issue shares of one series of common stock in exchange for outstanding shares of the other series of common stock. Because certain exchanges would be at a premium to the market value, and since we could determine to effect an exchange at a time when either or both of Staples Stock and Staples.com Stock may be considered to be overvalued or undervalued, any such exchange may be disadvantageous to holders of Staples Stock or holders of Staples.com Stock. In addition, such exchange would preclude holders of the exchanged series of common stock from retaining their investment in a security that is intended to reflect separately the performance of the corresponding Business. We may dispose of assets of either Staples RD or Staples.com without your approval Delaware law requires stockholder approval only for a sale or other disposition of all or substantially all of the assets of Staples. As long as the assets attributed to a Business represent less than substantially all of Staples' assets, we may approve sales and other dispositions of any amount of the assets of that Business without any stockholder approval. If we dispose of all or substantially all of the assets of either Business, we would be required, if the disposition is not an exempt disposition under the terms of our charter, to choose one of the following three alternatives: . declare and pay a dividend, . redeem shares of the relevant series of stock, or . exchange shares of one series for outstanding shares of the other series at a 10% premium. Consequently, holders of either series of common stock may receive less value for their shares than the value that a third-party buyer might pay for all or substantially all of the assets of such Business. The board of directors will decide, in its sole discretion, how to proceed and is not required to select the option that would result in the highest value to holders of Staples Stock or Staples.com Stock. 22 We are not required to pay dividends equally on Staples Stock and Staples.com Stock Although we do not intend to pay cash dividends in the foreseeable future, the Staples board of directors could elect to pay dividends on Staples Stock or Staples.com Stock, or both, in equal or unequal amounts. Such a decision would not necessarily have to reflect: . the financial performance of either Staples RD or Staples.com, . the amount of assets available for dividends on either series, or . the amount of prior dividends declared on either series. Holders of Staples Stock and Staples.com Stock will vote together as a single class and will have limited separate voting rights Holders of Staples Stock and Staples.com Stock will vote together as a single class, except in certain limited circumstances provided under the Delaware General Corporation Law. When holders of Staples Stock and Staples.com Stock vote together as a single class, holders of the series of common stock having a majority of the votes (initially the holders of Staples Stock) will be in a position to control the outcome of the vote even if the matter involves a conflict of interest between holders of Staples Stock and holders of Staples.com Stock. Having two series of common stock may inhibit or prevent acquisition bids for Staples, Staples RD or Staples.com If Staples RD and Staples.com were separate companies, any person interested in acquiring either Staples RD or Staples.com without negotiating with management could seek control of that entity by obtaining control of its outstanding voting stock by means of a tender offer or proxy contest. Although we intend Staples Stock and Staples.com Stock to reflect the separate performance of Staples RD and Staples.com, a person interested in acquiring only one Business without negotiation with Staples' management could obtain control of that Business only by obtaining control of the outstanding voting stock of Staples. The existence of two series of common stock could present complexities and could in certain circumstances pose obstacles, financial and otherwise, to an acquiring person. The existence of two series of common stock could, under certain circumstances, prevent stockholders from profiting from an increase in the market value of their shares as a result of a change in control of Staples by delaying or preventing such a change in control. In addition, some of the provisions of our charter, by-laws, and Delaware law may inhibit changes of control not approved by the board of directors. For additional anti-takeover constraints, see "Proposal 1--The Tracking Stock Proposal--Certain Other Provisions of Our Certificate of Incorporation, By- laws and Delaware Law." The values of Staples Stock and Staples.com Stock may decline due to future issuances of Staples Stock or Staples.com Stock Our certificate of incorporation will allow the Staples board of directors, in its sole discretion, to issue authorized but unissued shares of common stock. The board of directors may issue Staples Stock or Staples.com Stock to, among other things: . raise capital, . provide compensation or benefits to employees, . pay stock dividends, or . acquire companies or businesses. 23 Under the Delaware General Corporation Law, the board of directors would not need your approval for these issuances. We do not intend to seek your approval for any such issuances unless: . stock exchange regulations or other applicable law require approval, or . the board of directors deems it advisable. We may not offer Staples.com Stock at all This Proxy Statement describes our current intentions regarding future issuances of Staples.com Stock. Because such issuances are subject to various conditions and uncertainties, we cannot assure you that any will occur. The IRS could assert that the receipt of the tracking stock is taxable We have been advised by Ernst & Young LLP that no income, gain or loss will be recognized by you for federal income tax purposes as a result of the implementation of the Tracking Stock Proposal. However, the Internal Revenue Service could disagree. There are no court decisions or other authorities bearing directly on the effect of the features of Staples Stock or Staples.com Stock. In addition, the Internal Revenue Service has announced that it will not issue rulings on the characterization of stock with characteristics similar to Staples Stock and Staples.com Stock. It is possible, therefore, that the Internal Revenue Service could successfully assert that the issuance or receipt of Staples Stock, as well as the subsequent conversion of one stock into the other, could be taxable to you and to us as ordinary income. A recent Clinton Administration proposal could result in taxation on issuances of tracking stock A recent proposal by the Clinton Administration would impose a corporate level tax on the issuance of stock similar to Staples Stock or Staples.com Stock. If this proposal is enacted, we would be subject to tax on an issuance of Staples Stock or Staples.com Stock after the date of enactment. If our stockholders approve the Tracking Stock Proposal our board of directors currently intends to implement the proposal subject to further legislative developments relating to the Clinton Administration tax proposal or similar proposals. Under the Tracking Stock Proposal, we would be allowed to convert Staples Stock or Staples.com Stock into shares of the other series with a premium if there are adverse U.S. federal income tax law developments. The proposal of the Clinton Administration would be such an adverse development if it is implemented or proposed to be implemented by an applicable federal legislative committee or its chair. For additional information on the events that could cause us to effect a conversion, see "Proposal 1--The Tracking Stock Proposal--General Dividend, Redemption and Exchange Provisions" and "--Certain Federal Income Tax Consequences." If the Tracking Stock Proposal prevents us from using the pooling-of- interests method of accounting for acquisitions, we may be constrained in making certain acquisitions on terms favorable to us Under currently accepted accounting rules and practices, some acquisitions may be accounted for using a method of accounting known as the pooling-of- interests method. Pooling-of-interests transactions are favorable from an accounting perspective because they avoid the expense associated with goodwill amortization. The issuance of Staples.com Stock may preclude Staples from availing itself of the pooling-of-interests method of accounting for future acquisitions. This could make it less desirable for us to proceed with some acquisitions. 24 CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION This Proxy Statement includes or incorporates forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. You can identify these forward-looking statements by our use of the words "believes," "anticipates," "plans," "expects," "may," "will," "would," "intends," "estimates" and similar expressions, whether in the negative or affirmative. We cannot guarantee that we actually will achieve these plans, intentions or expectations. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements we make. We have included important factors in various cautionary statements herein, particularly under the heading "Risk Factors," that we believe could cause our actual results to differ materially from the forward-looking statements that we make. The forward-looking statements do not reflect the potential impact of any future acquisitions, mergers or dispositions. We do not assume any obligation to update any forward-looking statement we make. 25 PROPOSAL 1--THE TRACKING STOCK PROPOSAL General At the Special Meeting, we will ask you to consider and approve the Tracking Stock Proposal described in this Proxy Statement. The Tracking Stock Proposal would allow us to amend our certificate of incorporation to: . Create a new series of common stock called Staples.com Stock that could be issued from time to time by the board of directors. . Increase the aggregate number of shares of common stock that we may issue from 1,500,000,000 to 2,100,000,000, initially comprised of 1,500,000,000 shares of Staples Stock and 600,000,000 shares of Staples.com Stock. . Reclassify each outstanding share of existing common stock into a share of Staples Stock. We intend Staples.com Stock to reflect the performance of Staples.com, our e- commerce business. We intend Staples Stock to reflect the performance of Staples RD, which consists of our other lines of business and a retained interest in Staples.com. Staples RD's interest in Staples.com, excluding the interest represented by outstanding shares of Staples.com Stock, is called its "Retained Interest." We have allocated, for financial reporting purposes, all of Staples' consolidated assets, liabilities, revenue, expenses and cash flow between Staples RD and Staples.com. If the Tracking Stock Proposal is approved by stockholders, we will publish combined financial statements of Staples RD, combined financial statements of Staples.com, and consolidated financial statements of Staples covering both Staples RD and Staples.com. We currently plan to grant options for Staples.com Stock under the 1992 Equity Incentive Plan to all Staples employees who currently receive options under the Plan shortly following stockholder approval of the proposed amendment to the Plan. We expect to issue additional shares of Staples.com Stock in one or more private or public financings within 12 months of stockholder approval of the Tracking Stock Proposal. The specific terms of the financings, including whether they are private or public, the amount of Staples.com Stock we issue, and the timing of the financings, will depend upon factors such as stock market conditions and the performance of Staples.com. In addition, we may grant options to directors under the Amended and Restated 1990 Director Stock Option Plan and make available to our employees Staples.com Stock under our 1998 Employee Stock Purchase Plan if stockholders approve the proposed amendments to those plans. We expect to file the amendment to our certificate of incorporation implementing the Tracking Stock Proposal and reclassify your common stock shortly following the Special Meeting, assuming the Tracking Stock Proposal is approved. Background and Reasons for the Tracking Stock Proposal We continually review each of our businesses and Staples as a whole to determine the best way to realize the inherent value of our business operations. As a result of this review process, we recently began to evaluate various alternatives to maximize stockholder value, including the creation of Staples "tracking stock" intended to reflect the performance of Staples.com. Upon management's recommendation and after extensive consultation with our financial and legal advisors, the board of directors determined that the issuance of tracking stock would be desirable for a number of reasons, as discussed below. On September 14, 1999, the board of directors carefully considered the Tracking Stock Proposal and the other proposals described in this Proxy Statement, determined that those proposals are in the best interests of Staples and its stockholders, unanimously approved them and resolved to recommend that you vote for them. In arriving at its determination and recommendation, Staples' board of directors, with the assistance of its financial and legal advisors, considered the following benefits of the authorization of Staples.com Stock: . enabling investors to review separate information about Staples.com and separately value Staples.com Stock. This should encourage investors to focus more attention on Staples.com and result in greater market recognition of the value of Staples.com to Staples. 26 . enabling us to issue Staples.com Stock in one or more private or public financings, thus raising capital for Staples RD and/or Staples.com and perhaps creating a public trading market for Staples.com Stock. . enabling us to grant stock options or restricted stock tied to Staples.com, thereby providing more focused incentives to Staples.com management and employees. . providing us with greater flexibility in responding to strategic opportunities (including acquisitions), because it would allow us to issue either Staples Stock or Staples.com Stock as appropriate under the circumstances. . enabling us to realize some of the value of Staples.com without losing the financial, tax, operational, strategic and other benefits of being a single consolidated entity. Staples' board of directors also evaluated the potential negative aspects of the Tracking Stock Proposal, including the following: . The Tracking Stock Proposal will require a complex capital structure and additional reporting requirements with respect to each Business. . The costs associated with implementing the Tracking Stock Proposal and the ongoing cost of operating separate Businesses will likely exceed the costs associated with operating Staples as it currently exists. . The potential diverging or conflicting interests between the holders of Staples Stock and the holders of Staples.com Stock and issues that the board of directors may face in resolving any conflicts. . The pooling-of-interests method of accounting might not be available for future acquisitions using Staples Stock or Staples.com Stock. Staples' board of directors determined that the positive aspects of the Tracking Stock Proposal outweighed the negative aspects and concluded that the Tracking Stock Proposal and the other proposals are in the best interests of Staples and its stockholders. Description of Staples Stock and Staples.com Stock The following description is not complete and should be read with Annex II to this Proxy Statement, which contains the full text of the Certificate of Amendment that will be filed pursuant to the Tracking Stock Proposal. General Our certificate of incorporation (which we call the "Current Certificate of Incorporation") authorizes us to issue 1,505,000,000 shares, consisting of 1,500,000,000 shares of common stock, par value $0.0006 per share, and 5,000,000 shares of preferred stock, par value $0.01 per share. Only the preferred stock is currently issuable in series by our board of directors. As of October 5, 1999, we had 462,138,859 shares of common stock and no shares of preferred stock issued and outstanding. 27 In order to implement the Tracking Stock Proposal, we would file the Certificate of Amendment (the "Certificate of Amendment") which would amend our Current Certificate of Incorporation. The Certificate of Amendment would: . Create a new series of common stock called Staples.com Stock that could be issued from time to time by the board of directors. . Increase the aggregate number of shares of common stock that we may issue from 1,500,000,000 to 2,100,000,000, initially comprised of 1,500,000,000 shares of Staples Stock and 600,000,000 shares of Staples.com Stock. . Reclassify each outstanding share of existing common stock into a share of Staples Stock. We intend Staples.com Stock to reflect the performance of Staples.com, our e- commerce business. We intend Staples Stock to reflect the performance of Staples RD, which consists of our other businesses and a retained interest in Staples.com. We have allocated, for financial reporting purposes, all of Staples' consolidated assets, liabilities, revenue, expenses and cash flow between Staples RD and Staples.com. If the Tracking Stock Proposal is approved by stockholders, we will publish combined financial statements of Staples RD, combined financial statements of Staples.com, and consolidated financial statements of Staples (covering both Staples RD and Staples.com). The full definitions of the terms "Staples RD" and "Staples.com" are set forth under "--Mandatory Dividend, Redemption or Exchange on Disposition of All or Substantially All of the Assets of a Business" below. Before we first issue shares of, or options for shares of, Staples.com Stock, the board of directors would designate the initial Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com. See "-- Staples RD's Retained Interest in Staples.com," "--Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com" and Annex I for additional information about Staples RD's Retained Interest in Staples.com and the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com. The board of directors will have the authority to increase or decrease from time to time the total number of authorized shares comprising either series of common stock. However, the board of directors could not increase the number of authorized shares of a series above a number which, when added to all of the authorized shares of the other series of common stock, would exceed the total authorized number of shares of common stock. Likewise, the board of directors could not decrease the number of authorized shares of a series below the number of shares of such series then outstanding. The board of directors will have the authority in its sole discretion to issue authorized but unissued shares of common stock from time to time for any proper corporate purpose. The board of directors will have the authority to do so without your approval, except as provided by Delaware law or the rules and regulations of any securities exchange on which any series of outstanding common stock may then be listed. Dividends We currently intend to retain all of our earnings for use in the operation and expansion of our business. We therefore do not expect to pay any cash dividends on Staples Stock or Staples.com Stock in the foreseeable future. Although our revolving credit agreement currently restricts the payment of cash dividends, and in any event, as stated above, we do not expect to pay any dividends in the foreseeable future on any series of common stock, we will otherwise be permitted to pay dividends on: 28 . Staples Stock out of assets of Staples legally available for the payment of dividends under Delaware law, but the total amounts paid as dividends on Staples Stock cannot exceed the Available Dividend Amount for Staples RD, and . Staples.com Stock out of the assets of Staples legally available for the payment of dividends under Delaware law, while transferring corresponding amounts to Staples RD in respect of its Retained Interest in Staples.com. However, the total amounts paid as dividends on Staples.com Stock and the corresponding amounts transferred to Staples RD in respect of its Retained Interest in Staples.com cannot exceed the Available Dividend Amount for Staples.com. The "Available Dividend Amount" for Staples RD at any time is the amount that would then be legally available for the payment of dividends on Staples RD's common stock under Delaware law if (1) Staples RD and Staples.com were each a separate Delaware corporation, (2) Staples RD had outstanding (a) a number of shares of common stock, par value $0.0006 per share, equal to the number of shares of Staples Stock that are then outstanding and (b) a number of shares of preferred stock, par value $0.01 per share, equal to the number of shares of preferred stock of Staples that have been attributed to Staples RD and are then outstanding, (3) the assumptions about Staples.com set forth in the next sentence were true and (4) Staples RD owned a number of shares of Staples.com common stock equal to the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com. Similarly, the "Available Dividend Amount" for Staples.com at any time is the amount that would then be legally available for the payment of dividends on Staples.com Stock under Delaware law if Staples.com were a separate Delaware corporation having outstanding (1) a number of shares of common stock, par value $0.0006 per share, equal to the number of shares of Staples.com Stock that are then outstanding plus the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com and (2) a number of shares of preferred stock, par value $0.01 per share, equal to the number of shares of preferred stock of Staples that have been attributed to Staples.com and are then outstanding. The amount legally available for the payment of dividends on common stock of a corporation under Delaware law is generally limited to (1) the total assets of the corporation less its total liabilities less (2) the aggregate par value of the outstanding shares of its common stock and preferred stock. However, if that amount is not greater than zero, the corporation may also pay dividends out of the net profits for the corporation for the fiscal year in which the dividend is declared and/or the preceding fiscal year. As mentioned above, these restrictions will form the basis for calculating the Available Dividend Amounts for Staples RD and Staples.com. These restrictions will also form the basis for calculating the aggregate amount of dividends that Staples as a whole can pay on its common stock, regardless of series. Thus, net losses of either Business, and any dividends and distributions on, or repurchases of, either series of common stock, will reduce the assets legally available for dividends on both series of common stock. Subject to the foregoing limitations (and to any other limitations set forth in any future series of preferred stock or in any agreements binding on Staples from time to time), we have the right to pay dividends on both, one or neither series of common stock in equal or unequal amounts, notwithstanding the performance of either Business, the amount of assets available for dividends on either series, the amount of prior dividends paid on either series, the respective voting rights of each series or any other factor. At the time of any dividend on the outstanding shares of Staples.com Stock (including any dividend required as a result of a disposition of All or Substantially All of the Assets of Staples.com, but excluding any dividend payable in shares of Staples.com Stock) we will credit to Staples RD, and charge against Staples.com, a corresponding amount in respect of Staples RD's Retained Interest in Staples.com. Specifically, the corresponding amount will equal (1) the aggregate amount of such dividend multiplied by (2) a fraction, the numerator of which is the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com and the denominator of which is the number of shares of Staples.com Stock then outstanding. 29 Mandatory Dividend, Redemption or Exchange on Disposition of All or Substantially All of the Assets of a Business If we dispose of All or Substantially All of the Assets of a Business to one or more persons or entities, in one transaction or a series of related transactions (collectively, a "Disposition"), and the Disposition is not an Exempt Disposition as defined below, we would be required, by the 85th Trading Day after the consummation of such Disposition, to choose one of the following three alternatives: . declare and pay a dividend to holders of the series of common stock that relates to that Business (in cash, securities (other than common stock of Staples) or other property, or a combination thereof), in an amount having a Fair Value equal to their Proportionate Interest in the Net Proceeds of such Disposition, . redeem from holders of the series of common stock that relates to that Business, for cash, securities (other than common stock of Staples) or other property (or a combination thereof) in an amount having a Fair Value equal to their Proportionate Interest in the Net Proceeds of such Disposition, all of the outstanding shares of the relevant series of common stock (or, if such Business continues after such Disposition to own any material assets other than the proceeds of such Disposition, a number of shares of such series of common stock having an aggregate average Market Value, during the 20 consecutive Trading Day period beginning on the 16th Trading Day immediately following the date on which the Disposition is consummated, equal to such Fair Value), or . issue shares of the series of common stock that does not relate to that Business in exchange for all of the outstanding shares of the series of common stock that relates to that Business at a 10% premium (based on the average Market Value of the relevant series of common stock as compared to the average Market Value of the other series of common stock during the 20 consecutive Trading Day period beginning on the 16th Trading Day immediately following the date on which the Disposition is consummated). In connection with any special dividend on, or redemption of, Staples.com Stock as described above, we will credit to Staples RD, and charge against Staples.com, a corresponding amount in respect of Staples RD's Retained Interest in Staples.com. Specifically, the corresponding amount will equal (1) the aggregate Fair Value of such dividend or redemption multiplied by (2) a fraction, the numerator of which is the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com and the denominator of which is the number of shares of Staples.com Stock then outstanding. In addition, in connection with any redemption of Staples.com Stock as described above, we will decrease the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com by the same proportion as the proportionate decrease in outstanding shares of Staples.com caused by such redemption. At any time within one year after completing any dividend or partial redemption of the sort referred to above, we will have the right to issue shares of the series of common stock that does not relate to the Business in question in exchange for outstanding shares of the series of common stock that relates to that Business at a 10% premium (based on the average Market Value of the relevant series of common stock as compared to the average Market Value of the other series of common stock during the 20 consecutive Trading Day period ending on the 5th Trading Day immediately preceding the date on which Staples mails the notice of exchange to holders of the relevant series). In determining whether to effect any such exchange following such a dividend or partial redemption, we would, in addition to other matters, consider whether the remaining assets of such Business continue to constitute a viable business, the number of shares of such common stock remaining issued and outstanding, the per share market price of such common stock and the ongoing cost of continuing to have a separate series of such common stock outstanding. 30 The following terms used in this document have the meanings specified in the Certificate of Amendment and are set forth below: "All or Substantially All of the Assets" of either Business means a portion of such assets that represents at least 80% of the then-current Fair Value of the assets of such Business. "Exempt Disposition" means any of the following: . a Disposition in connection with the liquidation, dissolution or winding-up of Staples and the distribution of assets to stockholders, . a Disposition to any person or entity controlled by Staples, as determined by the board of directors in its sole discretion, . a Disposition by either Business for which Staples receives consideration primarily consisting of equity securities (including, without limitation, capital stock of any kind, interests in a general or limited partnership, interests in a limited liability company or debt securities convertible into or exchangeable for, or options or warrants to acquire, any of the foregoing, in each case without regard to the voting power or other management or governance rights associated therewith) of an entity that is primarily engaged or proposes to engage primarily in one or more businesses similar or complementary to businesses conducted by such Business prior to the Disposition, as determined by the board of directors in its sole discretion, . a dividend out of Staples.com's assets to holders of Staples.com Stock and a transfer of a corresponding amount to Staples RD in respect of its Retained Interest in Staples.com, . a dividend out of Staples RD's assets to holders of Staples Stock, and . any other Disposition, if (1) at the time of the Disposition there are no shares of Staples Stock outstanding, (2) at the time of the Disposition there are no shares of Staples.com Stock outstanding or (3) before the 30th Trading Day following the Disposition we have mailed a notice stating that we are exercising our right to exchange outstanding shares of either Staples Stock or Staples.com Stock for newly issued shares of the other series of common stock as contemplated under "-- Optional Exchange of One Series of Common Stock for the Other Series" below. "Fair Value" means (1) in the case of cash, the amount thereof, (2) in the case of capital stock that has been Publicly Traded for a period of at least 15 months, the Market Value thereof and (3) in the case of other assets or securities, the fair market value thereof as the board of directors shall determine in good faith. Any good faith determination by the board of directors of Fair Value shall be conclusive and binding on all stockholders. "Market Capitalization" of either series of common stock on any date means the Market Value of a share of such series on such date multiplied by the number of shares of such series outstanding on such date. Shares issuable with respect to Staples RD's Retained Interest in Staples.com are not considered to be outstanding unless and until they are in fact issued to third parties. "Market Value" of a share of any class or series of capital stock on any Trading Day generally means the average of the high and low reported sales prices of a share of such class or series on such Trading Day, subject to certain exceptions as described in the Certificate of Amendment. "Nasdaq NMS" means the Nasdaq National Market. 31 The "Net Proceeds" of a Disposition of any of the assets of a Business means the positive amount, if any, remaining from the gross proceeds of such Disposition after any payment of, or reasonable provision (as determined in good faith by the board of directors, which determination will be conclusive and binding on all stockholders) for: (1) any taxes payable by Staples in respect of such Disposition, (2) any taxes payable by Staples in respect of any resulting dividend or redemption, (3) any transaction costs, including, without limitation, any legal, investment banking and accounting fees and expenses and (4) any liabilities (contingent or otherwise) of, attributed to or related to, such Business, including, without limitation, any liabilities for deferred taxes, any indemnity or guarantee obligations which are outstanding or incurred in connection with the Disposition or otherwise, any liabilities for future purchase price adjustments and any obligations with respect to outstanding securities (other than common stock) attributed to such Business. "Proportionate Interest" of holders of Staples.com Stock in the Net Proceeds of a Staple.com Disposition (or in the outstanding shares of common stock of any subsidiaries holding Staples.com's assets and liabilities) means the amount of such Net Proceeds (or the number of such shares) multiplied by the number of shares of Staples.com Stock outstanding divided by the Total Number of Notional Staples.com Shares Deemed Outstanding. "Proportionate Interest" of holders of Staples Stock in the Net Proceeds of a Staples RD Disposition (or in the outstanding shares of common stock of any subsidiaries holding Staples RD's assets and liabilities) means the amount of such Net Proceeds (or the number of such shares). "Publicly Traded" with respect to any security means a security that is (1) registered under Section 12 of the Securities Exchange Act of 1934, as amended (the "Exchange Act") (or any successor provision of law), and (2) listed for trading on the New York Stock Exchange (or any other national securities exchange registered under Section 7 of the Exchange Act (or any successor provision of law)) or listed for trading on the Nasdaq NMS (or any successor market system). "Staples RD" means (1) all of the businesses, assets and liabilities of Staples and its subsidiaries, other than the businesses, assets and liabilities that are part of Staples.com, (2) the rights and obligations of Staples RD under any inter-Business debt deemed to be owed to or by Staples RD (as such rights and obligations are defined in accordance with policies established from time to time by the board of directors) and (3) a proportionate interest in Staples.com (after giving effect to any options, preferred stock, other securities or debt issued or incurred by Staples and attributed to Staples.com) equal to the Retained Interest Percentage; provided that: (a) Staples may re-allocate assets from one Business to the other Business in return for other assets or services rendered by that other Business in the ordinary course of business or in accordance with policies established by the board of directors from time to time, and (b) if Staples transfers cash, other assets or securities to holders of shares of Staples.com Stock as a dividend or other distribution on shares of Staples.com Stock (other than a dividend or distribution payable in shares of Staples.com Stock), or as payment in a redemption of shares of Staples.com Stock effected as a result of a Staples.com Disposition, then the board of directors shall re-allocate from Staples.com to Staples RD cash or other assets having a Fair Value equal to the aggregate Fair Value of the cash, other assets or securities so transferred multiplied by a fraction, the numerator of which shall equal the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com on the record date for such dividend or distribution, or on the date of such redemption, and the denominator of which shall equal the number of shares of Staples.com Stock outstanding on such date. "Staples.com" means (1) the e-commerce business division of Staples, including all of the businesses, assets and liabilities of Staples and its subsidiaries that the board of directors has, as of the date on which the Certificate of Amendment becomes effective under Delaware law (the "Effective Date"), allocated to Staples.com, (2) any assets or liabilities acquired or incurred by Staples or any of its subsidiaries after the Effective Date in the ordinary course of business and attributable to Staples.com, (3) any businesses, assets or liabilities acquired or incurred by Staples or any of its subsidiaries after the Effective Date that the board of directors has specifically allocated to Staples.com or that Staples otherwise allocates to Staples.com 32 in accordance with policies established from time to time by the board of directors and (4) the rights and obligations of Staples.com under any inter- Business debt deemed to be owed to or by Staples.com (as such rights and obligations are defined in accordance with policies established from time to time by the board of directors); provided that: (a) Staples may re-allocate assets from one Business to the other Business in return for other assets or services rendered by that other Business in the ordinary course of business or in accordance with policies established by the board of directors from time to time and (b) if Staples transfers cash, other assets or securities to holders of shares of Staples.com Stock as a dividend or other distribution on shares of Staples.com Stock (other than a dividend or distribution payable in shares of Staples.com Stock), or as payment in a redemption of shares of Staples.com Stock effected as a result of a Staples.com Disposition, then the board of directors shall re-allocate from Staples.com to Staples RD cash or other assets having a Fair Value equal to the aggregate Fair Value of the cash, other assets or securities so transferred multiplied by a fraction, the numerator of which shall equal the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com on the record date for such dividend or distribution, or on the date of such redemption, and the denominator of which shall equal the number of shares of Staples.com Stock outstanding on such date. "Total Number of Notional Staples.com Shares Deemed Outstanding" means the number of shares of Staples.com Stock outstanding plus the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com. "Trading Day" means each weekday on which the relevant security (or, if there are two relevant securities, each relevant security) is traded on the principal national securities exchange on which it is listed or admitted to trading or quoted on the Nasdaq NMS or, if such security is not listed or admitted to trading on a national securities exchange or quoted on the Nasdaq NMS, traded in the principal over-the-counter market in which it trades. Optional Exchange of One Series of Common Stock for the Other Series We will have the right, at any time, to issue shares of Staples Stock in exchange for outstanding shares of Staples.com Stock at a premium. The premium will initially be 25% (for exchanges occurring in the first quarter after the original issuance of Staples.com Stock, or options therefor) and will decline ratably each quarter over a period of three years to 15%. We will also have the right, at any time, to issue shares of Staples.com Stock in exchange for outstanding shares of Staples Stock at a premium. The premium will initially be 25% (for exchanges occurring in the first quarter after the original issuance of Staples.com Stock, or options therefor) and will decline ratably each quarter over a period of three years to 15%. Notwithstanding the preceding paragraphs, upon the occurrence of a Tax Event (as defined below), we will have the right to issue shares of either series of common stock in exchange for outstanding shares of the other series of common stock at a 10% premium, regardless of when such a Tax Event takes place. The exchange ratio that will result in the specified premium will be calculated based on the average Market Value of Staples Stock as compared to the average Market Value of Staples.com Stock during the 20 consecutive Trading Day period ending on, and including, the 5th Trading Day immediately preceding the date on which we mail the notice of exchange to holders of the outstanding shares being exchanged. In addition, we will have the right, at any time Staples.com Stock exceeds the 40% of Total Market Capitalization Threshold (as defined below) but is below the 60% of Total Market Capitalization Threshold (as defined below), to issue shares of either series of common stock in exchange for outstanding shares of the other series of common stock on a value for value basis. 33 The exchange ratio that will result in a value for value exchange will be based on the average Market Value of the series of the common stock being exchanged as compared to the average Market Value of the other series of common stock during the 20 consecutive Trading Day period ending on, and including, the 5th Trading Day immediately preceding the date on which we mail the notice of exchange to holders of the outstanding shares being exchanged. "Tax Event" means the receipt by Staples of an opinion of a tax advisor experienced in such matters, who shall not be an officer or employee of Staples or any of its affiliates, to the effect that, as a result of any amendment to, or change in, the laws (or any regulations thereunder) of the United States or any political subdivision or taxing authority thereof or therein (including any proposed change in such regulations announced by an administrative agency), or as a result of any official or administrative pronouncement or action or judicial decision interpreting or applying such laws or regulations, it is more likely than not that for United States federal income tax purposes (1) Staples, its subsidiaries or affiliates, or any of its successors or its stockholders is or, at any time in the future, will be subject to tax upon the issuance of shares of either Staples Stock or Staples.com Stock or (2) either Staples Stock or Staples.com Stock is not or, at any time in the future, will not be treated solely as stock of Staples. For purposes of rendering such opinion, the tax advisor shall assume that any administrative proposals will be adopted as proposed. However, in the event a change in law is proposed, the tax advisor shall render an opinion only in the event of enactment. Staples.com Stock will exceed the "40% of Total Market Capitalization Threshold" if the Market Capitalization of the outstanding Staples.com Stock exceeds 40% of the Total Market Capitalization of both series of common stock for 30 Trading Days during the 60 consecutive Trading Day period ending on, and including, the 5th Trading Day immediately preceding the date on which we mail the notice of exchange. Staples.com Stock will be below the "60% of Total Market Capitalization Threshold" if the Market Capitalization of the outstanding Staples.com Stock is below 60% of the total Market Capitalization of both series of common stock for 30 Trading Days during the 60 consecutive Trading Day period ending on, and including, the 5th Trading Day immediately preceding the date on which we mail the notice of exchange. If we have the right, on the date on which we mail a notice of exchange as contemplated above, to issue shares of either series of common stock in exchange for outstanding shares of the other series of common stock on a value for value basis as described above, we will not lose that right even if Staples.com Stock subsequently falls below the 40% of Total Market Capitalization Threshold or exceeds the 60% of Total Market Capitalization Threshold. Exchange for Stock of a Subsidiary at Staples' Option At any time at which all of the assets and liabilities of a Business (and no other assets or liabilities of Staples or any subsidiary thereof) are held directly or indirectly by one or more wholly owned subsidiaries of Staples (the "Business Subsidiaries"), we will have the right to deliver to holders of the relevant series of common stock their Proportionate Interest in all of the outstanding shares of the common stock of the Business Subsidiaries in exchange for all of the outstanding shares of such series of common stock. . If the series of common stock being exchanged is Staples Stock and the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com is greater than zero, we will also issue a number of shares of Staples.com Stock equal to the then current Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com and deliver those shares to the holders of Staples Stock or to one of the Business Subsidiaries, at our option. . If the series of common stock being exchanged is Staples.com Stock and the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com is greater than zero (so that less than all of the shares of common stock of the Business Subsidiaries are being delivered to the holders of Staples.com Stock), we may retain the remaining shares of common stock of the Business Subsidiaries or distribute those shares as a dividend on Staples Stock, at our option. 34 General Dividend, Redemption and Exchange Provisions If we complete a Disposition of All or Substantially All of the Assets of a Business (other than an Exempt Disposition), we would be required, not more than the 10 Trading Days after the consummation of such Disposition, to issue a press release specifying (1) the Net Proceeds of such Disposition, (2) the number of shares of the series of common stock related to such Business then outstanding, (3) the number of shares of such series of common stock issuable upon conversion, exchange or exercise of any convertible or exchangeable securities, options or warrants and the conversion, exchange or exercise prices thereof and (4) if the Business is Staples.com, the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com. Not more than 40 Trading Days after such consummation, we would be required to announce by press release which of the actions specified in the first paragraph under "-- Mandatory Dividend, Redemption or Exchange on Disposition of All or Substantially All of The Assets of a Business" we have determined to take, and upon making that announcement, that determination would become irrevocable. In addition, we would be required, not more than 40 Trading Days after such consummation and not less than 10 Trading Days before the applicable payment date, redemption date or exchange date, to send a notice by first-class mail, postage prepaid, to holders of the relevant series of common stock at their addresses as they appear on our transfer books. . If we determine to pay a special dividend, we would be required to specify in the notice (1) the record date for such dividend, (2) the payment date of such dividend (which cannot be more than 85 Trading Days after such consummation) and (3) the aggregate amount and type of property to be paid in such dividend (and the approximate per share amount thereof). . If we determine to undertake a redemption, we would be required to specify in the notice (1) the date of redemption (which cannot be more than 85 Trading Days after such consummation), (2) the aggregate amount and type of property to be paid as a redemption price (and the approximate per share amount thereof), (3) if less than all shares of the relevant series of common stock are to be redeemed, the number of shares to be redeemed and (4) the place or places where certificates for shares of such series of common stock, properly endorsed or assigned for transfer (unless we waive such requirement), should be surrendered in return for delivery of the cash, securities or other property to be paid by Staples in such redemption. . If we determine to undertake an exchange, we would be required to specify in the notice (1) the date of exchange (which cannot be more than 85 Trading Days after such consummation), (2) the number of shares of the other series of common stock to be issued in exchange for each outstanding share of such series of common stock and (3) the place or places where certificates for shares of such series of common stock, properly endorsed or assigned for transfer (unless we waive such requirement), should be surrendered in return for delivery of the other series of common stock to be issued by Staples in such exchange. If we determine to complete any exchange described under "--Optional Exchange of One Series of Common Stock for the Other Series" or "--Exchange for Stock of a Subsidiary at Staples' Option," we would be required, between 10 to 30 Trading Days before the exchange date, to send a notice by first-class mail, postage prepaid, to holders of the relevant series of common stock at their addresses as they appear on our transfer books, specifying (1) the exchange date and the other terms of the exchange and (2) the place or places where certificates for shares of such series of common stock, properly endorsed or assigned for transfer (unless we waive such requirement), should be surrendered for delivery of the stock to be issued or delivered by Staples in such exchange. Neither the failure to mail any required notice to any particular holder nor any defect therein would affect the sufficiency thereof with respect to any other holder or the validity of any dividend, redemption or exchange. If we are redeeming less than all of the outstanding shares of a series of common stock as described above, we would redeem such shares pro rata or by lot or by such other method as the board of directors determines to be equitable. 35 No holder of shares of a series of common stock being exchanged or redeemed will be entitled to receive any cash, securities or other property to be distributed in such exchange or redemption until such holder surrenders certificates for such shares, properly endorsed or assigned for transfer, at such place as we specify (unless we waive such requirement). As soon as practicable after our receipt of certificates for such shares, we would deliver to the person for whose account such shares were so surrendered, or to the nominee or nominees of such person, the cash, securities or other property to which such person is entitled, together with any fractional payment referred to below, in each case without interest. If less than all of the shares of common stock represented by any one certificate were to be exchanged or redeemed, we would also issue and deliver a new certificate for the shares of such common stock not exchanged or redeemed. We would not be required to issue or deliver fractional shares of any capital stock or any other fractional securities to any holder of common stock upon any exchange, redemption, dividend or other distribution described above. If more than one share of common stock were held at the same time by the same holder, we may aggregate the number of shares of any capital stock that would be issuable or any other securities that would be distributable to such holder upon any such exchange, redemption, dividend or other distribution. If there are fractional shares of any capital stock or any other fractional securities remaining to be issued or distributed to any holder, we would, if such fractional shares or securities were not issued or distributed to such holder, pay cash in respect of such fractional shares or securities in an amount equal to the Fair Value thereof, without interest. From and after the date set for any exchange or redemption, all rights of a holder of shares of common stock that were exchanged or redeemed would cease except for the right, upon surrender of the certificates representing such shares, to receive the cash, securities or other property for which such shares were exchanged or redeemed, together with any fractional payment as provided above, in each case without interest (and, if such holder was a holder of record as of the close of business on the record date for a dividend not yet paid, the right to receive such dividend). A holder of shares of common stock being exchanged would not be entitled to receive any dividend or other distribution with respect to shares of the other series of common stock until after the shares being exchanged are surrendered as contemplated above. Upon such surrender, we would pay to the holder the amount of any dividends or other distributions, without interest, which theretofore became payable with respect to a record date occurring after the exchange, but which were not paid by reason of the foregoing, with respect to the number of whole shares of the other series of common stock represented by the certificate or certificates issued upon such surrender. From and after the date set for any exchange, we would, however, be entitled to treat the certificates for shares of common stock being exchanged that were not yet surrendered for exchange as evidencing the ownership of the number of whole shares of the other series of common stock for which the shares of such common stock should have been exchanged, notwithstanding the failure to surrender such certificates. We would pay any and all documentary, stamp or similar issue or transfer taxes that might be payable in respect of the issue or delivery of any shares of capital stock and/or other securities on any exchange or redemption described herein. We would not, however, be required to pay any tax that might be payable in respect of any transfer involved in the issue or delivery of any shares of capital stock and/or other securities in a name other than that in which the shares so exchanged or redeemed were registered, and no such issue or delivery will be made unless and until the person requesting such issue pays to Staples the amount of any such tax or establishes to our satisfaction that such tax has been paid. We may, subject to applicable law, establish such other rules, requirements and procedures to facilitate any dividend, redemption or exchange contemplated as described above as the board of directors may determine to be appropriate under the circumstances. Voting Rights Currently, holders of existing common stock have one vote per share on all matters submitted to a vote of stockholders. Once the Tracking Stock Proposal is implemented, holders of Staples Stock and Staples.com Stock would vote together as one class on all matters as to which common stockholders generally are entitled 36 to vote, unless a separate class vote is required by applicable law. On all such matters for which no separate vote is required, each outstanding share of Staples Stock would entitle the holder to one vote and each outstanding share of Staples.com Stock would entitle the holder to one vote. When holders of Staples Stock and Staples.com Stock vote together as a single class, the holders of the series of common stock having a majority of the votes (initially the holders of Staples Stock) will be in a position to control the outcome of the vote even if the matter involves a conflict of interest between the holders of Staples Stock and holders of Staples.com Stock. The Delaware General Corporation Law requires a separate vote of holders of shares of common stock of any series on any amendment to the certificate of incorporation if the amendment would increase or decrease the par value of the shares of such series or alter or change the powers, preferences or special rights of the shares of such series so as to affect them adversely. After Staples.com Stock is issued, we would set forth the number of outstanding shares of Staples Stock and Staples.com Stock in our annual and quarterly reports filed pursuant to the Exchange Act, and disclose in any proxy statement for a stockholder meeting the number of outstanding shares and per share voting rights of Staples Stock and Staples.com Stock. Liquidation Currently, in the event of our liquidation, dissolution or winding up (whether voluntary or involuntary), after payment, or provision for payment, of our debts and other liabilities and the payment of full preferential amounts to which the holders of any preferred stock are entitled, holders of existing common stock are entitled to share equally in our remaining net assets. If the Tracking Stock Proposal is approved, in the event of our dissolution, liquidation or winding up (whether voluntary or involuntary), the holders of Staples Stock and Staples.com Stock will be entitled to receive our assets remaining for distribution to holders of common stock on a per share basis in proportion to the liquidation units per share of such series, after payment or provision for payment of our debts and other liabilities and the payment of full preferential amounts to which holders of any preferred stock are entitled. Neither a merger nor consolidation of Staples into or with any other corporation, nor any sale, transfer or lease of any part of our assets, will, alone, be deemed a liquidation or winding up of Staples, or cause the dissolution of Staples, for purpose of these liquidation provisions. Each share of Staples.com Stock will have one liquidation unit. Each share of Staples Stock will have a number of liquidation units equal to the quotient of the average Market Value of a share of Staples Stock over the last 20 consecutive Trading Day period ending 300 days after the Effective Date divided by the average Market Value of a share of Staples.com Stock over the same period. If the liquidation, dissolution or winding up occurs prior to such 300th day, the average Market Value will be determined based on the 20 consecutive Trading Day period ending immediately prior to the liquidation, dissolution or winding up event. In the absence of a public trading market for the shares of Staples.com Stock, our board of directors will exercise its good faith judgment to determine the market value of a share of Staples.com Stock for purposes of this formula. After the number of liquidation units to which each share of Staples Stock is entitled has been calculated in accordance with this formula, that number will not be changed without the approval of holders of the series of common stock adversely affected except as described below. As a result, after the date of the calculation of the number of liquidation units to which the Staple Stock is entitled, the liquidation rights of the holders of the respective series of tracking stock will likely not bear any relationship to the relative market values or the relative voting rights of the two series at or near the time of liquidation. We consider that liquidation is a 37 remote contingency, and our financial advisors believe that, in general, these liquidation provisions will be immaterial to the value of the Staples.com Stock and the Staples Stock. No holder of Staples.com Stock will have any special right to receive specific assets of the Staples.com Business and no holder of Staples Stock will have any special right to receive specific assets of the Staples RD Business upon our dissolution, liquidation or winding up. If we subdivide or combine the outstanding shares of either series of common stock or declare a dividend or other distribution of shares of either series of common stock to holders of that series of common stock, the number of liquidation units of such series of common stock will be appropriately adjusted. This adjustment will be made by our board of directors, to avoid any dilution in the relative liquidation rights of any series of common stock. Staples RD's Retained Interest in Staples.com The number of shares of Staples.com Stock that Staples may issue for the account of Staples RD in respect of its Retained Interest is referred to as the "Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com." At the time that we first issue shares of, or options for shares of, Staples.com Stock, the board of directors would designate the initial Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com. In this document, we call the percentage interest in Staples.com intended to be represented at any time by the outstanding shares of Staples.com Stock the "Outstanding Interest Percentage,",and we call the remaining percentage interest in Staples.com intended to be represented at any time by Staples RD's Retained Interest in Staples.com the "Retained Interest Percentage." At any time, the Outstanding Interest Percentage equals the number of shares of Staples.com Stock outstanding divided by the Total Number of Notional Staples.com Shares Deemed Outstanding (expressed as a percentage) and the Retained Interest Percentage equals the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com divided by the Total Number of Notional Staples.com Shares Deemed Outstanding (expressed as a percentage). The sum of the Outstanding Interest Percentage and the Retained Interest Percentage always equals 100%. At the time that we file the Certificate of Amendment, the Retained Interest Percentage will be 100% and the Outstanding Interest Percentage will be 0%. Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com We currently intend to designate 200,000,000 as the initial Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com. We currently plan to grant options for approximately 28,303,304 shares of Staples.com Stock under the 1992 Equity Incentive Plan to all Staples employees who currently receive options under the Plan shortly following stockholder approval of the proposed amendment to the Plan. Assuming we do so, we intend to attribute the net proceeds of the exercise of such options to the equity of Staples.com. The issuance of shares of Staples.com Stock upon the exercise of those options will have no effect on the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com. Thus, after giving effect to the grant of those options, . there would be no shares of Staples.com Stock outstanding, but there would be 28,303,304 shares of Staples.com Stock reserved for issuance upon the exercise of outstanding options, . the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com would remain 200,000,000, . the Total Number of Notional Staples.com Shares Deemed Outstanding would be 200,000,000, but would increase to 228,303,304 if all such options were exercised, 38 . the Outstanding Interest Percentage would be approximately 12.4% if all such options were exercised, and . the Retained Interest Percentage would be approximately 87.6% if all such options were exercised. We expect to issue additional shares of Staples.com Stock in one or more private or public financings within 12 months of stockholder approval of the Tracking Stock Proposal. The specific terms of the financings, including whether they are private or public, the amount of Staples.com Stock we issue, and the timing of the financings, will depend upon factors such as stock market conditions and the performance of Staples.com. The effect of those financings on the Retained Interest Percentage and the Outstanding Interest Percentage would depend upon the number of shares of Staples.com Stock sold and whether we elect to attribute the net proceeds of such financings to the equity of Staples.com or to Staples RD in respect of its Retained Interest. Attribution of Issuances of Staples.com Stock. Whenever we decide to issue shares of Staples.com Stock, or options therefor, we would determine, in our sole discretion, whether to attribute that issuance (and the proceeds thereof) to Staples RD in respect of its Retained Interest in Staples.com (in a manner analogous to a secondary offering of common stock of a subsidiary owned by a corporate parent) or to Staples.com (in a manner analogous to a primary offering of common stock). If we issue any shares of Staples.com Stock and attribute that issuance (and the proceeds thereof) to Staples RD in respect of its Retained Interest in Staples.com, the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com would be reduced by the number of shares so issued, the number of outstanding shares of Staples.com Stock would be increased by the same number, the Total Number of Notional Staples.com Shares Deemed Outstanding would remain unchanged, the Retained Interest Percentage would be reduced and the Outstanding Interest Percentage would be correspondingly increased. If we instead attribute that issuance (and the proceeds thereof) to Staples.com, the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com would remain unchanged, the number of outstanding shares of Staples.com Stock and the Total Number of Notional Staples.com Shares Deemed Outstanding would be increased by the number of shares so issued, the Retained Interest Percentage would be reduced and the Outstanding Interest Percentage would be correspondingly increased. Issuances of Staples.com Stock as Distributions on Staples Stock. We reserve the right to issue shares of Staples.com Stock as a distribution on Staples Stock, although we do not currently intend to do so. If we did so, we would attribute that distribution to Staples RD in respect of its Retained Interest in Staples.com. As a result, the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com would be reduced by the number of shares so distributed, the number of outstanding shares of Staples.com Stock would be increased by the same number, the Total Number of Notional Staples.com Shares Deemed Outstanding would remain unchanged, the Retained Interest Percentage would be reduced and the Outstanding Interest Percentage would be correspondingly increased. If instead we issued shares of Staples.com Stock as a distribution on Staples.com Stock, we would attribute that distribution to Staples.com, in which case we would proportionately increase the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com. As a result, the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com and the Total Number of Notional Staples.com Shares Deemed Outstanding would each be increased by the same percentage as the number of outstanding shares of Staples.com Stock is increased and the Retained Interest Percentage and Outstanding Interest Percentage would remain unchanged. Dividends on Staples.com Stock. At the time of any dividend on the outstanding shares of Staples.com Stock (including any dividend required as a result of a Disposition of All or Substantially All of the Assets of Staples.com, but excluding any dividend payable in Staples.com Stock), we will credit to Staples RD, and charge against Staples.com, a corresponding amount in respect of Staples RD's Retained Interest in Staples.com. Specifically, the corresponding amount will equal (1) the aggregate amount of such dividend multiplied by (2) a fraction, the numerator of which is the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com and the denominator of which is the number of shares of Staples.com Stock then outstanding. 39 Repurchases of Staples.com Stock. If we decide to repurchase shares of Staples.com Stock, we would determine, in our sole discretion, whether to attribute that repurchase, and the cost thereof, to Staples RD (in a manner analogous to a purchase of common stock of a subsidiary by a corporate parent) or to Staples.com (in a manner analogous to an issuer repurchase). If we repurchase shares of Staples.com Stock and attribute that repurchase, and the cost thereof, to Staples RD, the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com would be increased by the number of shares so purchased, the number of outstanding shares of Staples.com Stock would be decreased by the same number, the Total Number of Notional Staples.com Shares Deemed Outstanding would remain unchanged, the Retained Interest Percentage would be increased and the Outstanding Interest Percentage would be correspondingly decreased. If we instead attribute that repurchase, and the cost thereof, to Staples.com, the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com would remain unchanged, the number of outstanding shares of Staples.com Stock and the Total Number of Notional Staples.com Shares Deemed Outstanding would be decreased by the number of shares so repurchased, the Retained Interest Percentage would be increased and the Outstanding Interest Percentage would be correspondingly reduced. Transfers of Cash or Other Property between Staples RD and Staples.com. We may, in our sole discretion, determine to transfer cash or other property of Staples.com to Staples RD in return for a decrease in Staples RD's Retained Interest in Staples.com (in a manner analogous to a return of capital) or to transfer cash or other property of Staples RD to Staples.com in return for an increase in Staples RD's Retained Interest in Staples.com (in a manner analogous to a capital contribution). If we determine to transfer cash or other property of Staples.com to Staples RD in return for a decrease in Staples RD's Retained Interest in Staples.com, the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com and the Total Number of Notional Staples.com Shares Deemed Outstanding would each be decreased by an amount equal to the Fair Value of such cash or other property divided by the Market Value of a share of Staples.com Stock on the day of transfer, the number of outstanding shares of Staples.com Stock would remain unchanged, the Retained Interest Percentage would be decreased and the Outstanding Interest Percentage would be correspondingly increased. If we instead determine to transfer cash or other property of Staples RD to Staples.com in return for an increase in Staples RD's Retained Interest in Staples.com, the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com and the Total Number of Notional Staples.com Shares Deemed Outstanding would each be increased by an amount equal to the Fair Value of such cash or other property divided by the Market Value of a share of Staples.com Stock on the day of transfer, the number of outstanding shares of Staples.com Stock would remain unchanged, the Retained Interest Percentage would be increased and the Outstanding Interest Percentage would be correspondingly decreased. We may not attribute issuances of Staples.com Stock to Staples RD, transfer cash or other property of Staples.com to Staples RD in return for a decrease in its Retained Interest in Staples.com or take any other action to the extent that doing so would cause the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com to decrease below zero. For illustrations showing how to calculate the Retained Interest Percentage, the Outstanding Interest Percentage, the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com and the Total Number of Notional Staples.com Shares Deemed Outstanding after giving effect to certain hypothetical dividends, issuances, repurchases and transfers, see Annex I-- "Illustrations of Certain Terms." Effectiveness of Certain Terms The terms described under "--Dividends," "--Mandatory Dividend, Redemption or Exchange on Disposition of All or Substantially All of the Assets of a Business," "--Optional Exchange of One Series of Common Stock for the Other Series," "--Exchange for Stock of a Subsidiary at Staples' Option," "--General Dividend, Redemption and Exchange Provisions," "--Voting Rights" and "-- Liquidation" above apply only when there are shares of both series of common stock outstanding. 40 Determinations by the Board of Directors The Certificate of Amendment would provide that, subject to applicable law, any determinations made by the board of directors in good faith under our certificate of incorporation or in any certificate of designation filed pursuant thereto would be final and binding on all stockholders of Staples. The board of directors plans to establish a Business Advisory Board, which will be comprised of individuals who are not directors, officers or employees of Staples. The Business Advisory Board's members will be appointed by the board of directors or its chairman and will serve as consultants to Staples.com with respect to its business and not as a governing body. The board of directors also plans to establish a subcommittee comprised of some of Staples' independent directors to address and resolve, at the request of Staples' board of directors, any business issues concerning the relationship between Staples RD and Staples.com. Preemptive Rights Holders of Staples Stock and Staples.com Stock will not have any preemptive rights to subscribe for any additional shares of capital stock or securities that we may issue in the future. Certain Other Provisions of Our Certificate of Incorporation, By-laws and Delaware Law Preferred Stock We may issue preferred stock from time to time in one or more series and the board of directors, without further approval of our stockholders, is authorized to fix the dividend rights and terms, conversion rights, voting rights, redemption rights, liquidation preferences, sinking funds and any other rights, preferences, privileges and restrictions applicable to each series of preferred stock. The purpose of authorizing the board of directors to determine such rights and preferences is to eliminate delays associated with a stockholder vote on specific issuances. The issuance of preferred stock, while providing flexibility in connection with possible acquisitions and other corporate purposes, could, among other things, adversely affect the voting power of holders of our common stock and make it more difficult for a third party to gain control of Staples. There are no outstanding shares of preferred stock and, other than the Series A junior participating preferred stock discussed below, no designated series of preferred stock. Rights Plan In February 1994, we adopted the Staples Rights Plan. Under the Rights Plan, preferred stock purchase rights were distributed as a dividend, adjusted for subsequent stock splits, at the rate of 32/243rds of a right for each share of our common stock outstanding. The rights will expire on February 15, 2004, unless the rights are redeemed or exchanged before that time. Each right entitles the holder to purchase one one-hundredth of a share of Series A junior participating preferred stock at an exercise price of $130 per right, subject to adjustment. The rights will be exercisable only if a person or group has acquired beneficial ownership of 20% or more of the outstanding shares of our common stock or announces a tender or exchange offer that would result in such person or group owning 30% or more of the outstanding shares of our common stock. Such percentages may, in the board of directors' discretion, be lowered, although in no event below 10%. If any person becomes the beneficial owner of 25% or more of the shares of our common stock, except pursuant to a tender or exchange offer for all shares at a fair price as determined by the outside members of the board of directors, or if a 20% or more stockholder constitutes or merges into or engages in certain self dealing transactions with Staples, or if there occurs any reclassification, merger or other transaction or transactions which increases by more than 1% the proportionate share of our outstanding common stock held by a 20% or more stockholder, 41 each right not owned by a 20% or more stockholder will enable its holder to purchase that number of shares of our common stock which equals the exercise price of the right dividend by one-half of the current market price of our common stock at the date of the occurrence of the event. In addition, if we are involved in a merger or other business combination transaction with another person or group in which we are not the surviving corporation or in connection with which our common stock is changed or converted, or we sell or transfer 50% or more of our assets or earning power to another person, each right that has not previously been exercised will entitle its holder to purchase that number of shares of common stock of such other person which equals the exercise price of the right divided by one-half of the current market price of such common stock at the date of the occurrence of the event. We will generally be entitled to redeem the rights at $0.02 per right at any time until the tenth day following public announcement that a 20% stock position has been acquired and in certain other circumstances. Because of the nature of the dividend, liquidation and voting rights of the Series A junior participating preferred stock, the value of the fraction of a share of Series A junior participating preferred stock purchasable upon exercise of the 32/243rds of a right associated with each share of common stock should approximate the value of one share of our common stock. The rights have certain anti-takeover effects. The rights may cause substantial dilution to a person or group that attempts to acquire us on terms not approved by the board of directors, except under the terms of an offer conditioned on a substantial number of rights being acquired. The rights should not interfere with any merger or other business combination approved by the board of directors since the rights may be redeemed by us at $0.02 per right prior to the tenth day after the public announcement by a person or group of the acquisition of 20% or more of the outstanding shares of our common stock. If the Tracking Stock Proposal is approved, the rights would attach to the Staples Stock, and all terms of the rights relating to our existing common stock would instead relate to the Staples Stock. We may in the future decide to adopt a Rights Plan covering Staples.com Stock. Delaware Law and Certain Charter Provisions We are subject to the provisions of Section 203 of the General Corporation Law of Delaware, an anti-takeover law. In general, Section 203 prevents an "interested stockholder" of a corporation from engaging in any "business combination" with the corporation for a period of three years following the date on which such interested stockholder became an interested stockholder, unless: . before the person became an interested stockholder, the board of directors of the corporation approved either the business combination in question or the transaction which resulted in the interested stockholder becoming an interested stockholder; . upon consummation of the transaction which resulted in the interested stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced, excluding, for purposes of determining the number of shares outstanding, shares held by directors who are also officers and employee stock plans in which employee participants do not have the right to determine confidentially whether shares held subject to the plan will be tendered in a tender or exchange offer; or . following the transaction which resulted in the interested stockholder becoming an interested stockholder, the business combination is approved by the board of directors of the corporation and authorized at a meeting of stockholders by the affirmative vote of the holders of at least 66 2/3% of the outstanding voting stock of the corporation not owned by the interested stockholder. A "business combination" includes, mergers, asset sales and other transactions resulting in a financial benefit to the interested stockholder. Subject to certain exceptions, an "interested stockholder" is a person who, together with affiliates and associates, owns, or within three years did own, 15% or more of the corporation's voting stock. 42 Our certificate of incorporation requires that holders of two-thirds of our issued and outstanding stock entitled to vote approve any merger, consolidation, dissolution or sale of all or substantially all of our assets. The board of directors is divided into three classes of approximately equal size, one of which is elected each year. Our certificate of incorporation also requires all stockholder action to occur at a meeting and prohibits stockholder action by written consent. Our by-laws provide that special meetings of stockholders may be called only by the Chairman of the board of directors or the President. Limitation of Liability and Indemnification Our certificate of incorporation and bylaws include provisions to . eliminate the personal liability of its directors for monetary damages resulting from breaches of their fiduciary duty as directors to the fullest extent permitted by the General Corporation Law of Delaware, and . indemnify its directors and officers to the fullest extent permitted by the General Corporation Law of Delaware, including under circumstances in which indemnification is otherwise discretionary. We believe that these provisions are necessary to attract and retain qualified persons as directors and officers. Cash Management and Allocation Policies In order to prepare separate financial statements for Staples RD and Staples.com, we have allocated, for financial reporting purposes, all of our consolidated assets, liabilities, revenue, expenses and cash flow between Staples RD and Staples.com. Thus, the financial statements of Staples RD and Staples.com, taken together, comprise all of the accounts included in the corresponding financial statements of Staples. The financial statements of Staples RD and Staples.com reflect the application of cash management and allocation policies adopted by the board of directors. These policies are summarized below. The board of directors may, in its sole discretion, modify, rescind or add to any of these policies, although it has no present intention to do so. The decision of the board of directors to modify, rescind or add to any of these policies would, however, be subject to the board of directors' general fiduciary duties. Even though Staples has allocated all of its consolidated assets, liabilities, revenue, expenses and cash flow between Staples RD and Staples.com, holders of Staples.com Stock will be common stockholders of Staples and, as such, will be subject to all risks associated with an investment in Staples and all of its businesses, assets and liabilities. See "Risk Factors--Holders of Staples Stock and Staples.com Stock will be common stockholders of Staples and will not have any legal rights relating to specific assets of Staples." Finance Activities We manage most finance activities on a centralized, consolidated basis. These activities include the investment of surplus cash, the issuance, repayment and repurchase of short-term and long-term debt, and the issuance and repurchase of common stock. Staples.com generally remits its cash receipts to Staples RD, but is not obligated to do so, and Staples RD generally funds Staples.com's cash disbursements on a regular basis, but is not obligated to do so. In the combined financial statements of Staples RD and combined financial statements of Staples.com: (1) all equity transactions, and the proceeds thereof, were attributed to Staples RD, (2) whenever Staples.com held cash, that cash was transferred to Staples RD and accounted for as an inter-Business revolving credit advance and (3) whenever Staples.com had a cash need, that cash need was funded by Staples RD and accounted for as an inter-Business revolving credit advance. The inter-Business revolving credit arrangement bears interest at a 43 rate at which the board of directors, in its sole discretion, determines Staples could borrow such funds on a revolving credit basis, which was 6% for the fiscal years 1997, 1998 and 1999. After the date on which shares of Staples.com Stock, or options therefor are first issued, Staples intends to continue the above practice of transferring cash to Staples.com through an inter-Business revolving credit arrangement. The board of directors, at its sole discretion, may elect an alternative financing mechanism between the Businesses based upon the facts and circumstances. After the date on which shares of Staples.com Stock, or options therefor, are first issued: (1) Staples will attribute each future incurrence or issuance of external debt or preferred stock, and the proceeds thereof, to Staples RD, unless the board of directors determines otherwise. The board of directors may, but is not required to, attribute an incurrence or issuance of debt or preferred stock, and the proceeds thereof, to Staples.com to the extent that Staples incurs or issues the debt or preferred stock for the benefit of Staples.com. (2) Staples will attribute each future issuance of Staples Stock, and the proceeds thereof, to Staples RD. Staples may attribute any future issuance of Staples.com Stock, and the proceeds thereof, to Staples RD in respect of its Retained Interest in Staples.com (in a manner analogous to a secondary offering of common stock of a subsidiary owned by a corporate parent) or to Staples.com (in a manner analogous to a primary offering of common stock). Dividends on and repurchases of Staples Stock will be charged against Staples RD, and dividends on and repurchases of Staples.com Stock will be charged against Staples.com. In addition, at the time of any dividend on Staples.com Stock, Staples will credit to Staples RD, and charge against Staples.com, a corresponding amount in respect of Staples RD's Retained Interest in Staples.com. See"--Description of Staples Stock and Staples.com Stock." (3) Whenever Staples.com holds cash, Staples.com will normally transfer that cash to Staples RD. Conversely, whenever Staples.com has a cash need, Staples RD will normally fund that cash need. However, the board of directors will determine, in its sole discretion, whether to provide any particular funds to either Business and will not be obligated to do so. (4) Staples will account for all cash transfers from one Business to or for the account of the other Business (other than transfers in return for assets or services rendered or transfers in respect of Staples RD's Retained Interest that correspond to dividends paid on Staples.com Stock), as inter-Business revolving credit advances unless: . the board of directors determines that a given transfer, or type of transfer, should be accounted for as a long-term loan, . the board of directors determines that a given transfer, or type of transfer, should be accounted for as a capital contribution increasing Staples RD's Retained Interest in Staples.com, or . the board of directors determines that a given transfer, or type of transfer, should be accounted for as a return of capital reducing Staples RD's Retained Interest in Staples.com. There are no specific criteria to determine when Staples will account for a cash transfer as a long-term loan, a capital contribution or a return of capital rather than an inter-Business revolving credit advance. The board of directors would make such a determination in the exercise of its business judgment at the time of such transfer, or the first of such type of transfer, based upon all relevant circumstances. Factors the board of directors would consider include: . the current and projected capital structure of each Business, . the relative levels of internally generated funds of each Business, . the financing needs and objectives of the recipient Business, . the investment objectives of the transferring Business, 44 . the availability, cost and time associated with alternative financing sources, and . prevailing interest rates and general economic conditions. (5) Any cash transfer accounted for as an inter-Business revolving credit advance will bear interest at the rate at which the board of directors, in its sole discretion, determines Staples could borrow such funds on a revolving credit basis. Any cash transfer accounted for as a long-term loan will have interest rate, amortization, maturity, redemption and other terms that generally reflect the then prevailing terms on which the board of directors, in its sole discretion, determines Staples could borrow such funds. (6) Any cash transfer from Staples RD to Staples.com, or for Staples.com's account, accounted for as a capital contribution will correspondingly increase Staples.com's division equity and Staples RD's Retained Interest in Staples.com. As a result, the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com will increase by the amount of such capital contribution divided by the Market Value of Staples.com Stock on the date of transfer. (7) Any cash transfer from Staples.com to Staples RD, or for Staples RD's account, accounted for as a return of capital will correspondingly reduce Staples.com's division equity and Staples RD's Retained Interest in Staples.com. As a result, the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com will decrease by the amount of such return of capital divided by the Market Value of Staples.com Stock on the date of transfer. Shared Services and Support Activities The cost of services shared by Staples RD and Staples.com, including general and administrative expenses, has been allocated between Staples RD and Staples.com based upon the use of such services and the good faith judgment of the board of directors or our management. Where determinations based on use alone were not practical, other methods and criteria were used to provide a reasonable allocation of the cost of shared services, including support activities attributable between Staples RD or Staples.com. Such allocated shared services represent, among other things, financial and accounting services, information system services, certain selling and marketing activities, certain merchandising and replenishment services, transportation and warehouse management services, certain customer service activities, executive management, human resources, legal and corporate planning activities. Taxes Federal income taxes, which are determined on a consolidated basis, are allocated between the Businesses, and reflected in their respective financial statements, in accordance with Staples' tax allocation policy. In general, this policy provides that the consolidated tax provision, deferred tax accounts and related tax payments or refunds, are allocated between the Businesses based principally upon the financial income, taxable income, credits and other amounts directly related to the respective Businesses. Tax benefits that cannot be used by the Business generating such attributes, but can be utilized on a consolidated basis, are allocated to the Business that generated such benefits. As a result, the allocated Business amounts of taxes payable or refundable are not necessarily comparable to those that would have resulted if the Businesses had filed separate tax returns. State income taxes generally are computed on a separate company basis. Carrying Charge Staples RD maintains inventory to support Staples.com's inventory needs and the processing of receivables for Staples.com. Staples RD charges Staples.com a carrying charge for use of their capital for these purposes as determined by the board of directors. The carrying charge is reflected in Staples.com's financial statements as part of operating and selling expenses and in Staples RD's financial statements as a credit to operating and selling expenses. This charge is calculated based on the amount of receivables and inventory that Staples RD is required to carry for Staples.com. In addition, inventory, shrink, obsolescence and other inventory costs are 45 allocated to Staples.com based on Staples.com's share of such costs. The board of directors may, in its sole discretion, change the carrying charge charged to Staples.com as it deems appropriate in light of the circumstances from time to time. Employee Benefits Staples RD and Staples.com participate in the following Staples employee benefit plans: an Employee Stock Purchase Plan, an Employee 401(k) Savings Plan, a Supplemental Executive Retirement Plan and a contributory Medical and Dental Plan. The costs of these plans are allocated based on the benefits received under the plans by the employees comprising Staples RD and Staples.com or such other basis as management believes to be an equitable and reasonable estimate of such costs. No Appraisal Rights Under the Delaware General Corporation Law, you will not have appraisal rights in connection with the Tracking Stock Proposal. Stock Transfer Agent and Registrar ChaseMellon Shareholder Services, L.L.C. is the registrar and transfer agent for our existing common stock. We expect ChaseMellon Shareholder Services, L.L.C. to serve as registrar and transfer agent for Staples Stock and Staples.com Stock. Certain Federal Income Tax Considerations The following discussion is a summary of the material United States federal income tax consequences of the issuance of Staples Stock pursuant to the Tracking Stock Proposal. This discussion, including the Ernst & Young LLP opinion discussed below, is based on certain assumptions and representations of Staples as well as the Internal Revenue Code of 1986 (the "Code"), Treasury Department regulations, published positions of the Internal Revenue Service, and court decisions now in effect, all of which are subject to change. In particular, Congress could enact legislation affecting the treatment of stock with characteristics similar to Staples Stock or Staples.com Stock or the Treasury Department could issue regulations or other guidance that change current law. Any future legislation or regulations (or other guidance) could apply retroactively to the implementation of the Tracking Stock Proposal and render the Ernst & Young opinion inaccurate. See"--Clinton Administration Proposal" below. This discussion addresses only those of you who hold your existing common stock and would hold Staples Stock and Staples.com Stock as a capital asset and did not acquire your shares in a compensatory transaction, including the exercise of employee stock options. We have included this discussion for general information only. It does not discuss all aspects of United States federal income taxation that may be relevant to you in light of your particular tax circumstances or any future transactions that may be undertaken with respect to Staples Stock or Staples.com Stock. This discussion does not apply to you if you are a tax-exempt organization, S corporation or other pass- through entity, mutual fund, small business investment company, regulated investment company, insurance company or other financial institution or broker- dealer, or are otherwise subject to special treatment under the federal income tax laws. This discussion also does not apply to those of you who hold your existing common stock as part of a straddle, hedging or conversion transaction. You should consult your own tax advisor with regard to the application of the federal income tax laws, as well as to the applicability and effect of any state, local, or foreign tax laws to which you may be subject. Tax Implications of the Tracking Stock Proposal to Stockholders Ernst & Young LLP has provided us with an opinion that the Tracking Stock Proposal will qualify as a "reorganization" for federal income tax purposes. This means that: 46 . We and you will not recognize any income, gain or loss on the exchange of your existing common stock for shares of Staples Stock; . Your basis in the existing common stock held immediately before the implementation of the Tracking Stock Proposal will be transferred to the Staples Stock you receive; . Your holding period for the Staples Stock will include the holding period of your existing common stock; and . Any gain or loss recognized upon a subsequent sale or exchange of Staples Stock will be capital gain or loss. Tax Implications of a Conversion into Different Series of Tracking Stock Ernst & Young LLP has advised us that, under current law, if we exercise our option to convert one series of common stock into the other series of common stock, that conversion will be tax-free to you. You will have a carry-over adjusted tax basis in your newly received common stock and generally a holding period that includes the holding period of the common stock you surrendered in the exchange. No Internal Revenue Service Ruling No ruling has been sought from the Internal Revenue Service. The Internal Revenue Service has announced that it will not issue any advance rulings on the classification of an instrument that has certain voting and liquidation rights in an issuing corporation but whose dividend rights are determined by reference to the earnings of a segregated portion of the issuing corporation's assets, including assets held by a subsidiary. In addition, there are no court decisions or other authorities that bear directly on the effect of the features of Staples Stock or Staples.com Stock. The opinion of Ernst & Young LLP is not binding on the Internal Revenue Service or the courts and merely represents its best judgment based upon existing authorities and certain assumptions and representations made to Ernst & Young LLP by our management. Therefore, the tax treatment of the Tracking Stock Proposal is subject to some uncertainty under current law. It is possible that the Internal Revenue Service could assert successfully that the receipt of Staples Stock as well as a subsequent conversion or exchange of Staples Stock or Staples.com Stock could be taxable to you and to us. The Internal Revenue Service could also successfully assert that gain from a subsequent taxable sale of Staples Stock or Staples.com Stock is taxable as ordinary income rather than capital gain. Once again, you should consult your own tax advisor. Clinton Administration Proposal A recent proposal by the Clinton Administration would impose a corporate level tax on the issuance of stock similar to Staples Stock or Staples.com Stock. It would also permit the Internal Revenue Service to treat tracking stock as an interest other than stock, thereby making such tracking stock ineligible for the tax free exchange treatment available under the Code in certain transactions. For a description of the risks associated with this proposal, see "Risk Factors--A recent Clinton Administration proposal could result in taxation on issuances of tracking stock." Backup Withholding Certain non-corporate holders of existing common stock and Staples Stock could be subject to backup withholding at a rate of 31% on the payment of dividends on or proceeds from the sale of such stock. Backup withholding will apply only if the stockholder (1) fails to furnish its taxpayer identification number ("TIN"), which, for an individual, would be his or her social security number, (2) furnishes an incorrect TIN, (3) is notified by the Internal Revenue Service that it has failed to properly report payments of interest or dividends 47 or (4) under certain circumstances, fails to certify under penalties of perjury that it has furnished a correct TIN and has been notified by the Internal Revenue Service that it is subject to backup withholding for failure to report payments of interest or dividends. Stockholders should consult their tax advisors regarding their qualification for exemption from backup withholding and the procedures for obtaining such an exemption if applicable. The amount of any backup withholding from a payment to a stockholder will be allowed as a credit against such stockholder's federal income tax liability and may entitle such holder to a refund, provided that the required information is furnished to the Internal Revenue Service. ---------------- The board of directors recommends a vote FOR the Tracking Stock Proposal. 48 PROPOSALS 2, 3 and 4--THE STOCK PLAN PROPOSALS General At the Special Meeting, we will also ask you to consider and approve proposals to amend each of Staples' 1992 Equity Incentive Plan (the "Incentive Plan"), Staples' Amended and Restated 1990 Director Stock Option Plan (the "Director Plan") and Staples' 1998 Employee Stock Purchase Plan (the "Stock Purchase Plan") (1) to permit grants of awards under each such plan to be made with respect to either series of common stock of Staples, and (2) to increase the number of shares authorized for issuance under each Plan. Description of Amendments to Incentive Plan (Proposal 2) The proposed amendments to the Incentive Plan will (1) clarify that grants of options and other stock-based awards under the Incentive Plan may be made with respect to either Staples Stock or Staples.com Stock, or both, in the same manner as currently permitted with respect to existing common stock, and (2) increase the number of shares of common stock, regardless of series, available for issuance under the Incentive Plan. The following summary of the amendments to the Incentive Plan is not complete and should be read with the full proposed text of the Incentive Plan as set forth in Annex III hereto. Grants of Awards Under the current Incentive Plan, grants of options and other stock-based awards may be made with respect to shares of existing common stock. Officers, employees and consultants of Staples and its subsidiaries are eligible to be granted awards under the Incentive Plan. Options may be granted at an exercise price not less than the fair market value of the common stock on the date of grant or at an exercise price not less than 110% of the fair market value in the case of incentive stock options granted to optionees holding more than 10% of the voting power of Staples. Under the amended Incentive Plan, grants of options and other stock-based awards may be made with respect to either Staples Stock or Staples.com Stock, or both, in the same manner as currently permitted with respect to existing common stock. Shares Available for Issuance under Incentive Plan Under the current Incentive Plan, up to 87,750,000 shares of existing common stock may be available for grants of awards, and the shares of common stock issued under the Incentive Plan may be authorized and unissued shares or treasury shares, as Staples may from time to time determine. Under the amended Incentive Plan, up to 122,850,000 shares of common stock (regardless of series) will be available for issuance out of authorized and unissued or treasury shares, as Staples may from time to time determine. The maximum number of shares with respect to which awards may be granted to any one person may not exceed 3,037,500 shares in any calendar year. Shares subject to an award that expires unexercised, are forfeited, or terminated, or settled in cash instead of common stock, and shares tendered to pay for the exercise of an option, will thereafter again be available for grant under the Incentive Plan. Types of Awards Under the Incentive Plan Under the amended Incentive Plan, the incentive compensation plan committee will, in its discretion, be able to grant awards under the Incentive Plan with respect to Staples Stock, Staples.com Stock, or both, in such amounts and types as it determines in accordance with the terms of the Incentive Plan. In determining whether awards in respect of Staples Stock, Staples.com Stock, or both, will be made to specific employees, it is anticipated that the incentive compensation plan committee will consider, among other things, the identity of the Business to which such employee provides services; provided, however, that nothing shall prohibit the incentive compensation plan committee from granting awards with respect to Staples Stock, Staples.com Stock, or both, to any participant in the Incentive Plan without regard to the Business for which the participant provides services. 49 Effect on Outstanding Awards The approval of the amendments to the Incentive Plan will not result in any adjustment to the outstanding awards under the Incentive Plan. The approval of the Tracking Stock Proposal will result in each outstanding option for Staples common stock under the Incentive Plan instead becoming an option for Staples Stock. Federal Income Tax Consequences The following is a brief description of the federal income tax consequences generally arising with respect to awards under the Incentive Plan. The grant of an option or a stock appreciation right ("SAR") will create no tax consequences for the participant or Staples. A participant will not recognize taxable income upon exercising an incentive stock option (within the meaning of Section 422 of the Code) ("ISO") (except that the alternative minimum tax may apply). Upon exercising an option other than an ISO, the participant generally must recognize ordinary income equal to the difference between the exercise price and fair market value of the freely transferable and nonforfeitable shares acquired on the date of exercise. Upon exercising an SAR, the participant generally must recognize ordinary income equal to the cash or the fair market value of the freely transferable and nonforfeitable shares received. If the participant does not hold the common stock acquired upon exercise of an ISO for at least one year from the date of exercise and two years from the date of grant (the "Holding Period"), the participant generally must recognize ordinary income equal to the lesser of (1) the fair market value of the shares at the date of exercise of the ISO minus the exercise price, or (2) the amount realized upon the disposition of the ISO shares minus the exercise price. Otherwise, a participant's disposition of shares acquired upon the exercise of an option (including an ISO for which the ISO Holding Periods are met) or SAR generally will result in short-term or long-term capital gain or loss measured by the difference between the sale price and the participant's tax basis in such shares (the tax basis generally being the exercise price plus any amount recognized as ordinary income in connection with the exercise of the option or SAR). We generally will be entitled to a tax deduction equal to the amount recognized as ordinary income by the participant in connection with an option or SAR. We generally are not entitled to a tax deduction relating to amounts that represent a capital gain to a participant. Accordingly, we will not be entitled to any tax deduction with respect to an ISO if the participant holds the shares for the ISO Holding Period prior to disposition of the shares. With respect to awards granted under the Incentive Plan that result in the payment or issuance of cash or shares or other property that is either not restricted as to transferability or not subject to a substantial risk of forfeiture, the participant generally must recognize ordinary income equal to the cash or the fair market value of shares or other property received. We generally will be entitled to a deduction in an amount equal to the ordinary income recognized by the participant. With respect to awards involving the issuance of shares or other property that is restricted as to transferability and subject to a substantial risk of forfeiture (e.g., restricted stock), the participant generally must recognize ordinary income equal to the fair market value of the shares or other property at the first time the shares or other property becomes transferable or is not subject to a substantial risk of forfeiture, whichever occurs earlier. We generally will be entitled to a deduction in an amount equal to the ordinary income recognized by the participant. Description of Amendments to Director Plan (Proposal 3) The proposed amendments to the Director Plan will (1) clarify that grants of options or awards of performance accelerated restricted stock ("PARS") under the Director Plan may be made with respect to either Staples Stock or Staples.com Stock, or both, in the same manner as currently permitted with respect to 50 existing common stock, and (2) increase the number of shares of common stock, regardless of series, available for issuance under the Director Plan. The following summary of the amendments to the Director Plan is not complete and should be read with the full proposed text of the Director Plan as set forth in Annex IV hereto. Grants of Awards Under the current Director Plan, grants of options and awards of PARS may be made with respect to shares of existing common stock. Under the amended Director Plan, grants of options and awards of PARS made following the approval of the amendment may be made, at the discretion of the board of directors, with respect to either Staples Stock or Staples.com Stock, or both, in the same manner as currently provided for with respect to existing common stock. Shares Available for Issuance under Director Plan Under the current Director Plan, up to 2,392,030 shares of existing common stock are available for grants or awards. Under the amended Director Plan, up to 3,350,000 shares of common stock, regardless of series, will be available for grants or awards. Types of Awards under Director Plan Under the current Director Plan, each Outside Director (as defined in the Director Plan) automatically receives (1) upon election as a member of the board of directors, an initial grant of options to purchase 15,000 shares of common stock, and (2) on the date of the first regularly scheduled board of directors meeting following the end of each Staples fiscal year a grant of options to purchase 3,000 shares of common stock for each regularly scheduled meeting day of the board of directors that such Outside Director attended, up to a maximum of 15,000 shares. In addition, under the current Director Plan, at the first regularly scheduled board of directors meeting following the end of each fiscal year of Staples, in which performance targets are established relating to PARS awarded to executive officers of Staples, (x) each Outside Director is granted 400 PARS for each regularly scheduled meeting day of the board of directors attended by such Director in the previous 12 months (up to a maximum of 2,000 PARS) and (y) in addition, the Lead Director (as defined in the Director Plan) and the Chairman of each of the Audit, Compensation, and Governance Committees of the board of directors is granted 200 PARS for each regularly scheduled meeting day of the board of directors attended by such Director in the previous 12 months (up to a maximum of 1,000 PARS). All stock options granted under the Director Plan are granted at an exercise price equal to the fair market value of the common stock on the date of grant, and generally become exercisable on a cumulative basis in four equal annual installments, commencing on the first anniversary of the date of grant. Recipients of PARS own shares of common stock (which may be issued on a deferred basis) under terms that provide for vesting over a period of time and a right to repurchase in favor of Staples with respect to unvested stock, at a price equal to their original purchase price (if any), when the recipient ceases to be a director of Staples. Except as otherwise determined by the board of directors, all PARS issued under the Director Plan shall be issued without the payment of any cash purchase price by the recipient. The restrictions on transfer and forfeiture provisions of the PARS to be granted to the non- employee Directors shall lapse on the same basis as PARS awarded to Staples' executive officers. Effect on Outstanding Awards The approval of the amendments to the Director Plan will not result in any adjustment to the outstanding options under the Director Plan. The approval of the Tracking Stock Proposal will result in each outstanding option for Staples common stock under the Director Plan instead becoming an option for Staples Stock. Federal Income Tax Consequences The following is a brief description of the federal income tax consequences generally arising with respect to options granted under the Director Plan. 51 The grant of an option will create no tax consequences for the Outside Director or Staples. Upon exercising an option, the Outside Director generally must recognize ordinary income equal to the difference between the exercise price and fair market value of the shares acquired on the date of exercise, and we generally will be entitled to a tax deduction equal to the amount recognized as ordinary income by the participant. The disposition of shares acquired upon the exercise of an option generally will result in capital gain or loss measured by the difference between the sale price and the participant's tax basis in such shares (the tax basis generally being the exercise price plus any amount recognized as ordinary income in connection with the exercise of the option). Description of Amendments to Stock Purchase Plan (Proposal 4) The proposed amendments to the Stock Purchase Plan will (1) clarify that grants of options under the Stock Purchase Plan may be made with respect to either Staples Stock or Staples.com Stock, or both, in the same manner as currently permitted with respect to existing common stock, and Stock Purchase Plan (2) increase the number of shares of common stock, regardless of series, available for issuance under the plan from 6,000,000 to 8,400,000. The following summary of the amendments to the Stock Purchase Plan is not complete and should be read with the full proposed text of the Stock Purchase Plan as set forth in Annex V hereto. Sales of Shares All employees of Staples and certain subsidiaries designated by the board of directors are eligible to participate in the Stock Purchase Plan if they have been employed at least three months and are customarily employed for more than 20 hours a week and more than five months a year. Under the current Stock Purchase Plan, participants may purchase shares of existing common stock. Under the amended Stock Purchase Plan, participants may purchase either Staples Stock or Staples.com Stock, or both, in the same manner as currently permitted with respect to existing common stock. Shares Available for Issuance under Stock Purchase Plan Under the current Stock Purchase Plan, up to 6,000,000 shares of existing common stock are available for sale to participants. Under the amended Stock Purchase Plan, up to 8,400,000 shares of common stock, regardless of series, will be available for sale to participants. Types of Awards under the Stock Purchase Plan Under the amended Stock Purchase Plan, the committee that administers the Stock Purchase Plan will, in its discretion, be able to authorize the issuance of Staples Stock, Staples.com Stock or both, as it determines in accordance with the terms of the Stock Purchase Plan. Effect on Outstanding Options The approval of the amendments to the Stock Purchase Plan will not result in any adjustment to the outstanding options to purchase common stock under the Stock Purchase Plan. The approval of the Tracking Stock Proposal will result in each outstanding option for Staples common stock under the Stock Purchase Plan instead becoming an option for Staples Stock. Federal Income Tax Consequences The following is a brief description of the federal income tax consequences generally arising with respect to options granted under the Stock Purchase Plan. An employee will not recognize ordinary compensation income upon the exercise of the option granted under the Stock Purchase Plan. If an employee disposes of the common stock after the expiration of the Holding Period, the employee will recognize ordinary compensation income in an amount equal to the lesser of 52 (1) the excess of the fair market value of the common stock upon disposition over the option price thereof or (2) the excess of the fair market value of the common stock at the time of grant over the option price thereof. Any additional gain upon the sale of the acquired common stock will be long-term capital gain. We will not be entitled to a deduction for any income recognized by the employee pursuant to either the exercise of options granted under the Stock Purchase Plan or the sale of the acquired common stock. If the employee disposes of the common stock acquired upon exercise of the option prior to the end of the Holding Period, the employee will recognize ordinary compensation income in the year of the disposition in an amount equal to the difference between the fair market value of the common stock on the date of exercise over the option price thereof. We will be entitled to an income tax deduction equal to the amount of the ordinary compensation income recognized by the employee. Any additional gain (or loss) on the sale of the common stock by the employee will be taxed as short-term or long-term capital gain (or loss), as the case may be. ---------------- The board of directors recommends a vote FOR each of Proposals 2, 3 and 4. 53 EXECUTIVE COMPENSATION Summary Compensation The following table sets forth certain information concerning the compensation for each of the last three fiscal years of Staples' Chief Executive Officer and the four other most highly compensated executive officers during the fiscal year ended January 30, 1999 (the "Senior Executives"). SUMMARY COMPENSATION TABLE
Annual Compensation(1) Long Term Compensation --------------------- -------------------------- Restricted Common Name and Principal Fiscal Stock Stock All Other Position Year Salary Bonus(2) Awards Options(3) Compensation(4) ------------------ ------ -------- -------- ----------- ---------- --------------- Thomas G. Stemberg 1998 $645,833 $673,556 $ 2,606,250(5) 2,400,000 $ 17,769 Chairman and CEO 1997 587,500 446,172 1,543,434(6) 360,000 13,924 1996 447,917 414,315 1,216,875(7) 360,000 6,304 Ronald L. Sargent 1998 $449,083 $349,261 $ 1,282,032(8) 1,361,250 $ 32,193 President, Chief 1997 392,084 218,235 1,005,552(9) 375,000 29,583 Operating Office 1996 302,775 208,257 774,375(10) 258,750 21,802 John J. Mahoney 1998 $439,250 $335,880 $ 1,172,813(11) 585,000 $ 42,848 Exec. Vice President 1997 395,834 220,160 1,033,614(12) 330,000 35,553 Chief Financial Officer 1996 171,243 251,210(13) 774,375(14) 348,750 36,433 & Chief Administrative Officer Joseph S. Vassalluzzo 1998 $439,250 $325,636 $ 1,064,202(15) 585,000 $ 48,150 President, Realty and 1997 391,250 198,007 776,394(16) 220,312 43,774 Development 1996 312,500 193,347 553,125(17) 157,500 34,884 John C. Bingleman 1998 $410,735 $311,889 $ 5,460,947(18) 450,000 $150,152(19) President--Staples 1997 385,883(20) 215,555 -- (21) -- (21) 56,976 International 1996 356,609(22) 243,065 774,375(23) 258,750 43,572
- -------- (1) In accordance with the rules of the Securities and Exchange Commission, other compensation in the form of perquisites and other personal benefits has been omitted because such perquisites and other personal benefits constituted less than the lesser of $50,000 or 10% of the total annual salary and bonus for the Senior Executive for each year shown. (2) Except as noted below, represents amounts paid under Staples' Executive Officer Incentive plan or executive bonus plan for the relevant fiscal year. (3) Amounts reflect the three-for-two stock splits effected on March 25, 1996, January 30, 1998 and January 28, 1999, as applicable. (4) Except as noted below, represents an actuarial equivalent benefit to the Senior Executive from payment of annual premiums by Staples under a split dollar insurance program. Because of differences in Mr. Stemberg's insurance policy, Mr. Stemberg's benefit is calculated using a method that, at this time, results in a lower benefit. (5) On October 1, 1998, Mr. Stemberg was awarded 150,000 shares of PARS with a per share value of $17.375. As of January 30, 1999, these restricted shares owned by Mr. Stemberg had a total value of $4,293,750. See "Performance Accelerated Restricted Stock Awards." (6) On October 1, 1997, Mr. Stemberg was awarded 123,750 shares of PARS with a per share value of $12.4722. As of January 30, 1999, these restricted shares owned by Mr. Stemberg had a total value of $3,542,343. See "Performance Accelerated Restricted Stock Awards." 54 (7) On October 1, 1996, Mr. Stemberg was awarded 123,750 shares of PARS with a per share value of $9.8333. As of January 30, 1999, none of these restricted shares were owned by Mr. Stemberg. See "Performance Accelerated Restricted Stock Awards." (8) On October 1, 1998, Mr. Sargent was awarded 67,500 shares of PARS with a per share value of $17.375. On January 1, 1999, Mr. Sargent was awarded 3,750 shares of PARS with a per share value of $29.125. As of January 30, 1999, these restricted shares owned by Mr. Sargent had a combined total value of $2,039,531. See "Performance Accelerated Restricted Stock Awards." (9) On October 1, 1997, Mr. Sargent was awarded 80,623 shares of PARS with a per share value of $12.4722. As of January 30, 1999, these restricted shares owned by Mr. Sargent had a total value of $2,307,833. See "Performance Accelerated Restricted Stock Awards." (10) On October 1, 1996, Mr. Sargent was awarded 78,750 PARS shares with a per share value of $9.8333. As of January 30, 1999, none of these restricted shares were owned by Mr. Sargent. See "Performance Accelerated Restricted Stock Awards." (11) On October 1, 1998, Mr. Mahoney was awarded 67,500 shares of PARS with a per share value of $17.375. As of January 30, 1999, these restricted shares owned by Mr. Mahoney had a total value of $1,932,187. See "Performance Accelerated Restricted Stock Awards." (12) On October 1, 1997, Mr. Mahoney was awarded 82,873 shares of PARS with a per share value of $12.4722. As of January 30, 1999, these restricted shares owned by Mr. Mahoney had a total value of $2,372,239. See "Performance Accelerated Restricted Stock Awards." (13) Mr. Mahoney joined Staples in September 1996. Bonus payment for 1996 included a payment of $134,517 pursuant to Mr. Mahoney's offer of employment. (14) On October 1, 1996, Mr. Mahoney was awarded 78,750 shares of PARS with a per share value of $9.8333. As of January 30, 1999, none of these restricted shares were owned by Mr. Mahoney. See "Performance Accelerated Restricted Stock Awards." (15) On October 1, 1998, Mr. Vassalluzzo was awarded 61,249 shares of PARS with a per share value of $17.375. As of January 30, 1999, these restricted shares owned by Mr. Vassalluzzo had a total value of $1,753,252. See "Performance Accelerated Restricted Stock Awards." (16) On October 1, 1997, Mr. Vassalluzzo was awarded 62,250 shares of PARS with a per share value of $12.4722. As of January 30, 1999, these restricted shares owned by Mr. Vassalluzzo had a total value of $1,781,906. See "Performance Accelerated Restricted Stock Awards." (17) On October 1, 1996, Mr. Vassalluzzo was awarded 56,250 PARS shares with a per share value of $9.8333. As of January 30, 1999, none of these restricted shares were owned by Mr. Vassalluzzo. See "Performance Accelerated Restricted Stock Awards." (18) On September 1, 1998, Mr. Bingleman was awarded 281,250 shares of PARS with a per share value of $19.4167. As of January 30, 1999, these restricted shares owned by Mr. Bingleman had a total value of $8,050,781. See "Performance Accelerated Restricted Stock Awards." (19) Includes reimbursement of $95,886 for relocation expenses. (20) Includes payment of $25,420 paid to Mr. Bingleman by Staples' Canadian subsidiary, The Business Depot, Ltd. (21) Mr. Bingleman was not granted options or PARS during fiscal 1997 as a result of his assumption of new responsibilities for international operations. Staples developed a long-term compensation strategy for certain international executives, including Mr. Bingleman, that was implemented during fiscal 1998. (22) Includes payment of $25,993 paid to Mr. Bingleman by Staples' Canadian subsidiary, The Business Depot, Ltd. (23) On October 1, 1996, Mr. Bingleman was awarded 78,750 PARS shares with a per share value of $9.8333. As of January 30, 1999, none of these restricted shares were owned by Mr. Bingleman. See "Performance Accelerated Restricted Stock Awards." 55 Performance Accelerated Restricted Stock ("PARS") Awards In order to maintain Staples' high risk-high reward philosophy, the Compensation Committee adopted, as part of the 1992 Equity Incentive Plan, a PARS plan (the "PARS Plan") for certain key executives. Under the PARS Plan, shares of Staples common stock are granted to executives in consideration for services. The shares are "restricted" in that they may not be sold or transferred by the executive until they "vest." Staples' PARS issued in fiscal 1998 will vest on February 1, 2003 subject to acceleration upon achievement of certain pre-determined earnings per share ("EPS") growth targets over the next two to five fiscal years. Staples' PARS issued in fiscal 1997 vested on May 1, 1999 as a result of Staples exceeding EPS targets for fiscal 1998. Staples' PARS that were issued in fiscal 1996 vested on May 1, 1998 as a result of Staples exceeding target EPS for such PARS for fiscal 1997. EPS growth targets are determined by the Compensation Committee and approved by the board of directors each year for grants under the PARS Plan in that year. Once the PARS have vested, they become "unrestricted" and may be freely sold or transferred. Generally, the PARS are forfeited if the executive's employment with Staples terminates prior to vesting. Option Grants The following table sets forth certain information concerning grants of stock options during the fiscal year ended January 30, 1999 for each of the Senior Executives. 56 OPTION GRANTS IN LAST FISCAL YEAR
Individual Grants - ----------------------------------------------------------------------------------------- Percent of Total Number of Options Granted Exercise Grant Date Options to Employees in Price per Expiration Present Name Granted Fiscal Year Share(1)(2) Date Value(1)(3) ---- --------- ---------------- ----------- ---------- ----------- Thomas G. Stemberg...... 1,950,000(4) 14.41% $20.0833 7/1/08 $14,608,000 450,000 3.33 20.0833 7/1/08 3,181,000 Ronald L. Sargent....... 450,000(5) 3.33 20.0833 7/1/08 3,118,000 135,000 0.99 20.0833 7/1/08 954,000 675,000(6) 4.98 22.9167 11/16/08 5,337,000 101,250 0.74 29.1250 1/1/09 1,038,000 John J. Mahoney......... 450,000(5) 3.33 20.0833 7/1/08 3,118,000 135,000 0.99 20.0833 7/1/08 954,000 Joseph S. Vassalluzzo... 450,000(5) 3.33 20.0833 7/1/08 3,118,000 135,000 0.99 20.0833 7/1/08 954,000 John C. Bingleman....... 450,000(7) 3.33 20.0833 7/1/08 3,272,000
- -------- (1) All amounts reflect the three-for-two stock split effected on January 28, 1999. Except as otherwise noted, each of the options granted becomes exercisable in full on the third anniversary of the date of grant, provided that the optionee continues to be employed by Staples on such date. The exercisability of the options is accelerated under certain circumstances. See "Employment Contracts, Termination of Employment and Change-in-Control Agreements with Senior Executives." (2) The exercise price is equal to the fair market value per share of Common Stock on the date of grant. (3) The estimated present value at grant date has been calculated using a Black-Scholes option pricing model, based upon the following assumptions: a six year expected life of option; a dividend yield of 0.0%; expected volatility of 34%; and a risk-free interest rate of 4.5%, representing the interest rate on a U.S. Government zero-coupon bond on the date of grant, with a maturity corresponding to the expected life of the option. Values are adjusted to reflect a 5% risk of forfeiture due to vesting requirements. (4) This option becomes exercisable in full on July 25, 2000, provided that Mr. Stemberg continues to be employed by Staples on such date. (5) Options for 67,500 shares became exercisable on the first anniversary of the date of grant; options for 67,500 shares become exercisable on the second anniversary of the date of grant; options for 90,000 shares become exercisable on the third anniversary of the date of grant; options for 90,000 shares become exercisable on the fourth anniversary of the date of grant; and options for 135,000 shares become exercisable on the fifth anniversary of the date of grant; all provided that the optionee continues to be employed by Staples on such date. (6) Options for 101,250 shares become exercisable on the first anniversary of the date of grant; options for 101,250 shares become exercisable on the second anniversary of the date of grant; options for 135,000 shares become exercisable on the third anniversary of the date of grant; options for 135,000 shares become exercisable on the fourth anniversary of the date of grant; and options for 202,500 shares become exercisable on the fifth anniversary of the date of grant; all provided that Mr. Sargent continues to be employed by Staples on such date. (7) Options for 225,000 shares became exercisable on July 1, 2000 and the remaining 225,000 shares become exercisable on July 1, 2001, provided that Mr. Bingleman continues to be employed by Staples on such date. Option Exercises and Holdings The following table sets forth certain information concerning each exercise of stock options during the fiscal year ended January 30, 1999 by each of the Senior Executives and the number and value of unexercised options held by each of the Senior Executives on January 30, 1999. 57 AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR END FISCAL YEAR-END OPTION VALUES
No. of Shares of Common No. of Shares of Stock Underlying Value of Unexercised Common Stock Unexercised Options at In-The-Money Options at Acquired On Value Fiscal Year End(1) Fiscal Year End(1)(3) Name Exercise Realized(2) Exercisable/Unexercisable Exercisable/Unexercisable ---- ---------------- ----------- ------------------------- ------------------------- Thomas S. Stemberg...... 3,600,000 $63,061,455 2,080,544/3,120,000 $50,038,295/$34,110,060 Ronald L. Sargent....... 513,805 7,387,600 357,813/1,995,000 8,216,662/ 20,643,481 John J. Mahoney......... 0 0 0/1,263,750 0/ 17,742,236 Joseph S. Vassalluzzo... 488,419 7,151,978 1,097,872/ 962,812 27,923,242/ 11,926,733 John C. Bingleman....... 232,875 4,635,422 675,842/ 708,750 16,840,610/ 9,071,110
- -------- (1) All amounts reflect the three-for-two stock split effected on January 28, 1999. (2) Represents the difference between the exercise price and the fair market value of the common stock on the date of exercise. (3) Based on the fair market value of the common stock on January 30, 1999 ($28.625 per share), less the option exercise price. Employment Contracts, Termination of Employment and Change-in-Control Agreements with Senior Executives Staples has entered into Severance Benefit Agreements (the "Severance Agreements") with each of the Senior Executives. Under the Severance Agreements, which expire May 31, 2000, the Senior Executives would be entitled to continuation of salary and other benefits for (i) 18 months in the case of Mr. Stemberg, and (ii) 12 months in the case of Messrs. Bingleman, Mahoney, Sargent and Vassalluzzo, following termination of employment by Staples without cause (or "constructive discharge" as provided in the Severance Agreements). Each Senior Executive would receive such benefits for an additional period of six months if such termination occurred within two years following a "change in control" of Staples (as defined in the Severance Agreements). A change in control of Staples also results in a partial acceleration of the exercisability of outstanding options held by the Senior Executives (and all Staples associates) and a discharge without cause (or resignation for good reason) within one year after a change in control results in the acceleration in full of all options and PARS. In the event Mr. Mahoney is terminated without cause within one year after a change of control, Staples would also guarantee to him that the sum of all severance payments plus the total gain realized and realizable upon the sale and/or exercise of his PARS and/or options would equal at least $2,000,000. Director Compensation During the fiscal year ended January 30, 1999, under the Staples 1990 Director Stock Option Plan (the "Director Plan") each non-employee Director received a fee of $1,000 for each board of directors meeting attended and $300 for each committee meeting attended. All Directors are reimbursed for certain company-related travel expenses. Pursuant to an agreement with Staples, Senator Mitchell provides consulting services to Staples in return for a total annual fee of $75,000. The Director Plan also provided for a grant to each Outside Director, upon his or her initial election as a Director, of an option to purchase 10,000 shares of common stock. Accordingly, on September 10, 1998, Senator Mitchell was granted an option to purchase 15,000 shares of common stock at an exercise price of $17.33 per share (10,000 shares at an exercise price of $26.00 before adjustment for the January 28, 1999 stock split). On January 21, 1999, the stockholders of Staples approved an amendment and restatement of the Director Plan (the "Amended and Restated Director Plan"). Under the Amended and Restated Director Plan, Directors 58 are compensated exclusively through equity rather than receiving a portion of their compensation in cash. Accordingly, non-employee Directors will not receive any fees or other cash compensation for their services as Directors, other than reimbursement for expenses incurred in attending meetings of the Directors. Pursuant to the Amended and Restated Director Plan, each new member of the board of directors will be granted an option to purchase 15,000 shares of common stock upon such person's initial election to the board of directors. In addition, the Amended and Restated Director Plan provides for an annual stock option grant to each non-employee Director to purchase a number of shares equal to 3,000 multiplied by the number of regularly scheduled meeting days attended by such non-employee Director during the preceding year (up to a maximum of 15,000 shares). In addition, at the first regularly scheduled board of directors meeting following the end of each fiscal year of Staples in which performance targets are established relating to Performance Accelerated Restricted Stock ("PARS") awarded to executive officers of Staples, each non- employee Director is to be granted 400 PARS for each regularly scheduled meeting day attended by such Director during the preceding year (up to a maximum of 2,000 PARS); and each of the Lead Director and the Chairman of the Audit, Compensation and Governance Committees of the board of directors will be granted 200 PARS for each regularly scheduled meeting day of the board of directors attended by such Director during the previous twelve months (up to a maximum of 1,000 PARS). With respect to the fiscal year ended January 30, 1999 and in accordance with the Amended and Restated Director Plan, on March 3, 1999 each of Ms. Burton and Messrs. Anderson, Moody, Moriarty, Nakasone, Romney, Trust and Walsh was granted an option to purchase 15,000 shares of common stock, Mr. Heisey was granted an option to purchase 12,000 shares and Senator Mitchell was granted an option to purchase 3,000 shares of common stock, each at an exercise price of $28.00 per share. Pursuant to the Amended and Restated Director Plan, at the June 2, 1999 meeting of the compensation committee of the board of directors at which performance targets were established relating to PARS, the following were awarded: Mr. Moody was awarded 3,000 PARS; Messrs. Moriarty, Nakasone and Walsh were awarded 2,800 PARS; Mr. Anderson was awarded 2,200 PARS; Ms. Burton and Messrs. Romney and Trust were awarded 2,000 PARS; Mr. Heisey was awarded 1,600 PARS; and Senator Mitchell was awarded 400 PARS. All stock options under the Amended and Restated Director Plan are granted at an exercise price equal to the fair market value of the common stock on the date of grant, and generally become exercisable on a cumulative basis in four equal annual installments, commencing on the first anniversary of the date of grant. Recipients of PARS own shares of common stock (which may be issued on a deferred basis) under terms that provide for vesting over a period of time and a right to repurchase in favor of Staples with respect to unvested stock, at a price equal to their original purchase price (if any), when the recipient ceases to be a Director of Staples. Except as otherwise determined by the board of directors, all PARS issued under the Amended and Restated Director Plan shall be issued without the payment of any cash purchase price by the recipient. The restrictions on transfer and forfeiture provisions of the PARS to be granted to the non-employee Directors shall lapse on the same basis as PARS awarded to Staples' executive officers. Compliance with Section 16(a) of the Securities Exchange Act of 1934 Based solely on its review of copies of reports filed by persons ("Reporting Persons") required to file such reports pursuant to Section 16(a) under the Exchange Act, Staples believes that all filings required to be made by Reporting Persons of Staples were timely made in accordance with the requirements of the Exchange Act, with the exception of the option exercise and sale of 140,482 shares by Bain & Co., Inc., of which Mr. Romney is a director, in July 1998 which was reported in November 1998, and the sale in July 1998 by Mr. Bingleman of 52,500 shares which was reported in August 1998. Compensation Committee Interlocks and Insider Participation Messrs. Heisey, Nakasone and Trust, all non-employee Directors of Staples, served on the Compensation Committee for the entire fiscal year ended January 30, 1999. 59 Staples leases its Cedar Rapids, Iowa store from Toys "R" Us. Mr. Nakasone was Chief Executive Officer of Toys "R" Us from February 1998 to August 1999. The initial term of this lease, which commenced on October 8, 1996, is 15 years. Staples may renew the lease for two additional five year periods. Compensation Committee Report on Executive Compensation Staples' executive compensation program is administered by the Compensation Committee composed of the non-employee Directors listed below. Staples' executive compensation program is designed to retain and reward executives who are responsible for leading Staples in achieving its business objectives. All decisions by the Compensation Committee relating to the compensation of Staples' executive officers are reviewed by the full board of directors. This report is submitted by the Compensation Committee and addresses Staples' compensation policies for fiscal 1998 and forward as they affected the Chief Executive Officer and the other executive officers of Staples. Compensation Philosophy The objectives of the executive compensation program are to (i) align compensation with business objectives, individual performance and the interests of Staples' stockholders, (ii) motivate and reward high levels of performance, (iii) recognize and reward the achievement of Company and/or business unit goals, and (iv) enable Staples to attract, retain and reward executive officers who contribute to the long-term success of Staples. The Committee's executive compensation philosophy is that a significant portion of executive compensation should be tied directly to the performance of Staples as a whole. The base salaries paid to executives are targeted by the Committee to fall at or below the 40th percentile of the pay practices of publicly traded companies in the retail industry (including companies in the Standard & Poor's Retail Composite Index contained in the stock performance graph contained in this Proxy Statement, as determined by The Hay Group ("Hay"), an international compensation and human resource consulting firm). The Committee seeks, however, to provide its executives with opportunities for compensation substantially higher than base salary through performance-based bonuses, stock options and Performance Accelerated Restricted Stock ("PARS"). The Committee also believes that bonus awards tied to achievement of pre- approved performance goals serve as an influential motivator to its executives and help to align the executives' interests with those of the stockholders of Staples. The Committee also continues to believe that a substantial portion of the compensation of Staples' executives should be linked through Staples' stock option and PARS program to the success of Staples' stock in the marketplace. Stock options and PARS further align the interests of management and stockholders and assist in the retention of valued executives. Status of the Executive Compensation Program Based on information provided by Hay and consistent with Staples' objectives and philosophy, the Committee targeted total annual compensation (salary, cash bonus and stock) to fall above the median for total annual compensation for similar positions in the group of retail companies used in the Hay study. . Salaries: The Compensation Committee targets base annual salary for executive officers including the Senior Executives to be at the 40th percentile of the annual base salary for comparable positions in the Hay study group. . Bonus: Each of Staples' executive officers, including the Senior Executives, was eligible to participate in Staples' Executive Officer Incentive Plan in fiscal 1998 (the "Bonus Plan"). The Bonus Plan provided for the payment of a range of cash bonuses to executive officers based on "stretch" objectives relating to company-wide earnings per share and customer service goals. 60 The earnings per share and customer service goals for the Bonus Plan were determined by the Committee and approved by the board of directors at the beginning of fiscal 1998. In each case, these bonus goals represented "stretch" objectives, requiring performance in excess of amounts set for budget purposes to achieve target bonus payouts. The Committee established target bonus payouts for executives in an attempt to bring the cash portion of total annual compensation (base salary plus target bonus) to approximately the median of the cash compensation paid to the Hay comparison group. For fiscal 1998, Staples exceeded stretch objectives for earnings per share and fell short of the customer service objective. . Stock Options: In addition to base salary and bonus, Staples' executives are also granted annually performance-based long-term incentives represented by stock options, which have been valued using a modified Black-Scholes methodology. The exercise price of all options granted is the fair market value of the common stock on the date of grant. In general, the options granted under the option program since September 1, 1994 vest in full on the third anniversary of the date of grant to further encourage retention and promote identity of interest with Staples' stockholders. Certain executives, including the Senior Executives, were also granted special stock options in 1998, subject to a vesting requirement over a two to five year period and requiring continuous employment with Staples over the vesting period. A competitive review by Hay served as the basis for these special option grants. The review demonstrated that Staples' historical level of stock grants trailed that of its peer group relative to Staples' performance over the same period. This shortfall can, in part, be attributed to Staples' historical practice of not adjusting grant levels to reflect stock splits. Based on Hay's review, the Committee determined it advisable to make these special grants in order to achieve the objectives of the executive compensation program. . Performance Accelerated Restricted Stock (PARS): In order to maintain Staples' high risk-high reward philosophy, help retain key executives, maintain focus on stockholder returns and deliver the possibility of total direct compensation above the median of the Hay comparison group, the Committee has adopted the use of PARS for certain key management, including its executive officers. The shares are "restricted" in that they may not be sold or transferred by the executive until they "vest." Staples' PARS issued in fiscal 1998 will vest on February 1, 2003 subject to acceleration if Staples achieves certain pre-determined compound EPS growth over the next two to five fiscal years. EPS growth targets are determined by the Committee and approved by the board of directors each year for grants of PARS in that year. Once the PARS have vested, they become "unrestricted" and may be sold or transferred. In 1998, Staples developed a long term compensation strategy specifically for Mr. Bingleman, President International. This plan provided Mr. Bingleman with a restricted stock grant vesting five years from date of grant, subject to accelerated vesting based on the attainment of certain event based and financial objectives relating to Mr. Bingleman's responsibilities for certain of Staples international operations. This grant is in lieu of certain annual stock options and PARS grants under the stock option/PARS program. Mr. Stemberg, Staples' Chief Executive Officer, is eligible to participate in the same executive compensation program available to other Staples executives, and his total annual compensation, including compensation derived from the Bonus Plan and stock option/PARS program, was set by the Committee in accordance with the same criteria. Mr. Stemberg's annual salary was increased in fiscal 1998 from $600,000 to $650,000. Mr. Stemberg's annual salary remained below the low end of the base salary range recommended by Hay for Staples' Chief Executive Officer position and below the 25th percentile of the Hay comparison group. Under the Bonus Plan, Mr. Stemberg was paid a bonus of $673,556 placing his total cash compensation below the median of the Hay comparison group. In fiscal 1998, the Committee granted Mr. Stemberg 150,000 PARS, and options to purchase 450,000 shares of common stock under the options/PARS program, and special options to purchase 1,950,000 shares of common stock. These grants were valued and based on the same factors the Committee considered in fixing the size of other executive PARS and stock option grants. Using the Hay 61 valuation for options, total annual compensation to Mr. Stemberg in fiscal 1998 placed him above the median of the Hay comparison group. Tax Considerations Under Section 162(m) of the Internal Revenue Code of 1986, as amended, certain executive compensation in excess of $1 million paid to a public company's five most highly-paid executives is not deductible for federal income tax purposes unless the executive compensation is awarded under a performance- based plan approved by the stockholders. In 1998, the Committee adopted and Staples shareholders approved the Bonus Plan in compliance with Section 162(m). Staples' stock option plans are performance based, and accordingly, comply with Section 162(m). Finally, while Staples' PARS program has a significant performance component, it cannot be qualified under 162(m) without compromising valuable executive incentives which the Committee believes outweigh any tax benefit to Staples. Compensation Committee:Robert C. Nakasone, Chairman W. Lawrence Heisey Martin Trust 62 Stock Performance Graph The following graph compares the cumulative total stockholder return on the common stock of Staples between January 29, 1994 and January 30, 1999 (the end of fiscal 1998) with the cumulative total return of (i) Standard & Poor's 500 Composite Index and (ii) the Standard & Poor's Retail Store Composite Index. This graph assumes the Investment of $100.00 on January 29, 1994 in Staples' common stock, the Standard & Poor's 500 Composite Index and the Standard & Poor's Retail Store Composite Index, and assumes dividends are reinvested. Measurement points are January 28, 1995, February 3, 1996, February 1, 1997, January 31, 1998 and January 30, 1999 (Staples' last five fiscal year ends). [GRAPH APPEARS HERE]
January 29, January 28, February 3, February 1, January 31, January 30, 1994 1995 1996 1997 1998 1999 ----------- ----------- ----------- ----------- ----------- ----------- SPLS.................... 100.00 132.31 208.70 251.66 334.53 790.66 S&P Retail Composite.... 100.00 92.69 99.08 114.86 171.19 279.05 S&P 500................. 100.00 98.26 132.83 164.23 204.78 267.32
63 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth information regarding beneficial ownership of our common stock as of September 30, 1999 by: . each person we know who beneficially owns more than 5% of the outstanding shares of our common stock; . each of our directors; . each of our five most highly compensated executive officers in fiscal 1998; and . our directors and executive officers as of September 30, 1999 as a group. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission, and includes voting or investment power with respect to shares. Shares of common stock issuable under stock options that are exercisable within 60 days after September 30, 1999 are deemed outstanding for computing the percentage ownership of the person holding the options but are not deemed outstanding for computing the percentage ownership of any other person. Unless otherwise indicated below, to our knowledge, all persons named in the table have sole voting and investment power with respect to their shares of common stock, except to the extent authority is shared by spouses under applicable law. The inclusion of any shares in this table does not constitute an admission of beneficial ownership for the person named below.
Number of Shares Percentage of Beneficially Outstanding Name of Beneficial Owner Owned Common Stock - ------------------------ ---------------- ------------- 5% Stockholders FMR Corp.(1)................................... 36,629,910 7.93% 82 Devonshire Street Boston, MA 02109 Directors and Executive Officers Thomas G. Stemberg(2).......................... 5,172,829 1.11% Martin Trust(3)................................ 3,566,427 * Robert C. Nakasone............................. 490,086 * Rowland T. Moriarty(4)......................... 380,882 * Mary Elizabeth Burton.......................... 183,062 * Paul F. Walsh.................................. 106,400 * James L. Moody, Jr............................. 72,093 * W. Lawrence Heisey............................. 59,312 * W. Mitt Romney................................. 53,782 * Basil L. Anderson.............................. 28,075 * Margaret C. Whitman............................ 13,941 * George J. Mitchell............................. 4,150 * John C. Bingleman.............................. 1,220,956 * John J. Mahoney................................ 530,879 * Ronald L. Sargent.............................. 823,605 * Joseph S. Vassalluzzo.......................... 1,514,988 * All directors and executive officers as of September 30, 1999 as a group (28 persons).... 15,401,764 3.28%
- -------- * Less than 1% (1) Based on a Schedule 13G filed with the Securities and Exchange Commission as of January 7, 1999. (2) Includes 5,692 shares owned by Mr. Stemberg's wife; includes 254,046 shares owned by Thomas G. Stemberg 1998 Trust. (3) Includes 3,264,594 shares owned by Trust Investments, Inc., with which Mr. Trust is affiliated. Mr. Trust has shared investment and voting control of these shares. Also includes 17,083 shares held by Mr. Trust's wife. (4) Includes 39,480 shares held by trusts for the benefit of Mr. Moriarty's children. Mr. Moriarty is not a trustee of the trusts for the benefit of his children. 64 WHERE YOU CAN FIND MORE INFORMATION We file annual, quarterly and special reports, proxy statements, and other documents with the Securities and Exchange Commission. Our SEC filings are available to you on the SEC's Internet site at http://www.sec.gov. You may also read and copy any document we file at the SEC's public reference room at Judiciary Plaza Building, 450 Fifth Street, N.W., Room 1024, Washington, D.C. 20549. You should call 1-800-SEC-0330 for more information on the public reference room. The SEC allows us to "incorporate" information that we file with the SEC in other documents. This means that we can disclose important information to you by referring to other documents that contain that information. The information incorporated by reference is considered to be part of this proxy statement. Information contained in this proxy statement and information that we file with the SEC in the future and incorporate by reference in this proxy statement automatically updates and supersedes previously filed information. We incorporate by reference the documents listed below and any future filings we make with the SEC under Sections 13(a), 13(c), 14 or 15(d) of the Securities Exchange Act of 1934, as amended, prior to the Special Meeting. (1) Our Annual Report on Form 10-K for the fiscal year ended January 30, 1999; and (2) Our Quarterly Reports on Form 10-Q for the fiscal quarters ended May 1, 1999 and July 31, 1999. You may request a copy of these documents, which will be provided at no cost, by contacting: Staples, Inc., 500 Staples Drive, Framingham, Massachusetts 01702, Attention: Investor Relations; Telephone (508) 253-0879. OTHER MATTERS The board of directors does not know of any other matters which may come before the Special Meeting. However, if any other matters are properly presented at the Special Meeting, it is the intention of the persons named in the accompanying proxy to vote, or otherwise act, in accordance with their judgment on such matters. All costs of solicitation of proxies will be borne by Staples. In addition to solicitations by mail, Staples' directors, officers and regular employees, without additional remuneration, may solicit proxies by telephone, telegraph and personal interviews. Staples has also engaged ChaseMellon Shareholder Services, L.L.C. to solicit proxies on behalf of Staples. For these services, Staples will pay ChaseMellon Shareholder Services, L.L.C. a fee of $5,000 plus reimbursement of its reasonable out-of-pocket expenses. Brokers, custodians and fiduciaries will be requested to forward proxy soliciting material to the owners of stock held in their names, and Staples will reimburse them for their out-of-pocket expenses in this connection. Proposals of stockholders intended to be presented at the Special Meeting should be directed to the Corporate Secretary at 500 Staples Drive, Framingham, MA 01702. A stockholder proposal must be received a reasonable period of time before the printing and mailing of this Proxy Statement for inclusion in this Proxy Statement. In order for a stockholder to present a matter for action at the Special Meeting (other than matters included in Staples' proxy materials in accordance with Rule 14a-8 under the Exchange Act), Staples' by-laws require that Staples be given advance written notice of the matter. The Secretary of Staples must receive such notice at the address noted above not less than 60 nor more than 90 days prior to the date of the Special Meeting; provided, however, if less than 70 days' notice or prior public disclosure of the date of the Special Meeting is given or made to stockholders, such notice shall have been mailed or delivered to the Secretary not later than the close of business on the 10th day following the date on which the notice of the Special Meeting was mailed or public disclosure was made, whichever occurs first. If a stockholder proposal is not presented 65 within a reasonable period of time before the mailing of this Proxy Statement, then management proxies would be allowed to use their discretionary voting authority to vote on the proposal when the proposal is raised at the Special Meeting, even though there is no discussion of the proposal in this Proxy Statement. Proposals of stockholders intended to be presented at the 2000 Annual Meeting of Stockholders must be received by the Secretary of Staples not later than December 22, 1999 for inclusion in the proxy statement for that meeting. Staples' by-laws require that Staples be given advance written notice of matters which stockholders wish to present for action at an annual meeting of stockholders (other than matters included in Staples' proxy materials in accordance with Rule 14a-8 under the Exchange Act). For the 2000 Annual Meeting of Stockholders, the Secretary of Staples must receive such notice at the address noted above on or after January 21, 2000, but prior to February 20, 2000; provided, however, if less than 70 days' notice or prior public disclosure of the date of the meeting is given or made to stockholders, such notice shall have been mailed or delivered to the Secretary not later than the close of business on the 10th day following the date on which the notice of the meeting was mailed or public disclosure was made, whichever occurs first. If a stockholder proposal is not presented within these timeframes, then management proxies would be allowed to use their discretionary voting authority to vote on the proposal when the proposal is raised at the 2000 Annual Meeting, even though there is no discussion of the proposal in the 2000 proxy statement. 66 INDEX OF CERTAIN TERMS
Page on which term is defined in the Proxy Term Statement - ---- ------------- 40% of Total Market Capitalization Threshold.................... 34 60% of Total Market Capitalization Threshold.................... 34 All or Substantially All of the Assets.......................... 31 Available Dividend Amount....................................... 29 Business........................................................ 4 Business Subsidiaries........................................... 34 Certificate of Amendment........................................ 28 Code............................................................ 46 Current Certificate of Incorporation............................ 27 Director Plan................................................... 49 Disposition..................................................... 30 Exempt Disposition.............................................. 31 Fair Value...................................................... 31 Incentive Plan.................................................. 49 Market Capitalization........................................... 31 Market Value.................................................... 31 Nasdaq NMS...................................................... 31 Net Proceeds.................................................... 32 Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com ....................................... 38 Outstanding Interest Percentage................................. 38 Proportionate Interest.......................................... 32 Publicly Traded................................................. 32 Record Date..................................................... 19 Retained Interest............................................... 26 Retained Interest Percentage.................................... 38 Staples.com..................................................... 32 Staples.com Stock............................................... Cover letter Staples RD...................................................... 32 Staples Stock................................................... Cover letter Stock Plan Proposals............................................ Notice Stock Purchase Plan............................................. 49 Tax Event....................................................... 34 Total Number of Notional Staples.com Shares Deemed Outstanding.. 33 Tracking Stock Proposal......................................... Notice Trading Day..................................................... 33
67 ANNEX I Illustration of Certain Terms The following illustrations show how to calculate the Retained Interest Percentage, the Outstanding Interest Percentage, the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com and the Total Number of Notional Staples.com Shares Deemed Outstanding after giving effect to hypothetical issuances, repurchases, dividends and transfers, in each case based on the assumptions set forth herein. In these illustrations, the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com is initially assumed to be 100. Unless otherwise specified, each illustration below should be read independently as if none of the other transactions referred to below had occurred. These illustrations are not intended to be complete explanations of the matters covered and are qualified in their entirety by the more detailed information contained elsewhere in this Proxy Statement. These illustrations are purely hypothetical and the numbers used (including assumptions of market values) were chosen to simplify the calculations and are not intended to represent estimates of actual numbers or values. Any capitalized terms which are not defined in this Annex I have the meaning ascribed to them in this Proxy Statement. "Total Number of Notional Staples.com Shares Deemed Outstanding" means the number of shares of Staples.com Stock outstanding plus the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com. At any given time, the percentage interest in Staples.com intended to be represented by the outstanding shares of Staples.com Stock (i.e., the Outstanding Interest Percentage) is equal to: Number of outstanding shares of Staples.com Stock ------------------------------------------------------ Total Number of Notional Staples.com Shares Deemed Outstanding and the remaining percentage interest in Staples.com intended to be represented by Staples RD's Retained Interest in Staples.com (i.e., the Retained Interest Percentage) is equal to: Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com ------------------------------------------------------ Total Number of Notional Staples.com Shares Deemed Outstanding The sum of the Outstanding Interest Percentage and the Retained Interest Percentage will always equal 100%. In the examples below, before the first issuance of shares of Staples.com Stock, the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com and the Total Number of Notional Staples.com Shares Deemed Outstanding are each equal to 100, the Retained Interest Percentage is 100% and the Outstanding Interest Percentage is 0%. Issuance of Staples.com Stock The following illustrations reflect an assumed issuance by Staples of 15 shares of Staples.com Stock under the 1992 Equity Incentive Plan. Issuance for Account of Staples RD Assume the issuance is attributed to Staples RD in respect of its Retained Interest, with the net proceeds credited solely to Staples RD. Shares previously issued and outstanding.................................. 0 Newly issued shares for account of Staples RD............................. 15 --- Total issued and outstanding after the issuance......................... 15 ===
I-1 . The Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com would decrease by the number of shares of Staples.com Stock sold for the account of Staples RD. Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com prior to the issuance......................... 100 Shares issued in the issuance.......................................... 15 --- Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com after the Issuance.......................... 85 ===
. As a result, the issued and outstanding shares (15) would represent an Outstanding Interest Percentage of 15%, calculated as follows: 15 ---------- 15 + 85 The Retained Interest Percentage would accordingly be 85%. . In this case, in the event of any dividend or other distribution paid on the outstanding shares of Staples.com Stock (other than a dividend or other distribution payable in shares of Staples.com Stock), Staples RD would be credited, and Staples.com would be charged, with an amount equal to approximately 567% (representing the ratio of the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com (85) to the total number of shares of Staples.com Stock issued and outstanding following the issuance (15)) of the aggregate amount of such dividend or distribution. If, for example, a dividend of $1.00 per share were declared and paid on the 15 shares of Staples.com Stock outstanding (an aggregate of $15), Staples RD would be credited with $85, and Staples.com would be charged with that amount in addition to the $15 dividend paid to the holders of Staples.com Stock (a total of $100). Issuance for Account of Staples.com Assume the issuance is attributed to Staples.com as an increase in its equity, with the net proceeds credited solely to Staples.com. Shares previously issued and outstanding.................................. 0 Newly issued shares for account of Staples.com............................ 15 --- Total issued and outstanding after the issuance......................... 15 ===
. The Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com (100) would remain unchanged. . As a result, the issued and outstanding shares (15) would represent an Outstanding Interest Percentage of approximately 13%, calculated as follows: 15 ---------- 15 + 100 The Retained Interest Percentage would accordingly be approximately 87%. . In this case, in the event of any dividend or other distribution paid on the outstanding shares of Staples.com Stock (other than a dividend or other distribution payable in shares of Staples.com Stock), Staples RD would be credited, and Staples.com would be charged, with an amount equal to approximately 667% (representing the ratio of the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com (100) to the total number of shares of Staples.com Stock issued and outstanding following the issuance (15)) of the aggregate amount of such dividend or distribution. I-2 Offerings of Options and Convertible Securities If we were to grant options for Staples.com Stock or issue securities convertible into or exercisable for shares of Staples.com Stock, the Outstanding Interest Percentage and the Retained Interest Percentage would be unchanged at the time of such grant or issuance. If any shares of Staples.com Stock were issued upon exercise or conversion of such options or securities, however, the Outstanding Interest Percentage and the Retained Interest Percentage would be affected as shown above under "Issuance for Account of Staples RD," if such securities were attributed to Staples RD, or under "Issuance for Account of Staples.com," if such securities were attributed to Staples.com. Repurchases of Staples.com Stock The following illustrations reflect an assumed repurchase by Staples of 5 shares of Staples.com Stock after an assumed initial issuance of 15 shares of Staples.com Stock for the account of Staples RD. Repurchase for the Account of Staples RD Assume the repurchase is attributed to Staples RD as an increase in its Retained Interest in Staples.com, with the cost charged solely against Staples RD. Shares previously issued and outstanding.................................. 15 Shares repurchased for account of Staples RD.............................. 5 --- Total issued and outstanding after repurchase........................... 10 ===
. The Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com would be increased by the number of any shares of Staples.com Stock repurchased for the account of Staples RD. Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com prior to repurchase........................ 85 Number of shares repurchased for the account of Staples RD.......... 5 --- Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com after repurchase.......................... 90 ===
. As a result, the total issued and outstanding shares (10) would in the aggregate represent an Outstanding Interest Percentage of 10%, calculated as follows: 10 ---------- 10 + 90 The Retained Interest Percentage would accordingly be increased to 90%. Repurchase for Account of Staples.com without Participation by Staples RD Assume the repurchase is attributed to Staples.com, with the cost being charged solely against Staples.com. Further assume that the board of directors does not elect to transfer assets from Staples.com to Staples RD to hold constant the Outstanding Interest Percentage and Retained Interest Percentage. Shares previously issued and outstanding.................................. 15 Shares repurchased for account of Staples.com............................. 5 --- Total issued and outstanding after repurchase........................... 10 ===
I-3 . The Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com (85) would remain unchanged. . As a result, the total issued and outstanding shares (10) would in the aggregate represent an Outstanding Interest Percentage of approximately 11%, calculated as follows: 10 ---------- 10 + 85 The Retained Interest Percentage would accordingly be increased to approximately 89%. Repurchase for Account of Staples.com with Participation by Staples RD Assume the repurchase is attributed to Staples.com, with the cost being charged solely against Staples.com. Further assume that the repurchase is made in connection with a tender offer for 5, or 33%, of the then outstanding shares at a price of $20 per share, and that the board of directors elects to transfer cash or other assets from Staples.com to Staples RD to hold constant the Outstanding Interest Percentage and the Retained Interest Percentage. Shares previously issued and outstanding.................................. 15 Shares repurchased for account of Staples.com............................. 5 --- Total issued and outstanding after repurchase........................... 10 ===
. In order to hold constant the Outstanding Interest Percentage and Retained Interest Percentage, the board of directors determines that the Market Value of a share of Staples.com Stock in this context is $20 and transfers from Staples.com to Staples RD an amount of cash or other assets equal to approximately 567% (representing the ratio of the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com (85) to the total number of shares of Staples.com Stock issued and outstanding (15), in each case immediately prior to the repurchase) of the aggregate amount of the cash paid in the tender offer to holders of outstanding shares of Staples.com Stock ($100), or a total of $567. . In that case, the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com (85) would decrease by the amount of cash so transferred (approximately $567) divided by the Market Value per share of Staples.com Stock ($20), or 28 shares. Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com prior to transfer........................... 85 Adjustment in respect of Staples RD's Retained Interest to reflect transfer to Staples RD of funds previously allocated to Staples.com.. 28 --- Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com after transfer............................. 57 ===
. As a result, the total issued and outstanding shares (10) would in the aggregate continue to represent an Outstanding Interest Percentage of approximately 15%, calculated as follows: 10 ---------- 10 + 57 The Retained Interest Percentage would accordingly continue to be approximately 85%. I-4 . Assuming that the board of directors transferred only half of the $567 amount, or $283.50, from Staples.com to Staples RD, the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com (85) would decrease by the amount of cash so transferred ($283.50) divided by the Market Value per share of Staples.com Stock ($2). Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com prior to transfer....................................... 85 Adjustment in respect of Staples RD's Retained Interest to reflect transfer to Staples RD of funds previously allocated to Staples.com.... 14 --- Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com after transfer............................... 71 ===
. In that case, as a result, the total issued and outstanding shares (10) would in the aggregate represent an Outstanding Interest Percentage of approximately 12%, calculated as follows: 10 ---------- 10 + 71 The Retained Interest Percentage would accordingly be increased to approximately 88%. Staples.com Stock Dividends The following illustrations reflect assumed dividends of Staples.com Stock on outstanding shares of Staples Stock and outstanding shares of Staples.com Stock, respectively, after an assumed initial issuance of 15 shares of Staples.com Stock for the account of Staples RD. Staples.com Stock Dividend on Staples Stock Assume 500 shares of Staples Stock are outstanding and Staples declares a dividend of 1/10 of a share of Staples.com Stock on each outstanding share of Staples Stock. Shares previously issued and outstanding.................................. 15 Newly issued shares for account of Staples RD............................. 50 --- Total issued and outstanding after dividend............................. 65 ===
. Any dividend of shares of Staples.com Stock to the holders of shares of Staples Stock would be treated as a reduction in the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com. Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com prior to dividend............................ 85 Number of shares distributed on outstanding shares of Staples Stock for account of Staples.com........................................... 50 --- Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com after dividend............................. 35 ===
. As a result, the total issued and outstanding shares (65) would in the aggregate represent an Outstanding Interest Percentage of 65%, calculated as follows: 65 ---------- 65 + 35 I-5 The Retained Interest Percentage would accordingly be reduced to 35%. Note, however, that after the dividend, the holders of Staples Stock would also hold 50 shares of Staples.com Stock, which would be intended to represent a 50% interest in the value attributable to Staples.com. Staples.com Stock Dividend on Staples.com Stock Assume Staples declares a dividend of 1/5 of a share of Staples.com Stock on each outstanding share of Staples.com Stock. Shares previously issued and outstanding.................................. 15 Newly issued shares for account of Staples.com............................ 3 --- Total issued and outstanding after dividend............................. 18 ===
. The Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com would be increased proportionately to reflect the stock dividend payable in shares of Staples.com Stock to holders of shares of Staples.com Stock. That is, the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com would be increased by a number equal to approximately 567% (representing the ratio of the Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com (85) to the number of shares of Staples.com Stock issued and outstanding (15), in each case immediately prior to such dividend) of the aggregate number of shares issued in connection with such dividend (3), or 17. Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com prior to dividend....................................... 85 Adjustment in respect of Staples RD's Retained Interest to reflect shares distributed on outstanding shares of Staples.com Stock.......... 17 --- Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com after dividend.......................................... 102 ===
. As a result, the total issued and outstanding shares (18) would in the aggregate continue to represent an Outstanding Interest Percentage of approximately 15%, calculated as follows: 18 ---------- 18 + 102 The Retained Interest Percentage would accordingly continue to be approximately 85%. Capital Transfers of Cash or Other Assets between Staples RD and Staples.com Capital Contribution of Cash or Other Assets from Staples RD to Staples.com The following illustration reflects the assumed contribution by Staples RD to Staples.com, after an assumed initial issuance of 15 shares of Staples.com Stock for the account of Staples RD, of $100 of assets allocated to Staples RD at a time when the Market Value of the Staples.com Stock is $20 per share. Shares previously issued and outstanding.................................. 15 Newly issued shares....................................................... 0 --- Total issued and outstanding after contribution......................... 15 ===
I-6 . The Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com would be increased to reflect the contribution to Staples.com of assets previously allocated to Staples RD by a number equal to the value of the assets contributed ($100) divided by the Market Value of Staples.com Stock at that time ($20), or 5 shares. Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com prior to contribution...................... 85 Increase to reflect contribution to Staples.com of assets allocated to Staples RD...................................................... 5 --- Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com after contribution....................... 90 ===
. As a result, the total issued and outstanding shares (15) would in the aggregate represent an Outstanding Interest Percentage of approximately 14%, calculated as follows: 15 ---------- 15 + 90 The Retained Interest Percentage would accordingly be increased to approximately 86%. Return of Capital Transfer of Cash or Other Assets from Staples.com to Staples RD The following illustration reflects the assumed transfer by Staples.com to Staples RD, after an assumed initial issuance of 15 shares of Staples.com Stock for the account of Staples RD, of $100 of assets allocated to Staples.com on a date on which the Market Value of Staples.com Stock is $20 per share. Shares previously issued and outstanding.................................. 15 Newly issued shares....................................................... 0 --- Total issued and outstanding after contribution......................... 15 ===
. The Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com would be decreased to reflect the transfer to Staples RD of assets previously allocated to Staples.com by a number equal to the value of the assets transferred ($100) divided by the Market Value of Staples.com Stock at that time ($20), or 5 shares. Number of Shares Issuable with Respect to Staples RD's Retained Interest in Staples.com prior to contribution....................... 85 Decrease to reflect contribution to Staples RD of assets allocated to Staples.com......................................................... 5 --- Number of Shares Issuable with Respect to Staples RD's Retained In- terest in Staples.com after contribution.......................... 80 ===
. As a result, the total issued and outstanding shares (15) would in the aggregate represent an Outstanding Interest Percentage of approximately 16%, calculated as follows: 15 ---------- 15 + 80 The Retained Interest Percentage would accordingly be decreased to approximately 84%. I-7 ANNEX II CERTIFICATE OF AMENDMENT TO CERTIFICATE OF INCORPORATION OF STAPLES, INC. Pursuant to Section 242 of the General Corporation Law of the State of Delaware Staples, Inc. (the "Corporation"), a corporation organized and existing under and by virtue of the General Corporation Law of the State of Delaware (the "DGCL"), does hereby certify as follows: That the Board of Directors of the Corporation duly adopted, pursuant to Section 242 of the DGCL, a resolution declaring the advisability of the amendments to the Restated Certificate of Incorporation of the Corporation, as amended to date (the "Certificate"), set forth in this Certificate of Amendment. The stockholders of the Corporation duly approved, pursuant to Section 242 of the DGCL, the amendments set forth in this Certificate of Amendment. The amendments so approved by the Board of Directors and the stockholders of the Corporation are: RESOLVED: That ARTICLE IV of the Certificate is hereby deleted in its entirety and the following ARTICLE IV is inserted in lieu thereof: ARTICLE IV Capital Stock The total number of shares of all classes of stock which the Corporation shall have authority to issue is 2,105,000,000, consisting of (i) 2,100,000,000 shares of Common Stock, $0.0006 par value per share ("Common Stock"), and (ii) 5,000,000 shares of Preferred Stock, $0.01 par value per share ("Preferred Stock"). A. Common Stock. 1. Issuance of Common Stock in Series; Designation; Reclassification. The Corporation shall have the authority to issue shares of Common Stock in two series. One series of Common Stock shall be designated as Staples Retail and Delivery Common Stock ("Staples Stock"). The second series of Common Stock shall be designated as Staples.com Common Stock ("Staples.com Stock"). When the filing of this Certificate of Amendment becomes effective, each share of Common Stock outstanding immediately prior thereto shall automatically be reclassified as one share of Staples Stock (and outstanding certificates that had theretofore represented shares of Common Stock shall thereupon represent an equal number of shares of Staples Stock despite the absence of any indication thereon to that effect). The total number of shares of Staples Stock which the Corporation shall have the authority to issue shall initially be 1,500,000,000, and the total number of shares of Staples.com Stock which the Corporation shall have the authority to issue shall initially be 600,000,000. The Board of Directors shall have the authority to increase or decrease from time to time the total number of shares of Common Stock of either series which the Corporation shall have the authority to issue, but not above the number which, when added to the total number of shares of the other series of Common Stock that the Corporation would have the authority to issue, would exceed the total number of shares of Common Stock that the Corporation has the authority to issue, and not below the number of shares of such series then outstanding. The Board of Directors shall have the authority II-1 to designate, prior to the time of the first issuance of the Staples.com Stock, the number which, immediately prior to such first issuance, will constitute the Number of Shares Issuable with Respect to Staples' Retained Interest in Staples.com and any other terms which are consistent with applicable law and the provisions of this Article Fourth. 2. Dividends. (a) Dividends. Subject to the preferences and other terms of any outstanding series of Preferred Stock, the holders of either series of Common Stock shall be entitled to receive dividends on their shares of Common Stock if, as and when declared by the Board of Directors, out of legally available funds, but (i) the amount paid as dividends on Staples Stock may not exceed the Available Dividend Amount for Staples Retail and Delivery and (ii) the amount paid as dividends on Staples.com Stock may not exceed the Available Dividend Amount for Staples.com. (b) Discrimination Between or Among Series of Common Stock. Subject to paragraph (a) of this Section 2 and subject to the preferences and other terms of any outstanding series of Preferred Stock, the Corporation shall have the authority to declare and pay dividends on both, one or neither series of Common Stock in equal or unequal amounts, notwithstanding the performance of either Business, the amount of assets available for dividends on either series of Common Stock, the amount of prior dividends paid on either series of Common Stock, the respective voting rights of each series of Common Stock or any other factor. 3. Mandatory Dividend, Redemption or Exchange on Disposition of All or Substantially All of the Assets of a Business; Exchange of One Series of Common Stock for the Other Series or for Stock of a Subsidiary at the Corporation's Option. (a) Mandatory Dividend, Redemption or Exchange. (i) In the event of a Disposition of All or Substantially All of the Assets of a Business (other than an Exempt Disposition), the Corporation shall, on or prior to the 85th Trading Day after the consummation of such Disposition, either: (x) declare and pay a dividend to holders of the series of Common Stock that relates to that Business (in cash, securities (other than Common Stock) or other property, or a combination thereof), subject to the limitations on dividends set forth under Section 2 of this Article IV(A), in an amount having a Fair Value equal to their Proportionate Interest in the Net Proceeds of such Disposition; (y) redeem from holders of the series of Common Stock that relates to that Business, for cash, securities (other than Common Stock) or other property (or a combination thereof) in an amount having a Fair Value equal to their Proportionate Interest in the Net Proceeds of such Disposition, all of the outstanding shares of the relevant series of Common Stock (or, if such Business continues after such Disposition to own any material assets other than the proceeds of such Disposition, a number of shares of such series of Common Stock (rounded, if necessary, to the nearest whole number) having an aggregate average Market Value, during the 20 consecutive Trading Day period beginning on (and including) the 16th Trading Day immediately following the date on which the Disposition is consummated, equal to such Fair Value); or (z) issue, in exchange for all of the outstanding shares of the series of Common Stock that relates to that Business, a number of shares of the series of Common Stock that does not relate to that Business (rounded, if necessary, to the nearest whole number) having an aggregate value equal to 110% of the aggregate value of all of the outstanding shares of the series of Common Stock that relates to that Business (with value in each case based on the average Market Value of a share of the relevant series of Common Stock during the 20 consecutive Trading Day period beginning on (and including) the 16th Trading Day immediately following the date on which the Disposition is consummated). (ii) At any time within one year after completing any dividend or partial redemption pursuant to (x) or (y) of the preceding sentence, the Corporation may issue, in exchange for all of the remaining II-2 outstanding shares of the series of Common Stock that relates to the Business that consummated the applicable Disposition, a number of shares of the series of Common Stock that does not relate to that Business (rounded, if necessary, to the nearest whole number) having an aggregate value equal to 110% of the aggregate value of all of the outstanding shares of the series of Common Stock that relates to that Business (with value in each case based on the average Market Value of a share of the relevant series of Common Stock during the 20 consecutive Trading Day period ending on (and including) the 5th Trading Day immediately preceding the date on which the Corporation mails the notice of exchange to holders of the relevant series). (iii) For purposes of this Section 3, if a Business consummates a Disposition in a series of related transactions, such Disposition shall not be deemed to have been completed until consummation of the last of such transactions. (b) Optional Exchange of One Series of Common Stock for the Other Series. (i) The Corporation may, at any time, issue, in exchange for all of the outstanding shares of Staples.com Stock, a number of shares of Staples Stock (rounded, if necessary, to the nearest whole number) having an aggregate value equal to the percentage of the aggregate value of all of the outstanding shares of Staples.com Stock (the "Applicable Percentage") specified for the applicable date of exchange below (with value in each case based on the average Market Value of a share of the relevant series of Common Stock during the 20 consecutive Trading Day period ending on (and including) the 5th Trading Day immediately preceding the date on which the Corporation mails the notice of exchange to holders of Staples.com Stock).
The Applicable Percentage Will be the Percentage If the Exchange Date Falls During the Period Indicated Specified for Below Such Period Below ------------------------------------------------------ ----------------- First Quarter........................................... 125% Second Quarter.......................................... 124.166667% Third Quarter........................................... 123.333333% Fourth Quarter.......................................... 122.5% Fifth Quarter........................................... 121.666667% Sixth Quarter........................................... 120.833333% Seventh Quarter......................................... 120% Eighth Quarter.......................................... 119.166667% Ninth Quarter........................................... 118.333333% Tenth Quarter........................................... 117.5% Eleventh Quarter........................................ 116.666667% Twelfth Quarter......................................... 115.833333% After Twelfth Quarter................................... 115%
For purposes of the foregoing chart, (x) the first "Quarter" is the period from and including the date of first issuance of shares of Staples.com Stock, or options therefor, to but excluding the third month anniversary of such date (provided that, if the date of first issuance is the 29th, 30th or 31st day of any month, the first "Quarter" will be the period from and including such date of first issuance to but excluding the third month anniversary of the first day of the month immediately following the month in which such date of first issuance falls) and (y) each subsequent "Quarter" is the period from and including the day after the end of the prior Quarter to but excluding the third month anniversary of such day. (ii) The Corporation may, at any time, issue, in exchange for all of the outstanding shares of Staples Stock, a number of shares of Staples.com Stock (rounded, if necessary, to the nearest whole number) having an aggregate value equal to the Applicable Percentage (specified for the applicable date of exchange in the chart above) of the aggregate value of all of the outstanding shares of Staples Stock (with II-3 value in each case based on the average Market Value of a share of the relevant series of Common Stock during the 20 consecutive Trading Day period ending on (and including) the 5th Trading Day immediately preceding the date on which the Corporation mails the notice of exchange to holders of Staples Stock). (iii) The Corporation may, if Staples.com Stock exceeds the 40% of Total Market Capitalization Threshold but is below the 60% of Total Market Capitalization Threshold, issue, in exchange for all of the outstanding shares of either series of Common Stock (the "Series of Common Stock Being Retired"), a number of shares of the other series of Common Stock (rounded, if necessary, to the nearest whole number) having an aggregate value equal to the aggregate value of all of the outstanding shares of the Series of Common Stock Being Retired (with value in each case based on the average Market Value of a share of the relevant series of Common Stock during the 20 consecutive Trading Day period ending on (and including) the 5th Trading Day immediately preceding the date on which the Corporation mails the notice of exchange to holders of the Series of Common Stock Being Retired). Staples.com Stock will exceed the "40% of Total Market Capitalization Threshold" if the Market Capitalization of the outstanding Staples.com Stock exceeds 40% of the total Market Capitalization of both series of Common Stock for 30 Trading Days during the 60 consecutive Trading Day period ending on (and including) the 5th Trading Day immediately preceding the date on which the Corporation mails the notice of exchange to holders of the Series of Common Stock Being Retired. Staples.com Stock will be below the "60% of Total Market Capitalization Threshold" if the Market Capitalization of the outstanding Staples.com Stock is below 60% of the total Market Capitalization of both series of Common Stock for 30 Trading Days during the 60 consecutive Trading Day period ending on (and including) the 5th Trading Day immediately preceding the date on which the Corporation mails the notice of exchange to holders of the Series of Common Stock Being Retired. If the Corporation has the right, on the date on which it mails a notice of exchange as contemplated above, to issue shares of Staples Stock or Staples.com Stock in exchange for outstanding shares of the other series of Common Stock as described above, the Corporation will not lose that right if Staples.com Stock subsequently falls below the 40% of Total Market Capitalization Threshold or exceeds the 60% of Total Market Capitalization Threshold. (iv) Notwithstanding the preceding paragraphs, if a Tax Event has occurred, the Corporation may issue, in exchange for all of the outstanding shares of either series of Common Stock, a number of shares of the other series of Common Stock (rounded, if necessary, to the nearest whole number) having an aggregate value equal to 110% of the aggregate value of all of the outstanding shares of the Series of Common Stock Being Retired (with value in each case with value based on the average Market Value of a share of the relevant series of Common Stock during the 20 consecutive Trading Day period ending on (and including) the 5th Trading Day immediately preceding the date on which the Corporation mails the notice of exchange to holders of the Series of Common Stock Being Retired). "Tax Event" means the receipt by the Corporation of an opinion of a tax advisor experienced in such matters, who shall not be an officer or employee of the Corporation or any of its affiliates, to the effect that, as a result of any amendment to, or change in, the laws (or any regulations thereunder) of the United States or any political subdivision or taxing authority thereof or therein (including any proposed change in such regulations announced by an administrative agency), or as a result of any official or administrative pronouncement or action or judicial decision interpreting or applying such laws or regulations, it is more likely than not that for United States federal income tax purposes (1) the Corporation, its subsidiaries or affiliates or any of its successors or its stockholders is or, at any time in the future, will be subject to tax upon the issuance of shares of either Staples Stock or Staples.com Stock or (2) either Staples Stock or Staples.com Stock is not or, at any time in the future, will not be treated solely as stock of the Corporation. For purposes of rendering such opinion, a tax advisor shall assume that any administrative proposals will be adopted as proposed. However, in the event a change in law is proposed, a tax advisor shall render an opinion only in the event of enactment. II-4 (c) Optional Exchange for Stock of a Subsidiary. (i) At any time at which all of the assets and liabilities of a Business (and no other assets or liabilities of the Corporation or any subsidiary thereof) are held directly or indirectly by one or more wholly owned subsidiaries of the Corporation (the "Business Subsidiaries"), the Corporation may deliver to holders of the relevant series of Common Stock (including Staples in the case of Staples.com Stock) their Proportionate Interest in all of the outstanding shares of the common stock of the Business Subsidiaries in exchange for all of the outstanding shares of such series of Common Stock. (ii) If the series of Common Stock being exchanged pursuant to Section 3(c)(i) above is Staples Stock and the Number of Shares Issuable with Respect to Staples Retail and Delivery's Retained Interest in Staples.com is greater than zero, the Corporation shall also issue a number of shares of Staples.com Stock equal to the then current Number of Shares Issuable with Respect to Staples Retail and Delivery's Retained Interest in Staples.com and deliver those shares to the holders of Staples Stock or to one of the Business Subsidiaries, at the option of the Corporation. (iii) If the series of Common Stock being exchanged pursuant to Section 3(c)(i) above is Staples.com Stock and the Number of Shares Issuable with Respect to Staples Retail and Delivery's Retained Interest in Staples.com is greater than zero (so that less than all of the shares of common stock of the Business Subsidiaries are being delivered to the holders of Staples.com Stock), the Corporation may retain the remaining shares of common stock of the Business Subsidiaries or distribute those shares as a dividend on Staples Stock. (d) General Dividend, Exchange and Redemption Provisions. (i) If the Corporation completes a Disposition of All or Substantially All of the Assets of a Business (other than an Exempt Disposition), the Corporation shall, not more than the 10 Trading Days after the consummation of such Disposition, issue a press release specifying (w) the Net Proceeds of such Disposition, (x) the number of shares of the series of Common Stock related to such Business then outstanding, (y) the number of shares of such series of Common Stock issuable upon conversion, exchange or exercise of any convertible or exchangeable securities, options or warrants and the conversion, exchange or exercise prices thereof and (z) if the Business is Staples.com, the Number of Shares Issuable with Respect to Staples Retail and Delivery's Retained Interest in Staples.com. The Corporation shall, not more than 40 Trading Days after such consummation, announce by press release which of the actions specified in Section 3(a)(i) of this Article IV(A) it has determined to take, and upon making that announcement, that determination will be irrevocable. In addition, the Corporation shall, not more than 40 Trading Days after such consummation and not less than 10 Trading Days before the applicable payment date, redemption date or exchange date, send a notice by first-class mail, postage prepaid, to holders of the relevant series of Common Stock at their addresses as they appear on the transfer books of the Corporation, specifying: (1) if the Corporation has determined to pay a special dividend, (A) the record date for such dividend, (B) the payment date of such dividend (which cannot be more than 85 Trading Days after such consummation) and (C) the aggregate amount and type of property to be paid in such dividend (and the approximate per share amount thereof); (2) if the Corporation has determined to undertake a redemption, (A) the date of redemption (which cannot be more than 85 Trading Days after such consummation), (B) the aggregate amount and type of property to be paid as a redemption price (and the approximate per share amount thereof), (C) if less than all shares of the relevant series of Common Stock are to be redeemed, the number of shares to be redeemed and (D) the place or places where certificates for shares of such series of Common Stock, properly endorsed or assigned for transfer (unless the Corporation waives such requirement), should be surrendered in return for delivery of the cash, securities or other property to be paid by the Corporation in such redemption; and (3) if the Corporation has determined to undertake an exchange, (A) the date of exchange (which cannot be more than 85 Trading Days after such consummation), (B) the number of shares of II-5 the other series of Common Stock to be issued in exchange for each outstanding share of such series of Common Stock and (C) the place or places where certificates for shares of such series of Common Stock, properly endorsed or assigned for transfer (unless the Corporation waives such requirement), should be surrendered in return for delivery of the other series of Common Stock to be issued by the Corporation in such exchange. (ii) If the Corporation has determined to complete any exchange described in Section 3(b) or (c) of this Article IV(A), the Corporation shall, not less than 10 Trading Days and not more than 30 Trading Days before the exchange date, send a notice by first-class mail, postage prepaid, to holders of the relevant series of Common Stock at their addresses as they appear on the transfer books of the Corporation, specifying (x) the exchange date and the other terms of the exchange and (y) the place or places where certificates for shares of such series of Common Stock, properly endorsed or assigned for transfer (unless the Corporation waives such requirement), should be surrendered for delivery of the stock to be issued or delivered by the Corporation in such exchange. (iii) Neither the failure to mail any notice required by this Section 3(d) to any particular holder nor any defect therein would affect the sufficiency thereof with respect to any other holder or the validity of any dividend, redemption or exchange contemplated hereby. (iv) If the Corporation is redeeming less than all of the outstanding shares of a series of Common Stock pursuant to Section 3(a)(i) of this Article IV(A), the Corporation shall redeem such shares pro rata or by lot or by such other method as the Board of Directors determines to be equitable. (v) No holder of shares of a series of Common Stock being exchanged or redeemed shall be entitled to receive any cash, securities or other property to be distributed in such exchange or redemption until such holder surrenders certificates for such shares, properly endorsed or assigned for transfer, at such place as the Corporation shall specify (unless the Corporation waives such requirement). As soon as practicable after the Corporation's receipt of certificates for such shares, the Corporation shall deliver to the person for whose account such shares were so surrendered, or to the nominee or nominees of such person, the cash, securities or other property to which such person shall be entitled, together with any fractional payment referred to below, in each case without interest. If less than all of the shares of Common Stock represented by any one certificate is exchanged or redeemed, the Corporation shall also issue and deliver a new certificate for the shares of such Common Stock not exchanged or redeemed. (vi) The Corporation shall not be required to issue or deliver fractional shares of any capital stock or any other fractional securities to any holder of Common Stock upon any exchange, redemption, dividend or other distribution described above. If more than one share of Common Stock shall be held at the same time by the same holder, the Corporation may aggregate the number of shares of any capital stock that would be issuable or any other securities that would be distributable to such holder upon any such exchange, redemption, dividend or other distribution. If there are fractional shares of any capital stock or any other fractional securities remaining to be issued or distributed to any holder, the Corporation shall, if such fractional shares or securities are not issued or distributed to such holder, pay cash in respect of such fractional shares or securities in an amount equal to the Fair Value thereof (without interest). (vii) From and after the date set for any exchange or redemption contemplated by this Section 3, all rights of a holder of shares of Common Stock being exchanged or redeemed shall cease except for the right, upon surrender of the certificates theretofore representing such shares, to receive the cash, securities or other property for which such shares were exchanged or redeemed, together with any fractional payment as provided above, in each case without interest (and, if such holder was a holder of record as of the close of business on the record date for a dividend not yet paid, the right to receive such dividend). A holder of shares of Common Stock being exchanged shall not be entitled to receive any dividend or other distribution with respect to shares of the other series of Common Stock until after certificates theretofore representing the shares being exchanged are surrendered as contemplated above. Upon such surrender, the Corporation shall pay to the holder the amount of any dividends or other distributions (without interest) which theretofore became payable with respect to a record date occurring after the exchange, but which II-6 were not paid by reason of the foregoing, with respect to the number of whole shares of the other series of Common Stock represented by the certificate or certificates issued upon such surrender. From and after the date set for any exchange, the Corporation shall, however, be entitled to treat the certificates for shares of a series of Common Stock being exchanged that were not yet surrendered for exchange as evidencing the ownership of the number of whole shares of the other series of Common Stock for which the shares of such Common Stock should have been exchanged, notwithstanding the failure to surrender such certificates. (viii) The Corporation shall pay any and all documentary, stamp or similar issue or transfer taxes that might be payable in respect of the issue or delivery of any shares of capital stock and/or other securities on any exchange or redemption contemplated by this Section 3; provided, however, that the Corporation shall not be required to pay any tax that might be payable in respect of any transfer involved in the issue or delivery of any shares of capital stock and/or other securities in a name other than that in which the shares so exchanged or redeemed were registered, and no such issue or delivery will be made unless and until the person requesting such issue pays to the Corporation the amount of any such tax, or establishes to the satisfaction of the Corporation that such tax has been paid. (ix) The Corporation may, subject to applicable law, establish such other rules, requirements and procedures to facilitate any dividend, redemption or exchange contemplated by this Section 3 as the Board of Directors may determine to be appropriate under the circumstances. 4. Voting Rights. At every meeting of stockholders, the holders of Staples Stock and the holders of Staples.com Stock shall vote together as a single class on all matters as to which common stockholders generally are entitled to vote, unless a separate vote is required by applicable law. On all such matters for which no separate vote is required, (a) holders of Staples Stock shall be entitled to one vote per share of Staples Stock held and (b) holders of Staples.com Stock shall be entitled to a one vote per share of Staples.com Stock held. 5. Liquidation Rights. In the event of any voluntary or involuntary liquidation, dissolution or winding-up of the Corporation, holders of Staples Stock and holders of Staples.com Stock shall be entitled to receive in respect of shares of Staples Stock and shares of Staples.com Stock their proportionate interests in the net assets of the Corporation, if any, remaining for distribution to stockholders (after payment of or provision for all liabilities, including contingent liabilities, of the Corporation and payment of the liquidation preference payable to any holders of Preferred Stock), in proportion to the respective number of liquidation units per share of Staples Stock and Staples.com Stock. Each share of Staples.com Stock shall have one liquidation unit and each share of Staples Stock shall have a number of liquidation units (including a fraction of one liquidation unit) equal to the quotient (rounded to the nearest five decimal places) of the average Market Value of one share of Staples Stock during the 20 consecutive Trading Day period ending 300 days after the Effective Date, divided by the average Market Value of one share of Staples.com Stock during such 20 Trading Day period. If the liquidation, dissolution or winding up of the Corporation occurs prior to such 300th day, the average Market Value will be determined based on the 20 consecutive Trading Day period ending immediately prior to the liquidation, dissolution or winding up event. If the Corporation shall in any manner subdivide (by stock split, reclassification or otherwise) or combine (by reverse stock split, reclassification or otherwise) the outstanding shares of Staples Stock or Staples.com Stock, or declare a dividend in shares of either series to holders of such series, the per share liquidation units of such series of Common Stock specified in the preceding paragraph, as adjusted from time to time, shall be appropriately adjusted as determined by the Board of Directors, so as to avoid dilution in the aggregate, relative liquidation rights of the shares of any series of Common Stock. II-7 Neither the merger nor consolidation of the Corporation into or with any other entity, nor a sale, transfer or lease of all or any part of the assets of the Corporation, shall, alone, be deemed a liquidation or winding up of the Corporation or cause the dissolution of the Corporation, for purposes of this Section 5. 6. Adjustments to Number of Shares Issuable with Respect to Staples Retail and Delivery's Retained Interest in Staples.com. The Number of Shares Issuable with Respect to Staples Retail and Delivery's Retained Interest in Staples.com, as in effect from time to time, shall, automatically without action by the Board of Directors or any other person, be: (a) adjusted in proportion to any changes in the number of outstanding shares of Staples.com Stock caused by subdivisions (by stock split, reclassification or otherwise) or combinations (by reverse stock split, reclassification or otherwise) of shares of Staples.com Stock or by dividends or other distributions of shares of Staples.com Stock on shares of Staples.com Stock (and, in each such case, rounded, if necessary, to the nearest whole number); (b) decreased by (i) if the Corporation issues any shares of Staples.com Stock and the board of Directors attributes that issuance (and the proceeds thereof) to Staples Retail and Delivery, the number of shares of Staples.com Stock so issued, and (ii) if the Board of Directors re- allocates to Staples Retail and Delivery any cash or other assets theretofore allocated to Staples.com in connection with a redemption of shares of Staples.com Stock (as required pursuant to clause (ii) of the proviso to the definition of Staples Retail and Delivery below) or in return for a decrease in the Number of Shares Issuable with Respect to Staples Retail and Delivery's Retained Interest in Staples.com, the number (rounded, if necessary, to the nearest whole number) equal to (x) the aggregate Fair Value of such cash or other assets divided by (y) the Market Value of one share of Staples.com Stock as of the date of such re- allocation; and (c) increased by (i) if the Corporation repurchases any shares of Staples.com Stock and the Board of Directors attributes that repurchase (and the consideration therefor) to Staples Retail and Delivery, the number of shares of Staples.com Stock so repurchased and (ii) if the Board of Directors re-allocates to Staples.com any cash or other assets theretofore allocated to Staples Retail and Delivery in return for an increase in the Number of Shares Issuable with Respect to Staples Retail and Delivery's Retained Interest in Staples.com, the number (rounded, if necessary, to the nearest whole number) equal to (x) the Fair Value of such cash or other assets divided by (y) the Market Value of one share of Staples.com Stock as of the date of such re-allocation. Neither the Corporation nor the Board of Directors shall take any action that would, as a result of any of the foregoing adjustments, reduce the Number of Shares Issuable with Respect to Staples Retail and Delivery's Retained Interest in Staples.com to below zero. Subject to the preceding sentence, the Board of Directors may attribute the issuance of any shares of Staples.com Stock (and the proceeds here from) or the repurchase of Staples.com Stock (and the consideration therefor) to Staples Retail and Delivery or to Staples.com, as the Board of Directors determines in its sole discretion; provided, however, that the Board of Directors must attribute to Staples Retail and Delivery the issuance of any shares of Staples.com Stock that are issued (1) as a dividend or other distribution on, or as consideration for the repurchase of, shares of Staples Stock or (2) as consideration to acquire any assets or satisfy any liabilities attributed to Staples Retail and Delivery. 7. Additional Definitions. As used in this Article IV, the following terms shall have the following meanings (with terms defined in singular having comparable meaning when used in the plural and vice versa), unless the context otherwise requires: "All or Substantially All of the Assets" of either Business means a portion of such assets that represents at least 80% of the then-current Fair Value of the assets of such Business. II-8 "Available Dividend Amount" for Staples Retail and Delivery, on any day on which dividends are paid on shares of Staples Stock, is the amount that would, immediately prior to the payment of such dividends, be legally available for the payment of dividends on shares of Staples Stock under Delaware law if (a) Staples Retail and Delivery and Staples.com were each a separate Delaware corporation, (b) Staples Retail and Delivery had outstanding (i) a number of shares of common stock, par value $0.0006 per share, equal to the number of shares of Staples Stock that are then outstanding and (ii) a number of shares of preferred stock, par value $0.01 per share, equal to the number of shares of Preferred Stock that have been attributed to Staples Retail and Delivery and are then outstanding, (c) the assumptions about Staples.com set forth in the next sentence were true and (d) Staples Retail and Delivery owned a number of shares of Staples.com common stock equal to the Number of Shares Issuable with Respect to Staples Retail and Delivery's Retained Interest in Staples.com. "Available Dividend Amount" for Staples.com, on any day on which dividends are paid on shares of Staples.com Stock, is the amount that would, immediately prior to the payment of such dividends, be legally available for the payment of dividends on shares of Staples.com's common stock under Delaware law if Staples.com were a separate Delaware corporation having outstanding (a) a number of shares of common stock, par value $0.0006 per share, equal to the number of shares of Staples.com Stock that are then outstanding plus the Number of Shares Issuable with Respect to Staples Retail and Delivery's Retained Interest in Staples.com and (b) a number of shares of preferred stock, par value $0.01 per share, equal to the number of shares of Preferred Stock that have been attributed to Staples.com and are then outstanding. "Business" means either Staples Retail and Delivery or Staples.com. "Disposition" means a sale, transfer, assignment or other disposition (whether by merger, consolidation, sale or otherwise) of All or Substantially All of the Assets of a Business to one or more persons or entities, in one transaction or a series of related transactions. "Effective Date" means the date on which this Certificate of Amendment becomes effective under Delaware law. "Exempt Disposition" means any of the following: (a) a Disposition in connection with the liquidation, dissolution or winding-up of the Corporation and the distribution of assets to stockholders, (b) a Disposition to any person or entity controlled by the Corporation (as determined by the Board of Directors in its sole discretion), (c) a Disposition by either Business for which the Corporation receives consideration primarily consisting of equity securities (including, without limitation, capital stock of any kind, interests in a general or limited partnership, interests in a limited liability company or debt securities convertible into or exchangeable for, or options or warrants to acquire, any of the foregoing, in each case without regard to the voting power or other management or governance rights associated therewith) of an entity which is primarily engaged or proposes to engage primarily in one or more businesses similar or complementary to businesses conducted by such Business prior to the Disposition, as determined by the Board of Directors in its sole discretion, (d) a dividend, out of Staples.com's assets, to holders of Staples.com Stock and a re-allocation of a corresponding amount of Staples.com's assets to Staples Retail and Delivery as required pursuant to clause (ii) of the proviso to the definition of Staples Retail and Delivery below, (e) a dividend, out of Staples Retail and Delivery's assets, to holders of Staples Stock and (f) any other Disposition, if (i) at the time of the Disposition there are no shares of Staples Stock outstanding, (ii) at the time of the Disposition there are no shares of Staples.com Stock outstanding or (iii) before the 30th Trading Day following the Disposition the Corporation has mailed a notice stating that it is exercising its right to exchange all of the outstanding shares of Staples Stock or Staples.com Stock for newly issued shares of the other series of Common Stock as contemplated under Section 3(b) of this Article IV. II-9 "Fair Value" means (a) in the case of cash, the amount thereof, (b) in the case of capital stock that has been Publicly Traded for a period of at least 15 months, the Market Value thereof and (c) in the case of other assets or securities, the fair market value thereof as the Board of Directors shall determine in good faith (which determination shall be conclusive and binding on all stockholders). "Market Capitalization" of either series of Common Stock on any date means the Market Value of a share of such series on such date multiplied by the number of shares of such series outstanding on such date. "Market Value" of a share of any class or series of capital stock on any Trading Day means the average of the high and low reported sales prices regular way of a share of such class or series on such Trading Day or, in case no such reported sale takes place on such Trading Day, the average of the reported closing bid and asked prices regular way of a share of such class or series on such Trading Day, in either case as reported on the New York Stock Exchange ("NYSE") Composite Tape or, if the shares of such class or series are not listed or admitted to trading on the NYSE on such Trading Day, on the principal national securities exchange on which the shares of such class or series are listed or admitted to trading or, if not listed or admitted to trading on any national securities exchange on such Trading Day, on The Nasdaq National Market of the Nasdaq Stock Market ("Nasdaq NMS") or, if the shares of such class or series are not listed or admitted to trading on any national securities exchange or quoted on the Nasdaq NMS on such Trading Day, the average of the closing bid and asked prices of a share of such class or series in the over- the-counter market on such Trading Day as furnished by any NYSE member firm selected from time to time by the Corporation, or, if such closing bid and asked prices are not made available by any such NYSE member firm on such Trading Day, or if such class or series of stock is not listed on the NYSE, a national securities exchange, or the Nasdaq NMS or quoted in the over-the- counter market, the fair market value of a share of such class or series as the Board of Directors shall determine in good faith (which determination shall be conclusive and binding on all stockholders); provided, that, for purposes of determining the average Market Value of a share of any class or series of capital stock for any period, (a) the "Market Value" of a share of any class or series of capital stock on any day prior to any "ex-dividend" date or any similar date occurring during such period for any dividend or distribution (other than any dividend or distribution contemplated by clause (b)(ii) of this sentence) paid or to be paid with respect to such capital stock shall be reduced by the Fair Value of the per share amount of such dividend or distribution and (b) the "Market Value" of a share of any class or series of capital stock on any day prior to (i) the effective date of any subdivision (by stock split or otherwise) or combination (by reverse stock split or otherwise) of outstanding shares of such class or series of capital stock occurring during such period or (ii) any "ex-dividend" date or any similar date occurring during such period for any dividend or distribution with respect to such capital stock to be made in shares of such class or series of capital stock, shall be appropriately adjusted, as determined by the Board of Directors, to reflect such subdivision, combination, dividend or distribution; and provided further, if (a) the Corporation repurchases outstanding shares of Staples.com Stock and the Board of Directors attributes that repurchase (and the consideration therefor) to Staples.com and (b) the Board of Directors determines to re- allocate to Staples Retail and Delivery cash or other assets theretofore allocated to Staples.com in order to avoid a change in the Retained Interest Percentage, the "Market Value" of a share Staples.com Stock used to compute the corresponding reduction in the Number of Shares Issuable with Respect to Staples Retail and Delivery's Retained Interest in Staples.com shall equal the Fair Value of the consideration paid per share of Staples.com Stock so repurchased; and provided further, if the Corporation redeems a portion of the outstanding shares of Staples.com Stock (and the Board of Directors re- allocates to Staples Retail and Delivery cash or other assets theretofore allocated to Staples.com in the manner required by clause (ii) of the proviso to the definition of Staples Retail and Delivery below), the "Market Value" of a share Staples.com Stock used to compute the corresponding reduction in the Number of Shares Issuable with Respect to Staples Retail and Delivery's Retained Interest in Staples.com shall equal the Fair Value of the consideration paid per share of Staples.com Stock so redeemed. "Net Proceeds" of a Disposition of any of the assets of a Business means the positive amount, if any, remaining from the gross proceeds of such Disposition after any payment of, or reasonable provision (as determined in good faith by the Board of Directors, which determination shall be conclusive and binding on all stockholders) for, (a) any taxes payable by the Corporation in respect of such Disposition, (b) any taxes payable II-10 by the Corporation in respect of any resulting dividend or redemption, (c) any transaction costs, including, without limitation, any legal, investment banking and accounting fees and expenses and (d) any liabilities (contingent or otherwise) of, attributed to or related to, such Business, including, without limitation, any liabilities for deferred taxes, any indemnity or guarantee obligations which are outstanding or incurred in connection with the Disposition or otherwise, any liabilities for future purchase price adjustments and any obligations with respect to outstanding securities (other than Staples.com Stock) attributed to such Business. "Number of Shares Issuable with Respect to Staples Retail and Delivery's Retained Interest in Staples.com" shall initially be a number the Board of Directors designates prior to the time the Corporation first issues shares of Staples.com Stock, or options therefor, as the number of shares of Staples.com Stock that could be issued by the Corporation for the account of Staples Retail and Delivery in respect of its Retained Interest in Staples.com; provided, however, that such number as in effect from time to time shall automatically be adjusted as required by Section 6 of this Article IV(A). "Proportionate Interest" of holders of Staples.com Stock in the Net Proceeds of a Staples.com Disposition (or in the outstanding shares of common stock of any subsidiaries holding Staples.com's assets and liabilities) means the amount of such Net Proceeds (or the number of such shares) multiplied by the number of shares of Staples.com Stock outstanding divided by the Total Number of Notional Staples.com Shares Deemed Outstanding. "Proportionate Interest" of holders of Staples Stock in the Net Proceeds of a Staples Retail and Delivery Disposition (or in the outstanding shares of common stock of any subsidiaries holding Staples Retail and Delivery's assets and liabilities) means the amount of such Net Proceeds (or the number of such shares). "Publicly Traded" with respect to any security means (a) registered under Section 12 of the Securities Exchange Act of 1934, as amended (or any successor provision of law), and (b) listed for trading on the NYSE (or any other national securities exchange registered under Section 7 of the Securities Exchange Act of 1934, as amended (or any successor provision of law)) or listed on the Nasdaq NMS (or any successor market system). "Retained Interest" means Staples Retail and Delivery's interest in Staples.com, excluding the interest represented by outstanding shares of Staples.com Stock. "Retained Interest Percentage" means the Number of Shares Issuable with Respect to Staples Retail and Delivery's Retained Interest in Staples.com divided by the Total Number of Notional Staples.com Shares Deemed Outstanding. "Staples Retail and Delivery" means (a) all of the businesses, assets and liabilities of the Corporation and its subsidiaries, other than the businesses, assets and liabilities that are part of Staples.com, (b) the rights and obligations of Staples Retail and Delivery under any inter-Business debt deemed to be owed to or by Staples Retail and Delivery (as such rights and obligations are defined in accordance with policies established from time to time by the Board of Directors) and (c) a proportionate interest in Staples.com (after giving effect to any options, Preferred Stock, other securities or debt issued or incurred by the Corporation and attributed to Staples.com) equal to the Retained Interest Percentage; provided, however, that: (i) the Corporation may re-allocate assets from one Business to the other Business in return for other assets or services rendered by that other Business in the ordinary course of business or in accordance with policies established by the Board of Directors from time to time, and (ii) if the Corporation transfers cash, other assets or securities to holders of shares of Staples.com Stock as a dividend or other distribution on shares of Staples.com Stock (other than a dividend or distribution payable in shares of Staples.com Stock), or as payment in a redemption of shares of Staples.com Stock required by Section 3(a) of this Article IV(A), then the Board of Directors shall re-allocate from Staples.com to Staples Retail and Delivery cash or other assets having a Fair Value equal to the aggregate Fair Value of the cash, other assets or securities so transferred multiplied by a fraction, the numerator of which shall equal the Number of Shares Issuable with Respect to Staples Retail and Delivery's Retained Interest in Staples.com on the record date for such dividend or distribution, or on the date of such redemption, and the denominator of which shall equal the number of shares of Staples.com Stock outstanding on such date. II-11 "Staples.com" means (a) the e-commerce business division of the Corporation, including all of the businesses, assets and liabilities of the Corporation and its subsidiaries that the Board of Directors has, as of the Effective Date, allocated to Staples.com, (b) any assets or liabilities acquired or incurred by the Corporation or any of its subsidiaries after the Effective Date in the ordinary course of business and attributable to Staples.com, (c) any businesses, assets or liabilities acquired or incurred by the Corporation or any of its subsidiaries after the Effective Date that the Board of Directors has specifically allocated to Staples.com or that the Corporation otherwise allocates to Staples.com in accordance with policies established from time to time by the Board of Directors and (d) the rights and obligations of Staples.com under any inter-Business debt deemed to be owed to or by Staples.com (as such rights and obligations are defined in accordance with policies established from time to time by the Board of Directors); provided, however, that: (i) the Corporation may re-allocate assets from one Business to the other Business in return for other assets or services rendered by that other Business in the ordinary course of business or in accordance with policies established by the Board of Directors from time to time, and (ii) if the Corporation transfers cash, other assets or securities to holders of shares of Staples.com Stock as a dividend or other distribution on shares of Staples.com Stock (other than a dividend or distribution payable in shares of Staples.com Stock), or as payment in a redemption of shares of Staples.com Stock required by Section 3(a) of this Article IV(A), then the Board of Directors shall re-allocate from Staples.com to Staples Retail and Delivery cash or other assets having a Fair Value equal to the aggregate Fair Value of the cash, other assets or securities so transferred multiplied by a fraction, the numerator of which shall equal the Number of Shares Issuable with Respect to Staples Retail and Delivery's Retained Interest in Staples.com on the record date for such dividend or distribution, or on the date of such redemption, and the denominator of which shall equal the number of shares of Staples.com Stock outstanding on such date. "Total Number of Notional Staples.com Shares Deemed Outstanding" means the number of shares of Staples.com Stock outstanding plus the Number of Shares Issuable with Respect to Staples Retail and Delivery's Retained Interest in Staples.com. "Trading Day" means each weekday on which the relevant security (or, if there are two relevant securities, each relevant security) is traded on the principal national securities exchange on which it is listed or admitted to trading or on the Nasdaq NMS or, if such security is not listed or admitted to trading on a national securities exchange or quoted on the Nasdaq NMS, traded in the principal over-the-counter market in which it trades. 8. Effectiveness of Sections 2 Through 7 of This Article IV(A). The terms of Sections 2 through 7, inclusive, of this Article IV(A) shall apply only when there are shares of both series of Common Stock outstanding. 9. Determinations by the Board of Directors. Subject to applicable law, any determinations made by the Board of Directors in good faith under the Certificate of Incorporation, as it may be amended from time to time, including without limitation any such determinations with respect to the businesses, assets and liabilities of either Business, transactions between the Businesses or the rights of holders of any series of Common Stock or Preferred Stock made pursuant to or in the furtherance hereof, shall be final and binding on all stockholders of the Corporation. A record of all formal determinations of the Board of Directors made as contemplated hereby shall be filed with the records of the actions of the Board of Directors. II-12 B. Preferred Stock. 1. Designation. The Preferred Stock shall be designated and known as "Preferred Stock." The number of shares constituting such Preferred Stock shall be 5,000,000. 2. Rights and Preferences. Preferred Stock may be issued from time to time in one or more series, each of such series to have such terms as stated or expressed herein and in the resolution or resolutions providing for the issue of such series adopted by the Board of Directors of the Corporation as hereinafter provided. Any shares of Preferred Stock which may be redeemed, purchased or acquired by the Corporation may be reissued except as otherwise provided by law. Different series of Preferred Stock shall not be construed to constitute different classes of shares for the purposes of voting by classes unless expressly provided. Authority is hereby expressly granted to the Board of Directors from time to time to issue the Preferred Stock in one or more series, and in connection with the creation of any such series, by resolution or resolutions providing for the issue of the shares thereof, to determine and fix such voting powers, full or limited, or no voting powers, and such designations, preferences and relative participating, optional or other special rights, and qualifications, limitations or restrictions thereof, including without limitation thereof, dividend rights, conversion rights, redemption privileges and liquidation preferences, as shall be stated and expressed in such resolutions, all to the full extent now or hereafter permitted by the General Corporation Law of Delaware. Without limiting the generality of the foregoing, the resolutions providing for issuance of any series of Preferred Stock may provide that such series shall be superior or rank equally or be junior to the Preferred Stock of any other series to the extent permitted by law. Except as otherwise provided in the Certificate of Incorporation, no vote of the holders of the Preferred Stock or Common Stock shall be a prerequisite to the designation or issuance of any shares of any series of the Preferred Stock authorized by and complying with the conditions of the Certificate of Incorporation, the right to have such vote being expressly waived by all present and future holders of the capital stock of the Corporation. C. Series A Junior Participating Preferred Stock 1. Designation and Amount. One million of the authorized and unissued shares of Preferred Stock are designated as "Series A Junior Participating Preferred Stock" (the "Series A Preferred Stock"). Such number of shares may be increased or decreased by resolution of the Board of Directors; provided, that no decrease shall reduce the number of shares of Series A Preferred Stock to a number less than the number of shares then outstanding plus the number of shares reserved for issuance upon the exercise of outstanding options, rights or warrants or upon the conversion of any outstanding securities issued by the Corporation convertible into Series A Preferred Stock. 2. Dividends and Distributions. (A) Subject to the rights of the holders of any shares of any series of Preferred Stock (or any similar stock) ranking prior and superior to the Series A Preferred Stock with respect to dividends, the holders of shares of Series A Preferred Stock, in preference to the holders of Common Stock, par value $0.0006 per share, of the Corporation, and of any other junior stock, shall be entitled to receive, when, as and if declared by the Board of Directors out of funds of the Corporation legally available for the payment of dividends, quarterly dividends payable in cash on March 31, June 30, September 30 and December 31 in each year (each such date being referred to herein as a "Quarterly Dividend Payment Date"), commencing on the first Quarterly Dividend Payment Date after the first issuance of a share or fraction of a share of Series A Preferred Stock, in an amount per share (rounded to the nearest cent) equal to the greater of (a) $1 or (b) subject to the provision for adjustment hereinafter set forth, 100 times the aggregate per share amount of all cash dividends, and 100 times the aggregate per share amount (payable in kind) of all non-cash dividends or other distributions, other than a dividend payable in shares of Common Stock or a subdivision of the outstanding shares of Common Stock (by reclassification or otherwise), declared on the Common Stock since the immediately preceding Quarterly Dividend Payment Date or, with respect to the II-13 first Quarterly Dividend Payment Date, since the first issuance of any share or fraction of a share of Series A Preferred Stock. In the event the Corporation shall at any time declare or pay any dividend on the Common Stock payable in shares of Common Stock, or effect a subdivision, combination or consolidation of the outstanding shares of Common Stock (by reclassification or otherwise than by payment of a dividend in shares of Common Stock) into a greater or lesser number of shares of Common Stock, then in each such case the amount to which holders of shares of Series A Preferred Stock were entitled immediately prior to such event under clause (b) of the preceding sentence shall be adjusted by multiplying such amount by a fraction, the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event. (B) The Corporation shall declare a dividend or distribution on the Series A Preferred Stock as provided in paragraph (A) of this Section immediately after it declares a dividend or distribution on the Common Stock (other than a dividend payable in shares of Common Stock) and the Corporation shall pay such dividend or distribution on the Series A Preferred Stock before the dividend or distribution declared on the Common Stock is paid or set apart; provided that, in the event no dividend or distribution shall have been declared on the Common Stock during the period between any Quarterly Dividend Payment Date and the next subsequent Quarterly Dividend Payment Date, a dividend of $1 per share on the Series A Preferred Stock shall nevertheless be payable on such subsequent Quarterly Dividend Payment Date. (C) Dividends shall begin to accrue and be cumulative on outstanding shares of Series A Preferred Stock from the Quarterly Dividend Payment Date next preceding the date of issue of such shares, unless the date of issue of such shares is prior to the record date for the first Quarterly Dividend Payment Date, in which case dividends on such shares shall begin to accrue from the date of issue of such shares, or unless the date of issue is a Quarterly Dividend Payment Date or is a date after the record date for the determination of holders of shares of Series A Preferred Stock entitled to receive a quarterly dividend and before such Quarterly Dividend Payment Date, in either of which events such dividends shall begin to accrue and be cumulative from such Quarterly Dividend Payment Date. Accrued but unpaid dividends shall not bear interest. Dividends paid on the shares of Series A Preferred Stock in an amount less than the total amount of such dividends at the time accrued and payable on such shares shall be allocated pro rata on a share-by-share basis among all such shares at the time outstanding. The Board of Directors may fix a record date for the determination of holders of shares of Series A Preferred Stock entitled to receive payment of a dividend or distribution declared thereon, which record date shall be not more than 60 days prior to the date fixed for the payment thereof. 3. Voting Rights. The holders of shares of Series A Preferred Stock shall have the following voting rights: (A) Subject to the provisions for adjustment hereinafter set forth, each share of Series A Preferred Stock shall entitle the holder thereof to 100 votes on all matters submitted to a vote of the stockholders of the Corporation. In the event the Corporation shall at any time declare or pay any dividend on the Common Stock payable in shares of Common Stock, or effect a subdivision, combination or consolidation of the outstanding shares of Common Stock (by reclassification or otherwise than by payment of a dividend in shares of Common Stock) into a greater or lesser number of shares of Common Stock, then in each such case the number of votes per share to which holders of shares of Series A Preferred Stock were entitled immediately prior to such event shall be adjusted by multiplying such number by a fraction, the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event. (B) Except as otherwise provided herein, by law, or in any other Certificate of Designations creating a series of Preferred Stock or any similar stock, the holders of shares of Series A Preferred Stock and the holders of shares of Common Stock and any other capital stock of the Corporation having general voting rights shall vote together as one class on all matters submitted to a vote of stockholders of the Corporation. II-14 (C) (i) If any time dividends on any Series A Preferred Stock shall be in arrears in an amount equal to six quarterly dividends thereon, the holders of the Series A Preferred Stock, voting as a separate series from all other series of Preferred Stock and classes of capital stock, shall be entitled to elect two members of the Board of Directors in addition to any Directors elected by any other series, class or classes of securities and the authorized number of Directors will automatically be increased by two. Promptly thereafter, the Board of Directors of this Corporation shall, as soon as may be practicable, call a special meeting of holders of Series A Preferred Stock for the purpose of electing such members of the Board of Directors. Said special meeting shall in any event be held within 45 days of the occurrence of such arrearage. (ii) During any period when the holders of Series A Preferred Stock, voting as a separate series, shall be entitled and shall have exercised their right to elect two Directors, then and during such time as such right continues (a) the then authorized number of Directors shall be increased by two, and the holders of Series A Preferred Stock, voting as a separate series, shall be entitled to elect the additional Director so provided for, and (b) each such additional Director shall not be a member of any existing class of the Board of Directors, but shall serve until the next annual meeting of stockholders for the election of Directors, or until his successor shall be elected and shall qualify, or until his right to hold such office terminates pursuant to the provisions of this Section 3(C). (iii) A Director elected pursuant to the terms hereof may be removed with or without cause by the holders of Series A Preferred Stock entitled to vote in an election of such Director. (iv) If, during any interval between annual meetings of stockholders for the election of Directors and while the holders of Series A Preferred Stock shall be entitled to elect two Directors, there is no such Director in office by reason of resignation, death or removal, then, promptly thereafter, the Board of Directors shall cause a special meeting of the holders of Series A Preferred Stock for the purpose of filling such vacancy and such vacancy shall be filled at such special meeting. Such special meeting shall in any event be held within 45 days of the occurrence of such vacancy. (v) At such time as the arrearage is fully cured, and all dividends accumulated and unpaid on any shares of Series A Preferred Stock outstanding are paid, and, in addition thereto, at least one regular dividend has been paid subsequent to curing such arrearage, the term of this office of any Director elected pursuant to this Section 3(C), or his successor, shall automatically terminate, and the authorized number of Directors shall automatically decrease by two, the rights of the holders of the shares of the Series A Preferred Stock to vote as provided in this Section 3(C) shall cease, subject to renewal from time to time upon the same terms and conditions, and the holders of shares of the Series A Preferred Stock shall have only the limited voting rights elsewhere herein set forth. (D) Except as set forth herein, or as otherwise provided by law, holders of Series A Preferred Stock shall have no special voting rights and their consent shall not be required (except to the extent they are entitled to vote with holders of Common Stock as set forth herein) for taking any corporate action. 4. Certain Restrictions. (A) Whenever quarterly dividends or other dividends or distributions payable on the Series A Preferred Stock as provided in Section 2 are in arrears, thereafter and until all accrued and unpaid dividends and distributions, whether or not declared, on shares of Series A Preferred Stock outstanding shall have been paid in full, the Corporation shall not: (i) declare or pay dividends, or make any other distributions, on any shares of stock ranking junior (either as to dividends or upon liquidation, dissolutions or winding up) to the Series A Preferred Stock; (ii) declare or pay dividends, or make any other distributions, on any shares of stock ranking on a parity (either as to dividends or upon liquidation, dissolution or winding up) with the Series A Preferred Stock, except dividends paid ratably on the Series A Preferred Stock and all such parity stock on which dividends are payable or in arrears in proportion to the total amounts to which the holders of all such shares are then entitled; II-15 (iii) redeem or purchase or otherwise acquire for consideration shares of any stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series A Preferred Stock, provided that the Corporation may at any time redeem, purchase or otherwise acquire shares of any such junior stock in exchange for shares of any stock of the Corporation ranking junior (either as to dividends or upon dissolution, liquidation or winding up) to the Series A Preferred Stock; or (iv) redeem or purchase or otherwise acquire for consideration any shares of Series A Preferred Stock, or any shares of stock ranking on a parity with the Series A Preferred Stock, except in accordance with a purchase offer made in writing or by publication (as determined by the Board of Directors) to all holders of such shares upon such terms as the Board of Directors, after consideration of the respective annual dividend rates and other relative rights and preferences of the respective series and classes, shall determine in good faith will result in fair and equitable treatment among the respective series or classes. (B) The Corporation shall not permit any subsidiary of the Corporation to purchase or otherwise acquire for consideration any shares of stock of the Corporation unless the Corporation could, under paragraph (A) of this Section 4, purchase or otherwise acquire such shares at any time and in such matter. 5. Reacquired Shares. Any shares of Series A Preferred Stock purchased or otherwise acquired by the Corporation in any manner whatsoever shall be retired and canceled promptly after the acquisition thereof. All such shares shall upon their cancellation become authorized but unissued shares of Preferred Stock and may be reissued as part of a new series of Preferred Stock subject to the conditions and restrictions on issuance set forth herein, in the Restated Certificate of Incorporation, as amended, or in any other Certificate of Designations creating a series of Preferred Stock or any similar stock or as otherwise required by law. 6. Liquidation, Dissolution or Winding Up. (A) Upon any liquidation, dissolution or winding up of the Corporation, no distribution shall be made (1) to the holders of shares of stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series A Preferred Stock unless, prior thereto, the holders of shares of Series A Preferred Stock shall have received $100 per share, plus an amount equal to accrued and unpaid dividends and distributions thereon, whether or not declared, to the date of such payment, provided that the holders of shares of Series A Preferred Stock shall be entitled to receive an aggregate amount per share, subject to the provision for adjustment hereinafter set forth, equal to 100 times the aggregate amount to be distributed per share to holders of shares of Common Stock, or (2) to the holders of shares of stock ranking on a parity (either as to dividends or upon liquidation, dissolution or winding up) with the Series A Preferred Stock, except distributions made ratably on the Series A Preferred Stock and all such parity stock in proportion to the total amounts to which the holders of all such shares are entitled upon such liquidation, dissolution or winding up. (B) Neither the consolidation, merger or other business combination of the Corporation with or into any other corporation nor the sale, lease, exchange or conveyance of all or any part of the property, assets or business of the Corporation shall be deemed to be a liquidation, dissolution or winding up of the Corporation for purposes of this Section 6. (C) In the event the Corporation shall at any time declare or pay any dividend on the Common Stock payable in shares of Common Stock, or effect a subdivision, combination or consolidation of the outstanding shares of Common Stock (by reclassification or otherwise than by payment of a dividend in shares of Common Stock) into a greater or lesser number of shares of Common Stock, then in each such case the aggregate amount to which holders of shares of Series A Preferred Stock were entitled immediately prior to such event under the proviso in clause (1) of paragraph (A) of this Section 6 shall be adjusted by multiplying such amount by a fraction the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event. II-16 7. Consolidation, Merger, etc. Notwithstanding anything to the contrary contained herein, in case the Corporation shall enter into any consolidation, merger, combination or other transaction in which the shares of Common Stock are exchanged for or changed into other stock or securities, cash and/or any other property, then in any such case each share of Series A Preferred Stock shall at the same time be similarly exchanged or changed into an amount per share, subject to the provision for adjustment hereinafter set forth, equal to 100 times the aggregate amount of stock, securities, cash and/or any other property (payable in kind), as the case may be, into which or for which each share of Common Stock is changed or exchanged. In the event the Corporation shall at any time declare or pay any dividend on the Common Stock payable in shares of Common Stock, or effect a subdivision, combination or consolidation of the outstanding shares of Common Stock (by reclassification or otherwise than by payment of a dividend in shares of Common Stock) into a greater or lesser number of shares of Common Stock, then in each such case the amount set forth in the preceding sentence with respect to the exchange or change of shares of Series A Preferred Stock shall be adjusted by multiplying such amount by a fraction, the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event. 8. No Redemption. The shares of Series A Preferred Stock shall not be redeemable. 9. Rank. The Series A Preferred Stock shall rank, with respect to the payment of dividends and the distribution of assets, junior to all series of any other class of the Preferred Stock issued either before or after the issuance of the Series A Preferred Stock, unless the terms of any such series shall provide otherwise. 10. Amendment. The Restated Certificate of Incorporation, as amended, of the Corporation shall not be amended in any manner which would materially alter or change the powers, preferences or special rights of the Series A Preferred Stock so as to affect them adversely without the affirmative vote of the holders of at least two-thirds of the outstanding shares of Series A Preferred Stock, voting together as a single class. 11. Fractional Shares. Series A Preferred Stock may be issued in fractions of a share which are integral multiples of one-hundredth of a share which shall entitle the holder, in proportion to such holder's fractional shares, to exercise voting rights, receive dividends, participate in distributions and have the benefit of all other rights of holders of Series A Preferred Stock. IN WITNESS WHEREOF, the Corporation has caused this Certificate of Amendment to be executed as of this day of , 1999. STAPLES, INC. By: _________________________________ Jack A. VanWoerkom Senior Vice President II-17 ANNEX III STAPLES, INC. AMENDED AND RESTATED 1992 EQUITY INCENTIVE PLAN 1. Purpose. The purpose of this plan (the "Plan") is to secure for Staples, Inc. (the "Company") and its shareholders the benefits arising from capital stock ownership by employees or officers of, and consultants to, the Company and its parent and subsidiary corporations who are expected to contribute to the Company's future growth and success. Except where the context otherwise requires, the term "Company" shall include the parent and all present and future subsidiaries of the Company as defined in Sections 424(e) and 424(f) of the Internal Revenue Code of 1986, as amended or replaced from time to time (the "Code"). Those provisions of the Plan which make express reference to Section 422 shall apply only to Incentive Stock Options (as that term is defined herein). 2. Types of Options and Awards; Administration. a. Types of Options and Awards. Options granted pursuant to the Plan shall be authorized by action of the Board of Directors of the Company (or a Committee designated by the Board of Directors) and may be either incentive stock options ("Incentive Stock Options") meeting the requirements of Section 422 of the Code or non-statutory options which are not intended to meet the requirements of Section 422 of the Code. Awards of restricted stock made pursuant to Section 13 of the Plan shall be authorized by action of the Board of Directors of the Company (or a Committee designated by the Board of Directors) and shall meet the requirements of Section 13 of the Plan. b. Administration. i. The Plan will be administered by the Board of Directors of the Company, whose construction and interpretation of the terms and provisions of the Plan shall be final and conclusive. The Board of Directors may in its sole discretion (x) grant options to purchase shares of Staples Retail and Delivery common stock or Staples.com common stock (collectively, "Common Stock") and issue shares upon exercise of such options as provided in the Plan and (y) make restricted stock awards pursuant to Section 13 of the Plan. The Board shall have authority, subject to the express provisions of the Plan, to construe the respective option agreements, awards and the Plan, to prescribe, amend and rescind rules and regulations relating to the Plan, to determine the terms and provisions of the respective option agreements and restricted stock awards, which need not be identical, and to make all other determinations in the judgment of the Board of Directors necessary or desirable for the administration of the Plan. The Board of Directors may correct any defect or supply any omission or reconcile any inconsistency in the Plan or in any option agreement or restricted stock award in the manner and to the extent it shall deem expedient to carry the Plan into effect and it shall be the sole and final judge of such expediency. No director or person acting pursuant to authority delegated by the Board of Directors shall be liable for any action or determination under the Plan made in good faith. ii. The Board of Directors may, to the full extent permitted by or consistent with applicable laws or regulations and Section 3(b) of this Plan, delegate any or all of its powers under the Plan to a committee (the "Committee") appointed by the Board of Directors, and if the Committee is so appointed all references to the Board of Directors in the Plan shall mean and relate to such Committee. Unless all members of the Board of Directors are "outside directors" within the meaning of Section 162(m) of the Code, as such term is interpreted from time to time, the Board shall appoint such a Committee of two or more directors, all of whom are outside directors, and shall delegate to such Committee all of its powers under the Plan, except that the Board's concurrent approval shall be required for any amendment to the Plan which may be adopted by the Committee; and provided, that any failure of any director or Committee member to satisfy the definition of outside director shall not invalidate any action taken by the Board or Committee with respect to any participant in the Plan, whether or not such person is a "covered III-1 employee" within the meaning of Section 162(m) of the Code, as such term is interpreted from time to time. c. Applicability of Rule 16b-3. Those provisions of the Plan which make express reference to Rule 16b-3 promulgated under the Securities and Exchange Act of 1934 (the "Exchange Act") or, any successor rules ("Rule 16b-3") or which are required in order for certain option transactions to qualify for exemption under Rule 16b-3 shall apply only to such persons as are required to file reports under Section 16(a) of the Exchange Act (a "Reporting Person"). 3. Eligibility. a. General. Options and restricted stock awards may be granted or made to persons who are, at the time of grant, employees or officers of the Company (including any persons who have entered into an agreement with the Company under which they will be employed by the Company in the future) or consultants to the Company; provided, that the class of employees to whom Incentive Stock Options may be granted shall be limited to employees of the Company. A person who has been granted an option or award may, if he or she is otherwise eligible, be granted additional options or awards if the Board of Directors shall so determine; provided, that the maximum number of shares for which options or restricted stock awards may be granted to any one employee during any fiscal year shall be 3,037,500* shares, subject to adjustment as provided in Section 15 below. b. Grant of Options to Directors and Officers. The selection of a director or an officer (as the terms "director" and "officer" are defined for purposes of Rule 16b-3) as a participant, the timing of the option grant or restricted stock award, the exercise price of the option or the sale price of the award and the number of shares for which an option or restricted stock award may be granted or made to such director or officer shall be determined either (i) by the Board of Directors, of which all members shall be "disinterested persons" (as hereinafter defined), or (ii) by a committee of two or more directors having full authority to act in the matter, of which all members shall be "disinterested persons." For the purposes of the Plan, a director shall be deemed to be "disinterested" only if such person qualifies as a "disinterested person" within the meaning of Rule 16b-3, as such term is interpreted from time to time. 4. Stock Subject to Plan. Subject to adjustment as provided in Section 15 below, the maximum number of shares of Common Stock of the Company which may be issued and sold under the Plan is 122,850,000 shares* of Common Stock (regardless of series). Except as prohibited by Rule 16b-3, (i) if an option granted under the Plan shall expire or terminate for any reason without having been exercised in full, the unpurchased shares subject to such option shall again be available for subsequent option grants or awards under the Plan and (ii) if restricted stock awarded under the Plan shall be repurchased by the Company, the repurchased shares subject to such award shall again be available for subsequent option grants or awards under the Plan. 5. Forms of Option Agreements. As a condition to the grant of an option under the Plan, each recipient of an option shall execute an option agreement in such form not inconsistent with the Plan as may be approved by the Board of Directors. Such option agreements may differ among recipients. 6. Purchase Price Upon Exercise of Options. a. General. Subject to Section 3(b), the purchase price per share of stock deliverable upon the exercise of an option shall be determined by the Board of Directors but shall in no event be less than 100% of the fair market value of such stock, as determined by the Board of Directors, at the time of grant of such option, or, in the case of an Incentive Stock Option described in Section 11(b), be less than 110% of such fair market value. - -------- * Adjusted for stock splits through September 14, 1999 III-2 b. Payment of Purchase Price. Options granted under the Plan may provide for the payment of the exercise price by delivery of cash or a check to the order of the Company in an amount equal to the exercise price of such options, or, to the extent provided in the applicable option agreement, (i) by delivery to the Company of shares of Common Stock of the Company already owned by the optionee having a fair market value equal in amount to the exercise price of the options being exercised, (ii) by any other means (including, without limitation, by delivery of a promissory note of the optionee payable on such terms as are specified by the Board of Directors) which the Board of Directors determines are consistent with the purpose of the Plan and with applicable laws and regulations (including, without limitation, the provisions of Rule 16b-3 and Regulation T promulgated by the Federal Reserve Board) or (iii) by any combination of such methods of payment. The fair market value of any shares of Common Stock or other non-cash consideration which may be delivered upon exercise of an option shall be determined in such manner as may be prescribed by the Board of Directors. 7. Option Period. Each option and all rights thereunder shall expire on such date as shall be set forth in the applicable option agreement, except that, in the case of an Incentive Stock Option, such date shall not be later than ten years after the date on which the option is granted (or five years in the case of options described in Section 11(b)), and, in the case of non-statutory options, in no event after the expiration of ten years plus 30 days from the date on which the option is granted, and, in either case, options shall be subject to earlier termination as provided in the Plan. 8. Exercise of Options. Each option granted under the Plan shall be exercisable either in full or in installments at such time or times and during such period as shall be set forth in the agreement evidencing such option, subject to the provisions of the Plan. 9. Nontransferability of Options. No option granted under the Plan shall be assignable or transferable by the person to whom it is granted, either voluntarily or by operation of law, except by will or the laws of descent and distribution. During the life of the optionee, the options shall be exercisable only by the optionee. Notwithstanding the foregoing, non-statutory options may be transferred pursuant to a qualified domestic relations order (as defined in Rule 16b-3). 10. Effect of Termination of Employment or Other Relationship. Except as provided in Section 11(d) with respect to Incentive Stock Options, and subject to the provisions of the Plan, the Board of Directors shall determine the period of time during which an optionee may exercise an option following (i) the termination of the optionee's employment or other relationship with the Company or (ii) the death or disability of the optionee. Such periods shall be set forth in the agreement evidencing such option. 11. Incentive Stock Options. Options granted under the Plan which are intended to be Incentive Stock Options shall be subject to the following additional terms and conditions: a. Express Designation. All Incentive Stock Options granted under the Plan shall, at the time of grant, be specifically designated as such in the option agreement covering such Incentive Stock Options. b. 10% Shareholder. If any employee to whom an Incentive Stock Option is to be granted under the Plan is, at the time of the grant of such option, the owner of stock possessing more than 10% of the total III-3 combined voting power of all classes of stock of the Company (after taking into account the attribution of stock ownership rules of Section 424(d) of the Code), then the following special provisions shall be applicable to the Incentive Stock Option granted to such individual: i. The purchase price per share of the Common Stock subject to such Incentive Stock Option shall not be less than 110% of the fair market value of one share of such series of Common Stock at the time of grant; and ii. The option exercise period shall not exceed five years from the date of grant. c. Dollar Limitation. For so long as the Code shall so provide, options granted to any employee under the Plan (and any other incentive stock option plans of the Company) which are intended to constitute Incentive Stock Options shall not constitute Incentive Stock Options to the extent that such options, in the aggregate, become exercisable for the first time in any one calendar year for shares of Common Stock with an aggregate fair market value (determined as of the respective date or dates of grant) of more than $100,000. d. Dermination of Employment, Death or Disability. No Incentive Stock Option may be exercised unless, at the time of such exercise, the optionee is, and has been continuously since the date of grant of his or her option, employed by the Company, except that: i. an Incentive Stock Option may be exercised within the period of three months after the date the optionee ceases to be an employee of the Company (or within such lesser period as may be specified in the applicable option agreement), provided, that the agreement with respect to such option may designate a longer exercise period and that the exercise after such three-month period shall be treated as the exercise of a non-statutory option under the Plan; ii. if the optionee dies while in the employ of the Company, or within three months after the optionee ceases to be such an employee, the Incentive Stock Option may be exercised by the person to whom it is transferred by will or the laws of descent and distribution within the period of one year after the date of death (or within such lesser period as may be specified in the applicable option agreement); and iii. if the optionee becomes disabled (within the meaning of Section 22(e)(3) of the Code or any successor provision thereto) while in the employ of the Company, the Incentive Stock Option may be exercised within the period of one year after the date the optionee ceases to be such an employee because of such disability (or within such lesser period as may be specified in the applicable option agreement). For all purposes of the Plan and any option or restricted stock award granted hereunder, "employment" shall be defined in accordance with the provisions of Section 1.421-7(h) of the Income Tax Regulations (or any successor regulations). Notwithstanding the foregoing provisions, no stock option may be exercised after its expiration date. 12. Additional Provisions. a. Additional Option Provisions. The Board of Directors may, in its sole discretion, include additional provisions in option agreements covering options granted under the Plan, including without limitation restrictions on transfer, repurchase rights, commitments to pay cash bonuses, to make, arrange for or guaranty loans or to transfer other property to optionees upon exercise of options, or such other provisions as shall be determined by the Board of Directors; provided that such additional provisions shall not be inconsistent with any other term or condition of the Plan and such additional provisions shall not cause any Incentive Stock Option granted under the Plan to fail to qualify as an Incentive Stock Option within the meaning of Section 422 of the Code. b. Acceleration, Extension, Etc. The Board of Directors may, in its sole discretion, (i) accelerate the date or dates on which all or any particular option or options granted under the Plan may be exercised or (ii) extend III-4 the dates during which all, or any particular, option or options granted under the Plan may be exercised; provided, however, that no such extension shall be permitted if it would cause the Plan to fail to comply with Section 422 of the Code or with Rule 16b-3. 13. Awards. A restricted stock award ("award") shall consist of the issuance by the Company of shares of Common Stock (of either series), and purchase by the recipient of such shares, subject to the terms, conditions and restrictions described in the document evidencing the award and in this Section 13 and elsewhere in the Plan. a. Execution of Restricted Stock Award Agreement. As a condition to an award under the Plan, each recipient of an award shall execute an agreement in such form, which may differ among recipients, as shall be specified by the Board of Directors at the time of such award. b. Price. The Board of Directors shall determine the price at which shares of Common Stock shall be sold to recipients of awards under the Plan. The Board of Directors may, in its discretion, issue shares pursuant to awards without the payment of any cash purchase price by the recipients (in which case the "price per share originally paid" for purposes of Section 13(d)(3) below shall be zero) or issue shares pursuant to awards at a purchase price below the then fair market value of such series of Common Stock. If a purchase price is required to be paid, it shall be paid in cash or by check payable to the order of the Company at the time that the award is accepted by the recipient, or by such other means as may be approved by the Board of Directors. c. Number of Shares. The award shall specify the number of shares and series of Common Stock issued thereunder. d. Restrictions on Transfer. In addition to such other terms, conditions and restrictions upon awards as shall be imposed by the Board of Directors, all shares issued pursuant to an award shall be subject to the following restrictions: i. All shares of Common Stock subject to an award (including any shares issued pursuant to paragraph (e) of this Section) shall be subject to certain restrictions on disposition and obligations of resale to the Company as provided in subparagraph (2) below for the period specified in the document evidencing the award, and shall not be sold, assigned, transferred, pledged, hypothecated or otherwise disposed of until such restrictions lapse. The period during which such restrictions are applicable is referred to as the "Restricted Period." ii. In the event that a recipient's employment with the Company is terminated within the Restricted Period, whether such termination is voluntary or involuntary, with or without cause, or because of the death or disability of the recipient, the Company shall have the right and option for a period of three months following such termination to buy for cash that number of the shares of Common Stock purchased under the award as to which the restrictions on transfer and the forfeiture provisions contained in the award have not then lapsed, at a price equal to the price per share originally paid by the recipient. If such termination occurs within the last three months of the applicable restrictions, the restrictions and repurchase rights of the Company shall continue to apply until the expiration of the Company's three month option period. iii. Notwithstanding subparagraphs (1) and (2) above, the Board of Directors may, in its discretion, either at the time that an award is made or at any time thereafter, waive its right to repurchase shares of Common Stock upon the occurrence of any of the events described in this paragraph (d) or remove or modify any part or all of the restrictions. In addition, the Board of Directors may, in its discretion, impose upon the recipient of an award at the time of such award such other restrictions on any shares of Common Stock issued pursuant to such award as the Board of Directors may deem advisable. III-5 e. Additional Shares. Any shares received by a recipient of an award as a stock dividend on, or as a result of stock splits, combinations, exchanges of shares, reorganizations, mergers, consolidations or otherwise with respect to, shares of Common Stock received pursuant to such award shall have the same status and shall bear the same restrictions, all on a proportionate basis, as the shares initially purchased pursuant to such award. f. Transfers in Breach of Award. If any transfer of shares purchased pursuant to an award is made or attempted contrary to the terms of the Plan and of such award, the Board of Directors shall have the right to purchase for the account of the Company those shares from the owner thereof or his or her transferee at any time before or after the transfer at the price paid for such shares by the person to whom they were awarded under the Plan. In addition to any other legal or equitable remedies which it may have, the Company may enforce its rights by specific performance to the extent permitted by law. The Company may refuse for any purpose to recognize as a shareholder of the Company any transferee who receives any shares contrary to the provisions of the Plan and the applicable award or any recipient of an award who breaches his or her obligation to resell shares as required by the provisions of the Plan and the applicable award, and the Company may retain and/or recover all dividends on such shares which were paid or payable subsequent to the date on which the prohibited transfer or breach was made or attempted. g. Additional Award Provisions. The Board of Directors may, in its sole discretion, include additional provisions in any award granted under the Plan as shall be determined by the Board of Directors. 14. Rights as a Shareholder. The holder of an option or recipient of an award shall have no rights as a shareholder with respect to any shares covered by the option or award (including, without limitation, any rights to receive dividends or non-cash distributions with respect to such shares) until the date of issue of a stock certificate to him or her for such shares. No adjustment shall be made for dividends or other rights for which the record date is prior to the date such stock certificate is issued. 15. Adjustment Provisions for Recapitalizations and Related Transactions. a. General. If, through or as a result of any merger, consolidation, sale of all or substantially all of the assets of the Company, reorganization, recapitalization, reclassification, stock dividend, stock split, reverse stock split or other similar transaction, (i) the outstanding shares of one or both series of Common Stock are increased or decreased or are exchanged for a different number or kind of shares or other securities of the Company, or (ii) additional shares or new or different shares or other securities of the Company or other non-cash assets are distributed with respect to such shares of one or both series of Common Stock or other securities, an appropriate and proportionate adjustment shall be made in (x) the maximum number and kind of shares reserved for issuance under the Plan, (y) the number and kind of shares or other securities subject to any then outstanding options under the Plan for such series of Common Stock, and (z) the price for each share subject to any then outstanding options under the Plan or repurchase rights of the Company for such series of Common Stock, without changing the aggregate purchase price as to which such options or repurchase rights remain exercisable. Notwithstanding the foregoing, no adjustment shall be made pursuant to this Section 15 if such adjustment would cause the Plan to fail to comply with Section 422 of the Code or with Rule 16b-3. b. Board Authority to Make Adjustments. Any adjustments under this Section 15 will be made by the Board of Directors, whose determination as to what adjustments, if any, will be made and the extent thereof will be final, binding and conclusive. No fractional shares will be issued under the Plan on account of any such adjustments. 16. Merger, Consolidation, Asset Sale, Liquidation, etc. a. General. In the event of a consolidation or merger or sale of all or substantially all of the assets of the Company in which outstanding shares of one or both series of Common Stock are exchanged for securities, III-6 cash or other property of any other corporation or business entity or in the event of a liquidation of the Company, the Board of Directors of the Company, or the board of directors of any corporation assuming the obligations of the Company, may, in its discretion, take any one or more of the following actions, as to outstanding options for such series of Common Stock: (i) provide that such options shall be assumed, or equivalent options shall be substituted, by the acquiring or succeeding corporation (or an affiliate thereof), provided that any such options substituted for Incentive Stock Options shall meet the requirements of Section 424(a) of the Code, (ii) upon written notice to the optionees, provide that all unexercised options will terminate immediately prior to the consummation of such transaction unless exercised by the optionee within a specified period following the date of such notice, (iii) in the event of a merger under the terms of which holders of one or both series of Common Stock of the Company will receive upon consummation thereof a cash payment for each share surrendered in the merger (the "Merger Price"), make or provide for a cash payment to such optionees equal to the difference between (A) the Merger Price times the number of shares of Common Stock subject to such outstanding options (to the extent then exercisable at prices not in excess of the Merger Price) and (B) the aggregate exercise price of all such outstanding options in exchange for the termination of such options, and (iv) provide that all or any such outstanding options shall become exercisable in full immediately prior to such event. b. Substitute Options. The Company may grant options under the Plan in substitution for options held by employees of another corporation who become employees of the Company, or a subsidiary of the Company, as the result of a merger or consolidation of the employing corporation with the Company or a subsidiary of the Company, or as a result of the acquisition by the Company, or one of its subsidiaries, of property or stock of the employing corporation. The Company may direct that substitute options be granted on such terms and conditions as the Board of Directors considers appropriate in the circumstances so long as the ratio of the option exercise price to the fair market value of the stock for the substitute option is no more favorable to the optionee than the ratio of the option exercise price to the fair market value of the original option immediately before such substitution. 17. No Special Employment Rights. Nothing contained in the Plan or in any option or award shall confer upon any optionee or any recipient of an award any right with respect to the continuation of his or her employment by the Company or consulting relationship with the Company or interfere in any way with the right of the Company at any time to terminate such employment or consulting relationship or to increase or decrease the compensation of the optionee. 18. Other Employee Benefits. Except as to plans which by their terms include such amounts as compensation, neither the amount of any compensation deemed to be received by an employee as a result of the exercise of an option or the sale of shares received upon such exercise nor the value of an award granted to an employee will constitute compensation with respect to which any other employee benefits of such employee are determined, including, without limitation, benefits under any bonus, pension, profit-sharing, life insurance or salary continuation plan, except as otherwise specifically determined by the Board of Directors. 19. Amendment of the Plan. a. The Board of Directors may at any time, and from time to time, modify or amend the Plan in any respect, except that if at any time the approval of the shareholders of the Company is required as to such modification or amendment under Section 422 of the Code or any successor provision with respect to Incentive Stock Options, or under Rule 16b-3, the Board of Directors may not effect such modification or amendment without such approval. b. The termination or any modification or amendment of the Plan shall not, without the consent of an optionee or recipient of an award, affect his or her rights under an option or award previously granted to him or III-7 her. With the consent of the optionee or recipient of an award affected, the Board of Directors may amend outstanding option agreements or awards in a manner not inconsistent with the Plan. The Board of Directors shall have the right to amend or modify (i) the terms and provisions of the Plan and of any outstanding Incentive Stock Options granted under the Plan to the extent necessary to qualify any or all such options for such favorable federal income tax treatment (including deferral of taxation upon exercise) as may be afforded incentive stock options under Section 422 of the Code and (ii) the terms and provisions of the Plan and of any outstanding option or award to the extent necessary to ensure the qualification of the Plan under Rule 16b-3 or is required to ensure that any compensation attributable to any option under the Plan is deductible by the Company for federal income tax purposes under Section 162(m), or any successor rule. 20. Withholding. a. The Company shall have the right to deduct from payments of any kind otherwise due to the optionee or recipient of an award any federal, state or local taxes of any kind required by law to be withheld with respect to any shares issued upon exercise of options under the Plan or upon the expiration or termination of the Restricted Period relating to shares subject to the award. Subject to the prior approval of the Company, which may be withheld by the Company in its sole discretion, the optionee or recipient of an award may elect to satisfy such obligations, in whole or in part, (i) by causing the Company to withhold shares of Common Stock otherwise issuable pursuant to the exercise of an option or upon the expiration or termination of the Restricted Period relating to shares subject to the award or (ii) by delivering to the Company shares of Common Stock already owned by the optionee or award recipient. The shares so delivered or withheld shall have a fair market value equal to such withholding obligation. The fair market value of the shares used to satisfy such withholding obligation shall be determined by the Company as of the date that the amount of tax to be withheld is to be determined. An optionee or award recipient who has made an election pursuant to this Section 20(a) may only satisfy his or her withholding obligation with shares of Common Stock which are not subject to any repurchase, forfeiture, unfulfilled vesting or other similar requirements. b. Notwithstanding the foregoing, in the case of a Reporting Person, no election to use shares for the payment of withholding taxes shall be effective unless made in compliance with any applicable requirements of Rule 16b-3 (unless it is intended that the transaction not qualify for exemption under Rule 16b-3). c. If the recipient of an award under the Plan elects, in accordance with Section 83(b) of the Code, to recognize ordinary income in the year of acquisition of any shares awarded under the Plan, the Company will require at the time of such election an additional payment for withholding tax purposes based on the difference, if any, between the purchase price of such shares and the fair market value of such shares as of the date immediately preceding the date of the award. 21. Cancellation and New Grant of Options, Etc. The Board of Directors shall have the authority to effect, at any time and from time to time, with the consent of the affected optionees, (i) the cancellation of any or all outstanding options under the Plan and the grant in substitution therefor of new options under the Plan covering the same or different numbers of shares of Common Stock (of either series) and having an option exercise price per share which may be lower or higher than the exercise price per share of the cancelled options or (ii) the amendment of the terms of any and all outstanding options under the Plan to provide an option exercise price per share which is higher or lower than the then-current exercise price per share of such outstanding options. 22. Effective Date and Duration of the Plan. a. Effective Date. The Plan shall become effective when adopted by the Board of Directors, but no Incentive Stock Option granted under the Plan shall become exercisable unless and until the Plan shall have been approved by the Company's shareholders. If such shareholder approval is not obtained within twelve months after the date of the Board's adoption of the Plan, no options previously granted under the Plan shall be III-8 deemed to be Incentive Stock Options and no Incentive Stock Options shall be granted thereafter. Amendments to the Plan not requiring shareholder approval shall become effective when adopted by the Board of Directors; amendments requiring shareholder approval (as provided in Section 19) shall become effective when adopted by the Board of Directors, but no Incentive Stock Option granted after the date of such amendment shall become exercisable (to the extent that such amendment to the Plan was required to enable the Company to grant such Incentive Stock Option to a particular optionee) unless and until such amendment shall have been approved by the Company's shareholders. If such shareholder approval is not obtained within twelve months of the Board's adoption of such amendment, any Incentive Stock Options granted on or after the date of such amendment shall terminate to the extent that such amendment to the Plan was required to enable the Company to grant such option to a particular optionee. Subject to this limitation, options may be granted under the Plan at any time after the effective date and before the date fixed for termination of the Plan. b. Termination. Unless sooner terminated in accordance with Section 16, the Plan shall terminate, with respect to Incentive Stock Options, upon the earlier of (i) the close of business on the day next preceding the tenth anniversary of the date of its adoption by the Board of Directors, or (ii) the date on which all shares available for issuance under the Plan shall have been issued pursuant to the exercise or cancellation of options granted under the Plan or the grant of awards. Unless sooner terminated in accordance with Section 16, the Plan shall terminate with respect to awards and options which are not Incentive Stock Options on the date specified in (ii) above. If the date of termination is determined under (i) above, then options outstanding on such date shall continue to have force and effect in accordance with the provisions of the instruments evidencing such options. 23. Provision for Foreign Participants. The Board of Directors may, without amending the Plan, modify awards or options granted to participants who are foreign nationals or employed outside the United States to recognize differences in laws, rules, regulations or customs of such foreign jurisdictions with respect to tax, securities, currency, employee benefit or other matters. Adopted by the Board of Directors on April 16, 1992 and approved by the stockholders on June 18, 1992; amended by the Board of Directors on March 25, 1993 and approved by the stockholders on June 25, 1993; as further amended by the Board of Directors on June 25, 1993, which amendment did not require stockholder approval; as further amended, restated and renamed by the Board of Directors on April 27, 1994, and approved by the stockholders on June 30, 1994; as further amended on September 3, 1996, and approved by the stockholders on June 18, 1997; as further amended on September 14, 1999, and approved by stockholders on , 1999. III-9 ANNEX IV STAPLES, INC. AMENDED AND RESTATED 1990 DIRECTOR STOCK OPTION PLAN 1.Purpose. The purpose of this Amended and Restated 1990 Director Stock Option Plan (the "Plan") of Staples, Inc. (the "Company") is to encourage ownership in the Company by the Company's outside directors, whose continued services the Company considers essential to its future progress, and to provide these individuals with a further incentive to remain as directors of the Company. 2.Administration. The Board of Directors shall supervise and administer the Plan. Grants of stock options ("Options") and awards of performance accelerated restricted stock ("PARS") under the Plan and the amount and nature of the Options and PARS to be granted shall be made in accordance with Section 4. All questions concerning interpretation of the Plan or any Options or PARS issued under it shall be resolved by the Board of Directors and such resolution shall be final and binding upon all persons having an interest in the Plan. 3.Participation in the Plan. Directors of the Company who are not employees of the Company or any subsidiary of the Company ("outside directors") shall be eligible to receive Options and PARS under the Plan. 4.Terms, Conditions and Form of Options and PARS. All Options and PARS granted under the Plan shall be evidenced by a written agreement in such form as the Board of Directors shall from time to time approve, which agreements shall comply with and be subject to the following terms and conditions. (a) Stock Subject to Plan. Options and PARS may be granted under the Plan with respect to either Staples Retail and Delivery common stock or Staples.com common stock (collectively, "Common Stock"). Subject to adjustment as provided in the Plan, the maximum number of shares of Common Stock which may be issued under the Plan is 3,350,000 shares of Common Stock (regardless of series). All Options or PARS granted under the Plan, as provided below, shall be granted with respect to either series of Common Stock, or a combination of both series, as determined in the sole discretion of the Board of Directors. If an Option shall expire or terminate for any reason without having been exercised in full, the unpurchased shares subject to such Option shall again be available for subsequent Option grants or PARS under the Plan; and if the shares subject to a PARS shall be repurchased by the Company, the repurchased shares shall again be available for subsequent Option grants or PARS under the Plan. (b) Grants of Options and PARS. (i) Initial Option Grant. An Option to purchase 15,000 shares of Common Stock, shall be granted automatically to outside directors who are initially elected to the Board of Directors subsequent to the approval of the Plan by the Company's stockholders at the close of business on the date of such director's initial election to the Board of Directors. (ii) Annual Option Grants. On the date of the first regularly scheduled Board of Directors meeting following the end of each fiscal year of the Company, commencing with the fiscal year ending January 30, 1999, an Option shall be granted automatically to each outside director to purchase a number of shares of Common Stock equal to 3,000 multiplied by the number of regularly scheduled meeting days of the Board of Directors attended by such director in the previous 12 months (up to a maximum of 15,000 shares). IV-1 (iii) Annual Awards of PARS. At the first regularly scheduled Board of Directors meeting following the end of each fiscal year of the Company, at which performance targets are established for PARS awarded to executive officers of the Company, but no later than July 31 of each year (each, an "Award Date), (x) the Company shall grant to each outside director 400 PARS for each regularly scheduled meeting day of the Board of Directors attended by such director in the previous 12 months (up to a maximum of 2,000 PARS) and (y) in addition, the Company shall grant to the Lead Director and the Chairman of each of the Audit, Compensation, and Governance Committee of the Board of Directors 200 PARS for each regularly scheduled meeting day of the Board of Directors attended by such director in the previous 12 months (up to a maximum of 1,000 PARS). (c) Terms of Options. (i) Option Exercise Price. The option exercise price per share for each Option granted under the Plan shall be determined as follows: if such series of Common Stock is listed on the Nasdaq National Market on the date of grant, the option exercise price per share shall be equal to the last reported sale price per share of such series of Common Stock on the Nasdaq National Market on the date of grant (or, if no such price is reported on such date, such price as is reported on the nearest preceding date); if the applicable series of Common Stock is not listed on the Nasdaq National Market on the date of grant, the option exercise price per share shall be the fair market value per share of such series of Common Stock on the date of grant, as determined in good faith by the Board of Directors. (ii) Nature of Options. All Options granted under the Plan shall be nonstatutory options not entitled to special tax treatment under Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"). (iii) Vesting. Except as otherwise provided in the Plan, each Option shall become exercisable, on a cumulative basis, in four equal annual installments on each of the first, second, third and fourth anniversary dates of its date of grant, provided the optionee continues to serve as a director of the Company on such dates. Notwithstanding the foregoing, each outstanding Option shall immediately become exercisable in full in the event (A) a Change in Control (as defined in Section 8) of the Company occurs or (B) the optionee ceases to serve as a director of the Company due to his or her death, disability (within the meaning of Section 22(e)(3) of the Code or any successor provision) or retires pursuant to a retirement policy adopted by the Company. (iv) Option Exercise Procedure. An Option may be exercised only by written notice to the Company at its principal office accompanied by payment in cash of the exercise price with respect to the Option being exercised or by the tender (actual or constructive) of shares of Common Stock owned by the director having a value as of the date of exercise equal to the exercise price. In the case of a constructive tender of shares of Common Stock, the optionee and the Company may enter into an agreement to defer until an agreed-upon date the issuance, transfer and delivery of shares of Common Stock with a value equal to the difference between the fair market value of the Common Stock on the date of exercise and the exercise price of the Option being exercised. The Board of Directors may impose such restrictions on the tender of shares as it deems appropriate. (v) Termination. Each Option shall terminate, and may no longer be exercised, on the date six months after the optionee ceases to serve as a director of the Company; provided that, in the event (A) an optionee ceases to serve as a director due to his or her death or disability (within the meaning of Section 22(e)(3) of the Code or any successor provision), or (B) an optionee dies within six months after he or she ceases to serve as a director of the Company, then the exercisable portion of the Option may be exercised, within the period of one year following the date the optionee ceases to serve as a director, by the optionee or by the person to whom the Option is transferred by will, by the laws of descent and distribution, or by written notice pursuant to Section 4(c)(vii). Notwithstanding the foregoing, each Option shall terminate, and may no longer be exercised, on the date 10 years after the date of grant. IV-2 (vi) Options Nontransferable. Except as otherwise provided by the Board of Directors, each Option granted under the Plan by its terms shall not be transferable by the optionee otherwise than by will or the laws of descent and distribution, and shall be exercised during the lifetime of the optionee only by the optionee or his or her legal representative. No Option or interest therein may be transferred, assigned, pledged or hypothecated by the optionee during his or her lifetime, whether by operation of law or otherwise, or be made subject to execution, attachment or similar process. (vii) Option Exercise by Representative Following Death of Director. An optionee, by written notice to the Company, may designate one or more persons (and from time to time change such designation), including his or her legal representative, who, by reason of the optionee's death, shall acquire the right to exercise all or a portion of the Option. If the person or persons so designated wish to exercise any portion of the Option, they must do so within the term of the Option as provided herein. Any exercise by a representative shall be subject to the provisions of the Plan. (d) Terms of PARS. (i) Nature of PARS. All PARS hereunder shall consist of the issuance by the Company of shares of Common Stock or an agreement for the future delivery of shares of Common Stock at an agreed-upon date ("PARS Deferred Units") and the purchase by the recipient thereof of such shares, subject to the terms, conditions and restrictions described in the document evidencing the PARS and in this Plan. (ii) Execution of PARS Agreement. In the case of the actual issuance of Common Stock, the Company shall, upon the date of the PARS grant, issue the shares of Common Stock subject to the PARS by registering such shares in book entry form with the Company's transfer agent in the name of the recipient. No certificate(s) representing all or a part of such shares shall be issued until the conclusion of the vesting period described in paragraph (iv) below. (iii) Price. Except as otherwise determined by the Board of Directors, all PARS issued hereunder shall be issued without the payment of any cash purchase price by the recipients (in which case the "price per share originally paid" for purposes of clause (2) of paragraph (v) below shall be zero). (iv) Vesting. Except as otherwise provided in the Plan, the restrictions on transfer and the forfeiture provisions of each PARS shall lapse on the same basis as PARS that have been awarded to the Company's executive officers for the fiscal year in which the Award Date relating to such PARS occurs. If no PARS have been awarded to any executive officer of the Company during the six months preceding an Award Date, then the restrictions on transfer and the forfeiture provisions of all PARS granted pursuant to this Plan on such Award Date shall lapse on such terms as shall be determined by the Board of Directors. Notwithstanding the foregoing, the restrictions on transfer and the forfeiture provisions of all PARS granted under this Plan shall immediately lapse in the event (A) a Change in Control of the Company occurs, or (B) the recipient ceases to serve as a director of the Company due to his or her death, disability (within the meaning of Section 22(e)(3) of the Code or any successor provision) or retires pursuant to a retirement policy adopted by the Company. (v) Restrictions on Transfer. In addition to such other terms, conditions and restrictions on PARS contained in the Plan or the applicable PARS Agreement, all PARS shall be subject to the following restrictions: (1) No PARS shall be sold, assigned, transferred, pledged, hypothecated or otherwise disposed of until they become vested pursuant to paragraph (iv) above. The period during which such restrictions are applicable is referred to as the "Restricted Period." (2) Except as set forth in the last sentence of paragraph (iv) above, if a recipient ceases to be a director of the Company within the Restricted Period for any reason, the Company shall have the right and option for a period of three months following the date of such cessation to buy for cash that number of PARS as to which the restrictions on transfer and the forfeiture IV-3 provisions contained in the PARS have not then lapsed, at a price equal to the price per share originally paid by the recipient. If such cessation occurs within the last three months of the applicable Restricted Period, the restrictions and repurchase rights of the Company shall continue to apply until the expiration of the Company's three month option period. (3) Notwithstanding subparagraphs (1) and (2) above, the Board of Directors may, in its discretion, either at the time that PARS are awarded or at any time thereafter, waive the Company's right to repurchase shares of Common Stock or PARS Deferred Units upon the occurrence of any of the events described in this paragraph (v) or remove or modify any part or all of the restrictions. In addition, the Board of Directors may, in its discretion, impose upon the recipient of PARS at the time that such PARS are granted such other restrictions on any PARS as the Board of Directors may deem advisable. (vi) Additional Shares. Any shares received by a recipient of PARS as a stock dividend or any PARS Deferred Units received in respect of a stock dividend, or as a result of stock splits, combinations, exchanges of shares, reorganizations, mergers, consolidations or otherwise with respect to such PARS shall have the same status and shall bear the same restrictions, all on a proportionate basis, as the shares or PARS Deferred Units initially subject to such. (vii) Transfers in Breach of PARS. If any transfer of PARS is made or attempted contrary to the terms of the Plan and of such PARS, the Board of Directors shall have the right to purchase for the account of the Company those shares from the owner thereof or his or her transferee at any time before or after the transfer at the price paid for such shares by the person to whom they were awarded under the Plan. In addition to any other legal or equitable remedies which it may have, the Company may enforce its rights by specific performance to the extent permitted by law. The Company may refuse for any purpose to recognize as a shareholder of the Company any transferee who receives any shares contrary to the provisions of the Plan and the applicable PARS or any recipient of PARS who breaches his or her obligation to resell shares as required by the provisions of the Plan and the applicable PARS, and the Company may retain and/or recover all dividends on such shares which were paid or payable subsequent to the date on which the prohibited transfer or breach was made or attempted. (viii) Additional PARS Provisions. The Board of Directors may, in its sole discretion, include additional provisions in any PARS granted under the Plan. 5.Limitation of Rights. (a) No Right to Continue as a Director. Neither the Plan, nor the granting of an Option or PARS nor any other action taken pursuant to the Plan, shall constitute or be evidence of any agreement or understanding, express or implied, that the Company will retain the optionee or recipient of PARS as a director for any period of time. (b) Rights as a Stockholder. (i) Options. An optionee shall have no rights as a stockholder with respect to the shares covered by his or her Option until the date of the issuance to him or her of a stock certificate therefor, and no adjustment will be made for dividends or other rights (except as provided in Section 6) for which the record date is prior to the date such certificate is issued. (ii) PARS. Subject to the limitations set forth in Section 4(d) and except as otherwise provided herein, a recipient of PARS, other than PARS Deferred Units, shall have all rights as a shareholder with respect to the shares subject to such PARS including, without limitation, any rights to receive dividends or non-cash distributions with respect to such shares and to vote such shares and act in respect of such shares at any meeting of shareholders. A recipient of PARS Deferred Units shall have no rights as a shareholder with respect to the Common Stock until the date of issuance to him or her of a stock certificate therefor, but the agreement evidencing the PARS Deferred Units may include the crediting of additional PARS Deferred Units equal in value to the cash amount of dividends paid with respect to same number of shares of Common Stock as the PARS Deferred Units. IV-4 6.Adjustment Provisions for Recapitalizations and Related Transactions. (a) If, through or as a result of any merger, consolidation, sale of all or substantially all of the assets of the Company, reorganization, recapitalization, reclassification, stock dividend, stock split, reverse stock split, or other similar transaction, (i) the outstanding shares of one or both series of Common Stock are increased or decreased or are exchanged for a different number or kind of shares or other securities of the Company, or (ii) additional shares or new or different shares or other securities of the Company or other non-cash assets are distributed with respect to one or both series of Common Stock or other securities, except as otherwise determined by the Board of Directors, an appropriate and proportionate adjustment shall be made in (x) the number and kind of shares of such series of Common Stock subject to Options or the number and kind of shares of such series of Common Stock or PARS Deferred Units subject to PARS to be granted to outside directors after such event pursuant to Section 4(b), (y) the number and kind of shares of such series of Common Stock subject to then outstanding Options or the number and kind of shares of such series of Common Stock or PARS Deferred Units subject to any then outstanding PARS under the Plan, and (z) the exercise price for each share of such series of Common Stock subject to any then outstanding Options or repurchase rights of the Company under the Plan, without changing the aggregate purchase price as to which such Options or repurchase rights of the Company remain exercisable. No fractional shares or PARS Deferred Units will be issued under the Plan on account of any such adjustments. (b) All share numbers herein have been adjusted to reflect the three- for-two stock split declared on November 12, 1998. 7.Mergers, Consolidations, Asset Sales, Liquidations, etc. Subject to the provisions of Section 4(c)(iii) and 4(d)(iv), in the event of a merger or consolidation or sale of all or substantially all of the assets of the Company in which outstanding shares of one or both series of Common Stock are exchanged for securities, cash or other property of any other corporation or business entity or in the event of a liquidation of the Company, the Board of Directors of the Company, or the board of directors of any corporation assuming the obligations of the Company, shall take one or more of the following actions, as to outstanding Options for such series of Common Stock: (i) provide that such Options shall be assumed, or equivalent Options shall be substituted, by the acquiring or succeeding corporation (or an affiliate thereof); (ii) upon written notice to the optionees, provide that all unexercised Options shall (A) immediately become exercisable in full and (B) terminate immediately prior to the consummation of such transaction unless exercised by the optionee within a specified period following the date of such notice; or (iii) in the event of a merger under the terms of which holders of one or both series of Common Stock of the Company will receive upon consummation thereof a cash payment for each share surrendered in the merger (the "Merger Price"), make or provide for a cash payment to such optionees equal to the difference between (A) the Merger Price times the number of shares of Common Stock subject to such outstanding Options (to the extent then exercisable) with exercise prices not in excess of the Merger Price and (B) the aggregate exercise price of all such Options, in exchange for the termination of such Options. 8.Change in Control. For purposes of the Plan, a "Change in Control" shall be deemed to have occurred if (i) any "person", as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act") (other than the Company, any trustee or other fiduciary holding securities under an employee benefit plan of the Company, or any corporation owned directly or indirectly by the stockholders of the Company in substantially the same proportion as their ownership of stock of the Company), is or becomes the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Company representing 30% or more of the combined voting power of the Company's then outstanding securities (other than pursuant to a merger or consolidation described in clause (A) or (B) of subsection (iii) below); (ii) during any period of two consecutive years ending during the term of the Plan (not including any period prior to the adoption of the Plan), individuals who at the beginning of such period constitute the Board of Directors of the Company, and any new director (other than a director designated by a person who has IV-5 entered into an agreement with the Company to effect any transaction described in clause (i), (iii) or (iv) of this Section 8) whose election by the Board of Directors or nomination for election by the Company's stockholders was approved by a vote of at least two-thirds of the directors then still in office who were either directors at the beginning of the period or whose election or nomination for election was previously so approved (collectively, the "Disinterested Directors"), cease for any reason to constitute a majority of the Board of Directors; (iii) the closing of a merger or consolidation of the Company or any subsidiary of the Company with any other corporation, other than (A) a merger or consolidation which would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity) more than 50% of the combined voting power of the voting securities of the Company or such surviving entity outstanding immediately after such merger or consolidation or (B) a merger or consolidation effected to implement a recapitalization of the Company (or similar transaction) in which no "person" (as defined above) acquires more than 30% of the combined voting power of the Company's then outstanding securities; or (iv) a complete liquidation of the Company or a sale by the Company of all or substantially all of the Company's assets. 9.Modification, Extension and Renewal of Options and PARS. The Board of Directors shall have the power to modify or amend outstanding Options and PARS; provided, however, that no modification or amendment may (i) have the effect of altering or impairing any rights or obligations of any Option or PARS previously granted without the consent of the optionee or holder thereof, as the case may be, or (ii) modify the number of shares of Common Stock subject to the Option or number of shares of Common Stock or PARS Deferred Units subject to the PARS (except as provided in Section 6). 10.Amendment of the Plan. The Board of Directors may suspend or discontinue the Plan or amend it in any respect whatsoever; provided, however, that without approval of the stockholders of the Company, no amendment may (i) materially modify the requirements as to eligibility to receive Options or PARS under the Plan, or (ii) materially increase the benefits accruing to participants in the Plan. 11.Withholding. (a) The Company shall have the right to deduct from payments of any kind otherwise due to the optionee or recipient of PARS any federal, state or local taxes of any kind required by law to be withheld with respect to any shares issued upon exercise of Options under the Plan or upon the expiration or termination of the Restricted Period relating to the PARS. Subject to the prior approval of the Company, the optionee or recipient of PARS may elect to satisfy such obligations, in whole or in part, (i) by causing the Company to withhold shares of Common Stock otherwise issuable pursuant to the exercise of an Option or upon the expiration or termination of the Restricted Period relating to the PARS or (ii) by delivering to the Company shares of Common Stock already owned by the optionee or PARS recipient. The shares so delivered or withheld shall have a fair market value equal to such withholding obligation. The fair market value of the shares used to satisfy such withholding obligation shall be determined by the Company as of the date that the amount of tax to be withheld is to be determined. An optionee or PARS recipient who has made an election pursuant to this Section 11(a) may only satisfy his or her withholding obligation with shares of Common Stock which are not subject to any repurchase, forfeiture, unfulfilled vesting or other similar requirements. (b) If the recipient of PARS under the Plan elects, in accordance with Section 83(b) of the Code, to recognize ordinary income in the year of acquisition of any shares awarded under the Plan, the Company will require at the time of such election an additional payment for withholding tax purposes based on the difference, if any, between the purchase price of such shares and the fair market value of such shares as of the date immediately preceding the date on which the PARS are awarded. 12.Notice. Any written notice to the Company required by any of the provisions of the Plan shall be addressed to the Treasurer of the Company and shall become effective when it is received. IV-6 13.Governing Law. The Plan and all determinations made and actions taken pursuant hereto shall be governed by the laws of the State of Delaware. 14.Stockholder Approval. The Plan is conditional upon stockholder approval of the Plan, and the Plan shall be null and void if the Plan is not so approved by the Company's stockholders. Amended and restated by the Board of Directors on September 10, 1998 and approved by stockholders on January 21, 1999; amended by the Board of Directors on September 14, 1999 and approved by stockholders on , 1999. IV-7 ANNEX V STAPLES, INC. AMENDED AND RESTATED 1998 EMPLOYEE STOCK PURCHASE PLAN The purpose of this Plan is to provide eligible employees of Staples, Inc. (the "Company") and certain of its subsidiaries with opportunities to purchase shares of either of two series of common stock, Staples Retail and Delivery common stock ("Staples Stock") or Staples.com common stock ("Staples.com Stock", and collectively with the Staples Stock, "Common Stock"), commencing on November 1, 1998. Eight million four hundred thousand (8,400,000) shares of Common Stock (regardless of series) in the aggregate have been approved for this purpose. Employees participating in the Plan may elect to purchase shares of either series of Common Stock, or shares of both series, subject to any limitations that may be imposed by the Board of Directors (the "Board") or the Committee (as defined below). 1. Administration. The Plan will be administered by the Board or by a Committee appointed by the Board (the "Committee"). The Board or the Committee has authority to make rules and regulations for the administration of the Plan and its interpretation and decisions with regard thereto shall be final and conclusive. 2. Eligibility. Participation in the Plan will neither be permitted nor denied contrary to the requirements of Section 423 of the Internal Revenue Code of 1986, as amended (the "Code"), and regulations promulgated thereunder. All employees of the Company, including Directors who are employees, and all employees of any subsidiary of the Company (as defined in Section 424(f) of the Code) designated by the Board or the Committee from time to time (a "Designated Subsidiary"), are eligible to participate in any one or more of the offerings of Options (as defined in Section 9) to purchase Common Stock under the Plan provided that: a. they are customarily employed by the Company or a Designated Subsidiary for more than 20 hours a week and for more than five months in a calendar year; and b. they have been employed by the Company or a Designated Subsidiary for at least three (3) months prior to enrolling in the Plan; and c. they are employees of the Company or a Designated Subsidiary on the first day of the applicable Plan Period (as defined below). No employee may be granted an option hereunder if such employee, immediately after the option is granted, owns 5% or more of the total combined voting power or value of the stock of the Company or any subsidiary. For purposes of the preceding sentence, the attribution rules of Section 424(d) of the Code shall apply in determining the stock ownership of an employee, and all stock which the employee has a contractual right to purchase shall be treated as stock owned by the employee. 3. Offerings. The Company will make one or more offerings ("Offerings") to employees to purchase stock under this Plan. The first Offering will begin on November 1, 1998, or the first business day thereafter (the "Offering Commencement Dates") and end on June 30, 1999. Thereafter, each July 1 and January 1 or the first business day thereafter will be an Offering Commencement Date. Each Offering Commencement Date will begin a period (a "Plan Period") during which payroll deductions will be made and held for the purchase of Common Stock at the end of the Plan Period. The first Plan Period will be eight (8) months and thereafter each Plan Period will be six (6) months. The Board or the Committee may, at its discretion, choose a different Plan Period of twelve (12) months or less for subsequent Offerings. 4. Participation. An employee eligible on the Offering Commencement Date of any Offering may participate in such Offering by enrolling at least fourteen (14) days prior to the applicable Offering Commencement Date in said Offering in such manner and at such time as the Committee shall approve. The enrollment will authorize a regular payroll deduction from the Compensation received by the employee during the Plan Period. Unless an employee changes his enrollment in a manner prescribed by the Committee from V-1 time to time or withdraws from the Plan, his deductions and purchases will continue at the same rate for future Offerings under the Plan as long as the Plan remains in effect. The term "Compensation" shall mean regular earnings and sales rewards or other sales-related payments made to sales associates in lieu of commissions, and excluding payments for overtime, incentive compensation, shift premiums, bonuses, contributions to all employee fringe benefits plans (except employee contributions in lieu of cash earnings pursuant to any "cash or deferred plan" or "cafeteria plan"), allowances and reimbursements, income or gains on the exercise of Company stock options or stock appreciation rights, and other special payments except to the extent that the inclusion of any such item is specifically approved by the Board. 5. Deductions. The Company will maintain payroll deduction accounts for all participating employees. With respect to any Offering made under this Plan, an employee may authorize a payroll deduction in any dollar amount up to a maximum of ten percent (10%) of the Compensation he or she receives during the Plan Period or such shorter period during which deductions from payroll are made. Payroll deductions may be made in any whole percentage up to ten percent (10%). Each participating employee shall designate what percentage of his or her payroll deductions during the Offering shall be used to purchase Staples Stock and what percentage shall be used to purchase Staples.com Stock upon the completion of such Offering, subject to any limits as may be imposed for such Offering by the Board or the Committee. Any change in compensation during the Plan Period will result in an automatic corresponding change in the dollar amount withheld. No employee may be granted an Option (as defined in Section 9) which permits his rights to purchase Common Stock under this Plan and any other employee stock purchase plan (as defined in Section 423(b) of the Code) of the Company and its subsidiaries, to accrue at a rate which exceeds $25,000 of the fair market value of the Common Stock (determined at the Offering Commencement Date of the Plan Period) for each calendar year in which the Option is outstanding at any time. 6. Deduction Changes. An employee may discontinue his payroll deduction once during any Plan Period, up to fifteen (15) days prior to the close of business on the last business day, in such manner permitted by the Board or Committee. However, an employee may not increase or decrease his payroll deduction, or change the allocation between series of Common Stock, during a Plan Period. If an employee elects to discontinue his payroll deductions during a Plan Period, amounts previously withheld will be refunded to the employee without interest. 7. Interest. Interest will not be paid on any employee accounts. 8. Withdrawal of Funds. An employee may at any time up to fifteen (15) days prior to the close of business on the last business day in a Plan Period and for any reason permanently draw out the balance accumulated in the employee's account and thereby withdraw from participation in an Offering. Partial withdrawals are not permitted. The employee may not begin participation again during the remainder of the Plan Period. The employee may participate in any subsequent Offering in accordance with terms and conditions established by the Board or the Committee. 9. Purchase of Shares. On the Offering Commencement Date of each Plan Period, the Company will grant to each eligible employee who is then a participant in the Plan an option ("Option") to purchase on the last business day of such Plan Period (the "Exercise Date"), at the Option Price hereinafter provided for, the largest number of shares of Common Stock of the Company (allocated between series as specified in such employee's payroll deduction authorization, subject to any limits as may be imposed for such Offering by the Board or the Committee) as does not exceed the number of shares determined by dividing $12,500 by the closing price (as defined below) on the Offering Commencement Date of such Plan Period. The purchase price for each share purchased will be 85% of the Fair Market Value of such series of Common Stock on (i) the first business day of such Plan Period or (ii) the Exercise Date, whichever Fair Market Value shall be less. Such Fair Market Value shall be (a) the mean between the highest and lowest V-2 selling price on any national securities exchange on which the Common Stock is listed, (b) the mean between the highest and lowest selling price of the Common Stock on the Nasdaq National Market, (c) the average of the mean between the highest reported bid price and the lowest reported asked price in the over-the- counter market, whichever is applicable, as published in The Wall Street Journal, or (d) if such series of Common Stock is not listed on any national securities exchange, the Nasdaq National Market or quoted in the over-the- counter market, the fair market value as determined in good faith by the Board or the Committee. If such series of Common Stock is listed on a national securities exchange or on the Nasdaq National Market, and if no sales of such series of Common Stock were made on such a day, the Fair Market Value of such series of Common Stock for purposes of clauses (a) and (b) above shall be based on the reported prices for the next preceding day on which sales were made. Each employee who continues to be a participant in the Plan on the Exercise Date shall be deemed to have exercised his Option at the Option Price on such date and shall be deemed to have purchased from the Company the number of shares of Common Stock (including fractional shares calculated up to 4 decimal places) reserved for the purpose of the Plan that his accumulated payroll deductions on such date will pay for (but not in excess of the maximum number determined in the manner set forth above), allocated between series of Common Stock in the manner specified in such employee's payroll deduction authorization, subject to any limits on such allocation as may be imposed by the Board or the Committee for such Offering. Any balance remaining in an employee's payroll deduction account at the end of a Plan Period will be automatically refunded to the employee. 10. Issuance of Certificates. Certificates representing shares of Common Stock purchased under the Plan may be issued only in the name of the employee, in the name of the employee and another person of legal age as joint tenants with rights of survivorship, or (in the Company's sole discretion) in the name of a brokerage firm, bank or other nominee holder designated by the employee or in the name of the Plan with appropriate allocation to the participating employee. The Company may, in its sole discretion and in compliance with applicable laws, authorize the use of book entry registration of shares in lieu of issuing stock certificates. 11. Rights on Retirement, Death or Termination of Employment. In the event of a participating employee's termination of employment prior to the last business day of a Plan Period, no payroll deduction shall be taken from any pay due and owing to an employee and the balance in the employee's account shall be paid to the employee or, in the event of the employee's death, (a) to a beneficiary previously designated in a revocable notice signed by the employee (with any spousal consent required under state law) or (b) in the absence of such a designated beneficiary, to the executor or administrator of the employee's estate or (c) if no such executor or administrator has been appointed to the knowledge of the Company, to such other person(s) as the Company may, in its discretion, designate. If, prior to the last business day of the Plan Period, the Designated Subsidiary by which an employee is employed shall cease to be a subsidiary of the Company, or if the employee is transferred to a subsidiary of the Company that is not a Designated Subsidiary, the employee shall be deemed to have terminated employment for the purposes of this Plan. 12. Optionees Not Stockholders. Neither the granting of an Option to an employee nor the deductions from his pay shall constitute such employee a stockholder of the shares of Common Stock covered by an Option under this Plan until such shares have been purchased by and issued to him or to an account for his benefit. 13. Rights Not Transferable. Rights under this Plan are not transferable by a participating employee other than by will or the laws of descent and distribution, and are exercisable during the employee's lifetime only by the employee. 14. Application of Funds. All funds received or held by the Company under this Plan may be combined with other corporate funds and may be used for any corporate purpose. V-3 15. Adjustment in Case of Changes Affecting Common Stock. In the event of a subdivision of outstanding shares of one or both series of Common Stock, or the payment of a dividend in one or both series of Common Stock, the number of shares approved for this Plan, and the share limitation set forth in Section 9, shall be increased proportionately, and such other adjustment shall be made as may be deemed equitable by the Board or the Committee. In the event of any other change affecting one or both series of Common Stock, such adjustment shall be made as may be deemed equitable by the Board or the Committee to give proper effect to such event. 16. Merger. If the Company shall at any time merge or consolidate with another corporation and the holders of the capital stock of the Company immediately prior to such merger or consolidation continue to hold at least 80% by voting power of the capital stock of the surviving corporation ("Continuity of Control"), the holder of each Option then outstanding will thereafter be entitled to receive at the next Exercise Date upon the exercise of such Option for each share as to which such Option shall be exercised the securities or property which a holder of such shares of such series of Common Stock was entitled to upon and at the time of such merger or consolidation, and the Board or the Committee shall take such steps in connection with such merger or consolidation as the Board or the Committee shall deem necessary to assure that the provisions of Section 15 shall thereafter be applicable, as nearly as reasonably may be, in relation to the said securities or property as to which such holder of such Option might thereafter be entitled to receive thereunder. In the event of a merger or consolidation of the Company with or into another corporation which does not involve Continuity of Control, or of a sale of all or substantially all of the assets of the Company while unexercised Options remain outstanding under the Plan, (a) subject to the provisions of clauses (b) and (c), after the effective date of such transaction, each holder of an outstanding Option shall be entitled, upon exercise of such Option, to receive in lieu of shares of one or both series of Common Stock, shares of such stock or other securities as the holders of shares of such series of Common Stock received pursuant to the terms of such transaction; or (b) all outstanding Options may be cancelled by the Board or the Committee as of a date prior to the effective date of any such transaction and all payroll deductions shall be paid out to the participating employees; or (c) all outstanding Options may be cancelled by the Board or the Committee as of the effective date of any such transaction, provided that notice of such cancellation shall be given to each holder of an Option, and each holder of an Option shall have the right to exercise such Option in full based on payroll deductions then credited to his account as of a date determined by the Board or the Committee, which date shall not be less than ten (10) days preceding the effective date of such transaction. 17. Amendment of the Plan. The Board may at any time, and from time to time, amend this Plan in any respect, except that (a) if the approval of any such amendment by the shareholders of the Company is required by Section 423 of the Code, such amendment shall not be effected without such approval, and (b) in no event may any amendment be made which would cause the Plan to fail to comply with Section 423 of the Code. 18. Insufficient Shares. In the event that the total number of shares of Common Stock specified in elections to be purchased in any Offering plus the number of shares purchased under previous Offerings under this Plan exceeds the maximum number of shares issuable under this Plan, the Board or the Committee will allot the shares then available on a pro rata basis. In the event that the total number of shares of a series of Common Stock specified in elections to be purchased in any Offering exceeds the maximum number of shares of such series available for purchase in such Offering (as specified by the Board or the Committee), the Board or the Committee will allot the shares of such series available on a pro rata basis or in such other manner as it, in its sole discretion, deems appropriate. 19. Termination of the Plan. This Plan may be terminated at any time by the Board. Upon termination of this Plan all amounts in the accounts of participating employees shall be promptly refunded. 20. Governmental Regulations. The Company's obligation to sell and deliver Common Stock under this Plan is subject to the approval of all governmental authorities required in connection with the authorization, issuance or sale of such stock. V-4 21. Governing Law. The Plan shall be governed by Massachusetts law except to the extent that such law is preempted by federal law. 22. Issuance of Shares. Shares may be issued upon exercise of an Option from authorized but unissued Common Stock, from shares held in the treasury of the Company, or from any other proper source. 23. Notification upon Sale of Shares. Each employee agrees, by entering the Plan, to promptly give the Company notice of any disposition of shares purchased under the Plan where such disposition occurs within two years after the date of grant of the Option pursuant to which such shares were purchased. 24. Effective Date and Approval of Shareholders. The Plan shall take effect on November 1, 1998 subject to approval by the shareholders of the Company as required by Section 423 of the Code, which approval must occur within twelve months of the adoption of the Plan by the Board. Adopted by the Board of Directors on March 6, 1998 and approved by the stockholders on June 4, 1998; and amended by the Board of Directors on September 14, 1999 and approved by stockholders on , 1999. V-5 ANNEX VI STAPLES RETAIL AND DELIVERY COMBINED FINANCIAL INFORMATION VI-1 ANNEX VI STAPLES RETAIL AND DELIVERY INDEX TO COMBINED FINANCIAL INFORMATION Management's Discussion and Analysis of Financial Condition and Results of Operations........................................................... VI-3 Audited Financial Statements Report of Independent Auditors......................................... VI-14 Combined Balance Sheets -- January 30, 1999 and January 31, 1998....... VI-15 Combined Statements of Income -- Fiscal years ended January 30, 1999, January 31, 1998 and February 1, 1997................................. VI-16 Combined Statements of Business Equity -- Fiscal years ended January 30, 1999, January 31, 1998 and February 1, 1997....................... VI-17 Combined Statements of Cash Flows -- Fiscal years ended January 30, 1999, January 31, 1998 and February 1, 1997........................... VI-18 Notes to Staples Retail and Delivery Combined Financial Statements..... VI-19 Interim Financial Statements (Unaudited) Combined Balance Sheets -- July 31, 1999 and January 30, 1999.......... VI-39 Combined Statements of Income -- 26 weeks ended July 31, 1999 and August 1, 1998........................................................ VI-40 Combined Statements of Cash Flows -- 26 weeks ended July 31, 1999 and August 1, 1998........................................................ VI-41 Notes to Staples Retail and Delivery Combined Interim Financial Information........................................................... VI-42
VI-2 STAPLES RETAIL AND DELIVERY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS You should read this discussion along with the Staples.com Combined Financial Statements contained in this Proxy Statement. Historical results and percentage relationships may not necessarily be indicative of operating results for any future periods. The combined financial statements of Staples Retail and Delivery ("Staples RD") include the balance sheets, statements of operations, cash flows and group equity of Staples' retail stores, catalog businesses and contract stationer businesses. The Staples RD combined financial statements also include its retained interest in Staples.com, currently 100 percent. The stockholders of Staples, Inc. ("Staples" or the "Company") are scheduled to vote on a proposal (the "Tracking Stock Proposal") to amend the Company's certificate of incorporation to (i) create a new class of common stock called Staples.com common stock ("Staples.com Stock"), intended to reflect the performance of Staples.com, the Company's e-commerce business division, (ii) increase the aggregate number of shares of common stock that the Company may issue from 1,500,000,000 to 2,100,000,000, initially comprised of 1,500,000,000 shares of Staples Retail and Delivery common stock ("Staples Stock") and 600,000,000 shares of Staples.com Stock, and (iii) reclassify Staples' existing common stock as Staples Stock, intended to reflect the performance of Staples RD, which consists of all of the Company's other businesses and a retained interest in Staples.com. If the Tracking Stock Proposal is approved by the Company's stockholders, the filing of the amendment to the Company's certificate of incorporation implementing the proposal will automatically reclassify each share of existing common stock into Staples Stock. Subject to stockholder approval of the Tracking Stock Proposal, the Company expects to issue additional shares of Staples.com Stock in one or more private or public financings within twelve months of such approval. The specific terms of the financings, including whether they are private or public, the amount of Staples.com Stock issued, and the timing of the financings, will depend upon factors such as stock market conditions and the performance of Staples.com. The effect of any financings on the retained interest percentage and the outstanding interest percentage would depend upon the number of shares of Staples.com Stock sold and whether the Company elects to attribute the net proceeds of such financings to the equity of Staples.com or to Staples RD in respect of its retained interest. The Staples RD combined financial statements and Staples.com combined financial statements comprise all of the accounts included in the consolidated financial statements of Staples. The separate business combined financial statements give effect to all allocation and related party transaction policies as adopted by the Board of Directors of Staples (the "Board"). These policies are described in Note C to the Staples RD combined financial statements. The Staples RD combined financial statements have been prepared in a manner which management believes is reasonable and appropriate. Such combined financial statements include (i) the financial position, results of operations and cash flows of Staples RD, (ii) the Company's debt and the effects that such debt had on the related Staples RD statements of income and cash flows, and (iii) the effects of a 100 percent retained interest in Staples.com on the combined statements of income and combined balance sheets. If the Tracking Stock Proposal is approved by the Company's stockholders, the Company will provide to the holders of Staples Stock separate financial statements, financial reviews, descriptions of the business, and other relevant financial information for Staples RD and Staples.com as well as consolidated financial information for the Company. Notwithstanding the allocation of assets and liabilities, including contingent liabilities, between Staples RD and Staples.com for the purposes of preparing their respective combined financial statements, this allocation and the change in the capital structure of the Company as a result of the approval of the Tracking Stock Proposal will not result in the distribution or spin-off to stockholders of any of the Company's assets and liabilities and will not affect ownership of its assets or responsibility for its liabilities or those of its subsidiaries. Holders of Staples Stock will remain common stockholders of the Company. The VI-3 assets the Company attributes to one business will be subject to the liabilities of the other business, even if such liabilities arise from lawsuits, contracts or indebtedness that are attributed to the other business. If the Company is unable to satisfy one business's liabilities out of the assets attributed to it, the Company may be required to satisfy those liabilities with assets the Company has attributed to the other business. Further, holders of Staples Stock and Staples.com Stock will not have any legal rights related to specific assets of either business and in any liquidation will receive a fixed share of the net assets of the Company which may not reflect the actual trading prices, if any, of the respective businesses at such time. Financial effects from one business that affect the Company's consolidated results of operations or financial condition could, if significant, affect the results of operations or financial condition of the other businesses and the market price of the stock relating to the other businesses. In addition, net losses of either business and dividends and distributions on, or repurchases of, either class of common stock or repurchases of preferred stock at a price per share greater than par value will reduce the funds we can pay on each class of common stock under Delaware law. Accordingly, the Staples RD combined financial statements should be read in conjunction with the Company's audited consolidated financial information and Annual Report on Form 10-K, and the combined financial information of Staples.com contained in Annex VII of this Proxy Statement. Results of Operations Comparison of Fiscal Years Ended January 30, 1999, January 31, 1998, and February 1, 1997 General. During the fiscal year ended January 30, 1999, Staples RD acquired, in a pooling of interests transaction, Quill Corporation and certain related entities, including the operations of Quillcorp.com (collectively referred to as "Quill"), with 1997 net sales of approximately $551 million. The financial information set forth below includes adjustments to give effect to the acquisition of Quill for all periods presented. Prior to its acquisition by Staples RD, Quill elected to be treated as an S Corporation under the Internal Revenue Code, and accordingly, its earnings were not subject to taxation at the corporate level. Pro forma adjustments have been made to reflect a provision for income taxes on such previously untaxed earnings for each period presented at an assumed rate of 40%. The statements of income combine Staples RD's historical operating results for the fiscal years ended January 31, 1998 and February 1, 1997 with corresponding Quill operating results for the years ended December 31, 1997 and 1996, respectively. Sales. Sales increased 24.1% to $7,106,303,000 in the fiscal year ended January 30, 1999 from $5,728,439,000 in the fiscal year ended January 31, 1998. Sales increased 27.5% in the fiscal year ended January 31, 1998 from $4,493,554,000 in the fiscal year ended February 1, 1997. The growth in each year was attributable to an increase in the number of open stores, increased sales in existing stores and increased sales in delivery operations. In addition, sales for the fiscal years ended January 30, 1999 and January 31, 1998 (beginning in May 1997) include the consolidation of Staples UK and Staples (Deutschland) GmbH ("Staples Germany," formerly MAXI-Papier-Markt- GmbH). Comparable store and delivery sales for the fiscal year ended January 30, 1999 increased 11% over the fiscal year ended January 31, 1998. Comparable store and delivery hub sales for the year ended January 31, 1998 increased 10% over the year ended February 1, 1997. As of January 30, 1999, January 31, 1998, and February 1, 1997, Staples RD had 913, 742, and 557 open stores, respectively. The January 30, 1999 total includes 174 stores opened and 3 stores closed during the twelve months ended January 30, 1999. Gross Profit. Gross profit as a percentage of sales was 24.2%, 23.6%, and 23.6% for the fiscal years ended January 30, 1999, January 31, 1998, and February 1, 1997, respectively. The gross profit rate was increased by continually improving margins in the retail and delivery business segments due to lower product costs from vendors and increased buying as well as the leveraging of fixed distribution center and delivery costs over a larger sales base. This was offset by decreases in the margin rates due to price reductions as well as an increase in the sales of computer hardware (CPUs and laptops), which generate a lower margin rate than other categories. VI-4 Operating and Selling Expenses. Operating and selling expenses, which consist of payroll, advertising and other operating expenses, were 13.9%, 14.1%, and 14.0% of sales for the fiscal years ended January 30, 1999, January 31, 1998, and February 1, 1997, respectively. The decrease as a percentage of sales for the year ended January 30, 1999 was primarily due to decreased advertising as a percentage of sales and increased leveraging of fixed store payroll expenses and store operating costs as store sales have increased. These factors were partially offset by increases in store labor and costs incurred for Staples RD's store remodel program under which significant investments have been made in store layouts and signing to improve shopability and enhance customer service. In addition, operating and selling expenses for the year ended January 30, 1999 and the year ended January 31, 1998 (beginning in May 1997) include the results of Staples UK and Staples Germany, which have higher costs as a percentage of sales. Pre-opening Expenses. Pre-opening expenses relating to new store openings, consisting primarily of salaries, supplies, marketing and occupancy costs, are expensed by Staples RD as incurred and therefore fluctuate from period to period depending on the timing and number of new store openings. Pre-opening expenses averaged $80,000, $73,000, and $72,000 per store for the stores opened in the years ended January 30, 1999, January 31, 1998, and February 1, 1997, respectively. The increase during the fiscal year ended January 30, 1999 was due primarily to increased openings outside of the United States which generally involve higher pre-opening expenses per store. General and Administrative Expenses. General and administrative expenses as a percentage of sales were 4.2%, 3.9%, and 3.9% in the years ended January 30, 1999, January 31, 1998, and February 1, 1997, respectively. The increase as a percentage of sales for the year ended January 30, 1999 as compared to the years ended January 31, 1998 and February 1, 1997 was primarily due to costs incurred for Year 2000 compliance projects. In addition, Staples RD has made other investments in its information systems' ("IS") staffing and infrastructure, which Staples RD believes will reduce costs as a percentage of sales in future years. In addition, general and administrative expenses for the years ended January 30, 1999 and January 31, 1998 include the results of Staples UK and Staples Germany, which have higher costs as a percentage of sales. The overall increase in general and administrative costs were partially offset by Staples RD's ability to increase sales without proportionately increasing overhead expenses in its core retail and direct business. Merger-related and Integration Costs. In connection with the acquisition of Quill, Staples RD recorded a charge to operating expense of $41,000,000 during the year ended January 30, 1999. These costs consist of direct merger-related and integration costs from the transaction. The merger transaction costs of approximately $10,500,000 consist primarily of fees for investment bankers, attorneys, accountants and other related charges. The integration costs primarily include employee costs of approximately $7,000,000, contract and lease termination costs of approximately $14,100,000, the write-down of leasehold improvements of approximately $3,500,000 and other merger-related costs of approximately $5,900,000. Staples RD paid approximately $14,000,000 in fiscal year 1998, which consists primarily of transaction and employee related costs. During the year ended January 31, 1998, Staples RD charged to expense non-recurring costs in connection with the proposed merger with Office Depot, Inc. of $29,665,000. Store Closure Charge. In December 1998, Staples RD committed to a plan to close and relocate stores which cannot be expanded and upgraded to its current store model. In connection with this plan, Staples RD recorded a charge to operating expense of $49,706,000. This charge includes $29,620,000 for future rental payments under operating lease agreements that will be paid after the store is closed and will not be subsidized by subtenant income, $4,966,000 in fees, settlement costs and other expenses related to store closure and $15,120,000 in asset impairment charges. Lease agreements for the relocation sites will be executed during fiscal year 1999 and the stores will be closed and relocated during fiscal years 1999 and 2000. Staples RD made no payments in fiscal year 1998 related to the store closure charge. Interest and Other Expense, Net. Net interest and other expense totaled $17,342,000, $21,947,000, and $22,959,000 in the fiscal years ended January 30, 1999, January 31, 1998, and February 1, 1997, respectively. The interest expense relates primarily to existing borrowings which were used to fund the increase in store VI-5 inventories related to new store openings and improvements in in-stock levels; the acquisition of fixed assets for new stores opened and remodeled; continued investments in the information systems and distribution center infrastructure; and additional investments in Staples UK and Staples Germany as well as the purchase of them during the fiscal year ended January 31, 1998. The decrease in interest expense during the year ended January 30, 1999 is due primarily to the conversion of the Staples RD's $300,000,000 of 4 1/2% Debentures into common stock in December 1998. Equity in Loss of Affiliates. Staples RD's Equity in Loss of Affiliates was $5,953,000 and $11,073,000 respectively, in the years ended January 31, 1998 and February 1, 1997. Staples RD recorded no equity in loss of affiliates for the year ended January 30, 1999, due to the acquisition of Staples UK and Staples Germany on May 6, 1997 and May 7, 1997, respectively. As a result of the acquisitions, Staples RD's ownership interest of Staples UK increased to 100% and its ownership of Staples Germany increased to approximately 92% which was increased to 100% in December 1998. The transactions were accounted for in accordance with the purchase method of accounting and accordingly, the consolidated results of these entities are reflected in Staples RD's combined financial statements since the respective dates of acquisition. Prior to the acquisitions, Staples UK and Staples Germany were accounted for under the equity method which resulted in Staples RD's share of losses from operations being included in Equity in Loss of Affiliates. As of January 30, 1999, Staples UK and Staples Germany operated 48 and 25 stores, respectively. Retained Interest In Staples.com. Staples RD currently has a 100% retained interest in Staples.com, and accordingly, the loss related to the retained interest in Staples.com of $487,000, $300,000 and $207,000 for the years ended January 30, 1999, January 31, 1998 and February 1, 1997, respectively, represents the net loss of Staples.com for each of those years. Income Taxes. The provision for income taxes as a percentage of pre-tax income was 39.6%, 32.8% and 31.5% for the years ended January 30, 1999, January 31, 1998 and February 1, 1997. On a pro forma basis, to reflect a provision for income taxes on previously untaxed earnings of Quill, Staples RD's effective tax rate would have been 40.2%, 38.7% and 38.8% respectively for the same periods. The increase in the pro forma tax rate in fiscal year 1998 was primarily due to non-deductible merger-related costs. Comparison of the 26 Weeks Ended July 31, 1999 and August 1, 1998 Sales. Sales increased 23.7% to $3,884,874,000 for the six months ended July 31, 1999 compared to $3,141,258,000 for the six months ended August 1, 1998. This growth was attributable to an increased number of open stores and increased sales in existing stores and in the delivery and contract stationer segments. Comparable store and delivery hub sales for the six months ended July 31, 1999 increased 8% over the same period ended August 1, 1998. Comparable sales in the contract stationer segment, including Quill, increased 10% for the six months ended July 31, 1999 as compared to the six months ended August 1, 1998. Staples RD had 1,009 stores open as of July 31, 1999 compared to 830 stores as of August 1, 1998 and 913 stores as of January 30, 1999; this total includes 96 stores opened during the six months ended July 31, 1999. Gross Profit. Gross profit as a percentage of sales was 24.3% for the six months ended July 31, 1999 as compared to 23.2% for the same period in the prior year. The gross profit rate was increased by continually improving margins in the retail and delivery segments due to lower product costs from vendors and improved worldwide buying as well as the leveraging of fixed distribution center and delivery costs over a larger sales base. Furthermore, Staples Communications (formerly Claricom Holdings, Inc.), with its first full quarter of operations after being acquired by Staples RD on February 26, 1999, contributed to the increase in gross profit. These increases were partially offset by continued price reductions and decreased margins on computer hardware sales such as CPU's, laptops, and printers and new market occupancy costs. Operating and Selling Expenses. Operating and selling expenses, which consist of payroll, advertising and other operating expenses, increased as a percentage of sales in the six months ended July 31, 1999 to 14.9%, as compared to 14.5% for the same period in the prior year. The increase was primarily due to VI-6 increased costs of investing in selling operations, particularly retail and call center personnel, increased marketing costs in delivery operations and the addition of Staples Communications. Staples Communications had higher operating and selling expenses as a percentage of sales. These increases were partially offset by the continued leveraging of fixed store and delivery operating costs as sales have increased. Pre-Opening Expenses. Pre-opening expenses relating to new store openings, consisting primarily of salaries, supplies, marketing and occupancy costs, are expensed as incurred and therefore fluctuate from period to period depending on the timing and number of new store openings. Pre-opening expenses averaged $98,000 per store for the six months ended July 31, 1999, as compared to $85,000 per store for the same period in the prior year. General and Administrative Expenses. General and administrative expenses as a percentage of sales were 4.4% for the six months ended July 31, 1999 and August 1, 1998. Higher costs incurred for Year 2000 compliance projects and IS staffing infrastructure during the six months ended July 31, 1999 and the addition of Staples Communications which has higher general and administrative expenses as a percentage of sales were offset by Staples RD's ability to increase sales without proportionately increasing overhead expenses in its core retail and direct business. Amortization of Goodwill. Amortization of goodwill for the six months ended July 31, 1999 was $5,258,000 as compared to $1,851,000 for the same period in the prior year. The increase in amortization is due to the goodwill from the acquisitions of Ivan Allen Corporation on November 1, 1998 and Claricom Holdings, Inc., now referred to as Staples Communications, on February 26, 1999. Merger Related and Integration Costs. In connection with the acquisition of Quill, Staples RD recorded a charge to operating expense of $41,000,000 during the six months ended August 1, 1998. These costs consist of direct merger- related and integration costs from the transaction. Interest and Other Expense, Net. Net interest and other expense for the six months ended July 31, 1999 was $5,341,000 as compared to $10,613,000 for the same period in the prior year. The interest expense relates primarily to existing borrowings. The decrease in net interest expense during the six months ended July 31, 1999 was primarily due to the conversion of Staples RD's $300,000,000 of 4 1/2% Debentures into common stock in December 1998. Retained Interest in Staples.com. Staples RD currently has a 100% retained interest in Staples.com. Accordingly, the loss related to the retained interest in Staples.com of $3,706,000 and $104,000 for the six months ended July 31, 1999 and August 1, 1998 respectively, represents the net loss of Staples.com for each of those periods. Income Taxes. The provision for income taxes as a percentage of pre-tax income was 39.8% for the six months ended July 31, 1999 and 39.6% for the same period ended August 1, 1998. On a pro forma basis, to reflect a provision for income taxes on previously untaxed earnings of Quill, Staples RD's effective tax rate would have been 42.1% for the six months ended August 1, 1998. Liquidity and Capital Resources Staples manages most finance activities on a centralized, consolidated basis. These activities include the investment of surplus cash, the issuance, repayment and repurchase of short-term and long-term debt, and the issuance and repurchase of common stock. Staples currently attributes each incurrence or issuance of external debt, and the proceeds thereof, to Staples RD and will continue to do so in the future unless the Board determines otherwise. Whenever Staples.com holds cash, Staples.com will normally, but will not be obligated to, transfer that cash to Staples RD. Conversely, whenever Staples.com has a cash need, Staples RD will normally, but will not be obligated to, fund that cash need. The Board will determine, in its sole discretion, whether either business will provide any particular funds on any particular occasion to the other business, but will not be obligated to cause such cash transfers. VI-7 All cash transfers from one business to or for the account of the other business (other than transfers in return of assets or services rendered or transfers in respect of Staples RD's retained interest that correspond to dividends paid on Staples.com Stock), will be accounted for as inter-business revolving credit advances unless: . the Board determines that a given transfer, or type of transfer, should be accounted for as a long-term loan, . the Board determines that a given transfer or type of transfer, should be accounted for as a capital contribution increasing Staples RD's retained interest in Staples.com, . the Board determines that a given transfer, or type of transfer, should be accounted for as a return of capital reducing Staples RD's retained interest in Staples.com. There are no specific criteria to determine when Staples RD will account for a cash transfer as a long-term loan, a capital contribution or a return of capital rather than an inter-business revolving credit advance. The Board would make such a determination based on its judgment at the time of such transfer, or at the time of the first of such type of transfer, based upon all relevant circumstances. Factors the Board would consider include: . the current and projected capital structure of each business, . the relative levels of internally generated funds of each business, . the financing needs and objectives of the recipient business, . the investment objectives of the transferring business, the availability, cost and time associated with the alternative financing sources and prevailing interest rates and general economic conditions. Any cash transfer accounted for as an inter-business revolving credit advance will bear interest at a rate at which the Board, in its sole discretion, determines Staples could borrow such funds on a revolving credit basis. Any cash transfer accounted for as a long-term loan will have interest rate, amortization, maturity, redemption and other terms that generally reflect the then prevailing terms on which the Board, in its sole discretion, determines Staples could borrow such funds. Any cash transfer from Staples RD to Staples.com's, or for Staples.com's account, accounted for as a capital contribution will correspondingly increase Staples.com equity and Staples RD's retained interest in Staples.com. As a result, the number of shares issuable with respect to Staples RD's retained interest in Staples.com will increase by the amount of such capital contribution divided by the market value of Staples.com Stock on the date of transfer. Any cash transfer from Staples.com to Staples RD, or for Staples RD's account, accounted for as a return of capital will correspondingly reduce Staples.com's equity and Staples RD's retained interest in Staples.com . As a result, the number of shares issuable with respect to Staples RD's retained interest in Staples.com will decrease by the amount of such return of capital divided by the market value of Staples.com Stock on the date of transfer. As a result of the cash management policies in place between Staples RD and Staples.com, Staples.com is heavily dependent on Staples RD for its continued funding. Accordingly, Staples RD's liquidity could be adversely affected by the liquidity needs of Staples.com. Staples RD has traditionally used a combination of cash generated from operations and debt or equity offerings to fund its expansion and acquisition activities. Staples RD has also utilized its revolving credit facility to support various growth initiatives. Staples RD opened 174 stores, 130 stores, and 115 stores in the years January 30, 1999, January 31, 1998 and February 1, 1997, respectively, and closed three stores in the fiscal year ended January 30, 1999 and one store in each of the fiscal years ended January 31, 1998 and February 1, 1997. In addition, in the fiscal year ended January 31, 1998, 56 stores were added as a result of the acquisition of Staples UK and Staples Germany. VI-8 Staples RD opened 96 stores and 89 stores during the six months ended July 31, 1999 and August 1, 1998, respectively. During the six months ended August 1, 1998, one store was closed. To the extent that the store base matures and becomes more profitable, cash generated from store operations is expected to provide a greater portion of funds required for new store inventories and other working capital requirements. Sales generated by the contract stationer business segment and certain direct mail customers are made under regular credit terms, which requires that Staples RD carry its own receivables from these sales. As Staples RD expands its contract and direct mail businesses worldwide, it anticipates that its accounts receivable portfolio will grow. Receivables from Staples RD's vendors under rebate, cooperative advertising and marketing programs are a significant percentage of its total receivables and tend to fluctuate somewhat seasonally. Staples RD also utilized capital equipment financings to fund current working capital requirements. During the year ended January 30, 1999, Staples RD paid approximately $14,000,000 of mortgages in full on five distribution centers acquired from Quill. As of January 30, 1999, cash, cash equivalents, and short-term investments totaled $375,421,000, a decrease of $11,569,000 from the January 31, 1998 balance of $386,990,000. The principal sources of funds were primarily cash from operations, including an increase in accounts payable and accrued expenses of $273,195,000, which financed the increase in merchandise inventory of $211,052,000 related to new store openings, expanded product assortment and improvements in in-stock levels. These sources were offset by the acquisition of property and equipment of $321,236,000 and cash used in the acquisition of Quill of $48,102,000. During the six months ended July 31, 1999, cash, cash equivalents decreased by $357,993,000. This decrease was primarily attributable to cash used in investing activities of $289,867,000, including cash used in the acquisition of Staples Communications (formerly Claricom Holdings, Inc.) of $137,625,000 and the acquisition of property and equipment of $145,897,000, primarily for the 96 new stores opened; as well as cash used in operating activities of $84,008,000, which includes an increase in merchandise inventories of $170,321,000 and an increase in accounts receivable of $136,723,000. Cash provided by financing activities of $15,655,000 includes $68,658,000 of net borrowings and $25,243,000 of proceeds from sales of capital stock for the exercise of stock options and the employee stock purchase plan offset by treasury stock purchases of $78,246,000. Staples RD expects to open approximately 75 stores during the last two quarters of fiscal 1999. Staples RD estimates that its cash requirements, including pre-opening expenses, inventory, leasehold improvements and fixtures, will be approximately $1,400,000 for each new store (excluding the cost of any acquisitions of lease rights). Accordingly, Staples RD expects to use approximately $105,000,000 for store openings during this period. In December 1998, Staples RD committed to a plan to close and relocate stores which cannot be expanded and upgraded to its current store model. Lease agreements for the relocation sites will be executed during fiscal year 1999 and the stores will be closed and relocated during fiscal years 1999 and 2000. During the six months ended July 31, 1999, Staples began a stock repurchase program intended to provide shares for employee stock programs. Staples expects to repurchase approximately 6,000,000 shares of Staples common stock annually and has authorized up to $200,000,000 to be used in fiscal 1999 for these repurchases. During the six months ended July 31, 1999, Staples repurchased 2,321,000 shares for approximately $68,962,000 under this program and 309,000 shares for approximately $9,284,000 from employees upon exercise of PARS. In addition, during the quarter ended July 31, 1999, Staples entered into an equity forward purchase agreement to hedge against stock price fluctuations for the repurchase of its common stock in connection with the annual stock option grant to employees and directors. Under the agreement, Staples must purchase 2,600,000 shares at an average price of $30.263. The Company may elect to settle the contract on a net share basis in lieu of physical settlement. Staples RD also plans to continue to make investments in information systems, distribution centers and store remodeling to improve operational efficiencies and customer service, and may expend additional funds to acquire businesses or lease rights from tenants occupying retail space that is suitable for a Staples store. VI-9 Staples RD expects to meet these cash requirements through a combination of operating cash flow and borrowings from our existing revolving line of credit. In February 1999, Staples RD completed the acquisition of Claricom Holdings, Inc. and certain related entities, now referred to as Staples Communications, for a purchase price of approximately $140,000,000. On August 12, 1997, Staples RD issued $200,000,000 of 7.125% senior notes with interest payable semi-annually on February 15 and August 15 of each year commencing on February 15, 1998. Net proceeds of approximately $198,000,000 from the sale of the senior notes were used for repayment of indebtedness under Staples RD's revolving credit agreement and for general working capital purposes, including the financing of new store openings, distribution facilities and corporate offices. Staples RD also maintains a revolving credit facility, effective through November 2002, with a syndicate of banks which provides up to $350,000,000 of available borrowings. Borrowings made pursuant to this facility will bear interest at either the lead bank's prime rate, the federal funds rate plus 0.50%, the LIBOR rate plus a percentage spread based upon certain defined ratios, a competitive bid rate or a swing line loan rate. This agreement, among other conditions, contains certain restrictive covenants, including net worth maintenance, minimum fixed charge interest coverage and limitations on indebtedness and sales of assets. As of July 31, 1999, $60,000,000 of borrowings was outstanding under the revolving credit agreement. Staples RD also has available $35,000,000 in other uncommitted, short-term bank credit lines, of which no borrowings were outstanding as of July 31, 1999. Staples UK has a $50,000,000 line of credit which had an outstanding balance of $41,433,000 at July 31, 1999 and Business Depot has a $16,610,000 line of credit which had no outstanding balance at July 31, 1999. Total short-term investments and available revolving credit amounts totaled $351,429,000 as of July 31, 1999. Staples RD expects that income from operations, together with its current short-term investments and funds available under its revolving credit facility will be sufficient to fund its planned store openings, meet the cash needs of the Staples.com and other recurring operating cash needs for at least the next twelve to eighteen months. Staples RD continually evaluates financing possibilities, and it may seek to raise additional funds through any one or a combination of public or private debt or equity-related offerings, depending on market conditions, or through an additional commercial bank debt arrangement. Inflation and Seasonality While neither inflation nor deflation has had, and Staples RD does not expect either to have, a material impact upon operating results, there can be no assurance that its businesses will not be affected by inflation or deflation in the future. Staples RD believes that its businesses are somewhat seasonal, with sales and profitability slightly lower during the first and second quarters of the fiscal year. Future Operating Results This document includes or incorporates forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. You can identify these forward-looking statements by the use of the words "believes", "anticipates", "plans", "expects", "may", "will", "would", "intends", "estimates" and other similar expressions, whether in the negative or affirmative. Staples RD cannot guarantee that it actually will achieve these plans, intentions or expectations disclosed in the forward looking statements it makes. Staples RD has included important factors in the cautionary statements below that it believes could cause its actual results to differ materially from the forward-looking statements that it makes. The forward-looking statements do not reflect the potential impact of any future acquisitions, mergers or dispositions. Staples RD does not assume any obligation to update any forward-looking statement it makes. VI-10 Staples RD's market is highly competitive and Staples RD may not continue to compete successfully. Staples RD competes in a highly competitive marketplace with a variety of retailers, dealers and distributors. In most of Staples RD's geographic markets, it competes with other high-volume office supply chains, such as Office Depot, OfficeMax and Office World, that have store formats, pricing strategies and product selections that are similar to Staples RD. Staples RD also competes with mass merchants, such as Wal-Mart, warehouse clubs, computer and electronic superstores, and other discount retailers. In addition, Staples RD's retail stores and delivery and contract businesses compete with numerous mail order firms, contract stationer businesses and direct manufacturers. Many of Staples RD's competitors, including Office Depot, OfficeMax and Wal-Mart, have in recent years significantly increased the number of stores they operate within Staples RD's markets. Some of Staples RD's current and potential competitors are larger than Staples RD and have substantially greater financial resources. It is possible that increased competition or improved performance by Staples RD's competitors may reduce Staples RD's market share, may force Staples RD to charge lower prices than it otherwise would, and may adversely affect Staples RD's business and financial performance in other ways. Staples RD may be unable to continue to successfully open new stores. An important part of Staples RD's business plan is to aggressively increase the number of its stores. Staples RD opened 174 stores in the United States, Canada and Europe in fiscal 1998 and plans to open approximately 170 new stores in fiscal 1999. For Staples RD's growth strategy to be successful, it must identify and lease favorable store sites, hire and train employees and adapt its management and operational systems to meet the needs of its expanded operations. These tasks may be difficult to accomplish successfully. If Staples RD is unable to open new stores as quickly as planned, its future sales and profits could be materially adversely affected. Even if Staples RD succeeds in opening new stores, these new stores may not achieve the same sales or profit levels as Staples RD's existing stores. Also, Staples RD's expansion strategy includes opening new stores in markets where it already has a presence so it can take advantage of economies of scale in marketing, distribution and supervision costs. However, these new stores may result in the loss of sales in existing stores in nearby areas. Staples RD's quarterly operating results are subject to significant fluctuation. Staples RD's operating results have fluctuated from quarter to quarter in the past, and it expects that they will continue to do so in the future. Staples RD's earnings may not continue to grow at rates similar to the growth rates achieved in recent years and may fall short of either a prior fiscal period or investors' expectations. Factors that could cause these quarterly fluctuations include the following: . the number of new store openings, primarily because Staples RD expenses pre-opening expenses as they are incurred and newer stores are less profitable than mature stores; . the extent to which sales in new stores result in the loss of sales in existing stores; . the mix of products sold; . pricing actions of competitors; . the level of advertising and promotional expenses; . seasonality, primarily because the sales and profitability of its stores are typically slightly lower in the first and second quarter of our fiscal year than in other quarters; and . charges associated with acquisitions. Most of Staples RD's operating expenses, such as rent expense, advertising expense and employee salaries, do not vary directly with the amount of Staples RD's sales and are difficult to adjust in the short term. As a result, if sales in a particular quarter are below Staples RD's expectations for that quarter, it may not be able to proportionately reduce operating expenses for that quarter, and therefore this sales shortfall would have a disproportionate effect on Staples RD's net income for the quarter. VI-11 The market price of Staples Stock is based in large part on professional securities analysts' expectations that its business will continue to grow and that it will achieve certain levels of net income. If Staples RD's financial performance in a particular quarter does not meet the expectations of securities analysts, this may adversely affect the views of those securities analysts concerning Staples RD's growth potential and future financial performance. If the securities analysts that regularly follow Staples Stock lower their rating of the common stock or lower their projections for Staples RD's future growth and financial performance, the market price of Staples Stock is likely to drop significantly. In addition, in those circumstances the decrease in Staples Stock price would probably be disproportionate to the shortfall in financial performance. Staples RD's rapid growth may continue to strain its operations, which could adversely affect its business and financial results. Staples RD's business, including sales, number of stores and number of employees, has grown dramatically over the past several years. In addition, Staples RD has acquired a number of significant companies in the last few years and may make additional acquisitions in the future. This growth has placed significant demands on Staples RD's management and operational systems. If Staples RD is not successful in upgrading its operational and financial systems, expanding its management team and increasing and effectively managing its employee base, this growth is likely to result in operational inefficiencies and ineffective management of Staples RD's business and employees, which will in turn adversely affect Staples RD's business and financial performance. Staples RD's international operations may not become profitable. Staples RD currently operates in international markets through The Business Depot Ltd. in Canada, Staples UK in the United Kingdom and Staples Deutschland in Germany. Staples RD has recently acquired three European companies with operations in Germany, the Netherlands and Portugal. Staples RD's consolidated European operations are currently unprofitable, and Staples RD cannot guarantee that they will become profitable. Staples RD may seek to expand further into other international markets in the future. Staples RD's foreign operations encounter risks similar to those faced by its US stores, as well as risks inherent in foreign operations, such as local customs and competitive conditions and foreign currency fluctuations. Staples RD may be unable to obtain adequate future financing. It is possible that Staples RD will require additional sources of financing earlier than it anticipates, as a result of unexpected cash needs or opportunities, and expanded growth strategy or disappointing operating results. Additional funds may not be available on satisfactory terms when needed, or at all, whether in the next twelve to eighteen months or thereafter. For a discussion of other factors that may affect results, see "Risk Factors" included in this Proxy Statement. Year 2000 Readiness Disclosure Staples RD has completed a comprehensive assessment of its internal computer systems and applications, including those attributable to either business, to identify those that might be affected by computer programs using two digits rather than four to define the applicable year (the "Year 2000 issue"). Staples RD has used internal personnel as well as external contractors and consultants to identify those systems and applications which are affected by the Year 2000 issue. Those systems and applications identified as needing remediation have been or will be replaced or modified and tested for compliance. Remediation of the most critical Information Technology (IT) related systems and applications was completed on schedule during the first quarter of 1999, and anticipated individual application testing was completed during the second quarter of 1999. These systems include Merchandising/Logistics, Distribution, Store Point of Sale, and Corporate Finance. The remediation of the less critical IT systems was also completed during the second quarter of 1999. These systems and applications include Marketing Systems and Non-Mission Critical Desktop Applications. Testing of these less critical IT systems and full "end to end" testing of Staples RD's most critical systems is expected to be finished during the third quarter of 1999. VI-12 Staples RD has also finished its assessment of non-IT related systems and applications. The non-IT related systems and applications include but are not limited to telephone systems, store security systems and electrical systems. The remediation of these systems was completed during the first quarter of 1999 and testing will be completed during the third quarter of 1999. Assessment regarding the status of third parties' Year 2000 compliance continues to be ongoing and may carry into early 2000. Staples RD is also working with third parties, primarily major vendors but also customers, to ensure that they will be Year 2000 compliant as Staples RD's schedule requires. Responses have been received from the majority of vendors, but not all vendors have assured Staples RD that they will be compliant in time. As a contingency, alternative lists of third party vendors have been created in case a critical third party does not achieve compliance. Staples RD has completed its enterprise wide inventory review and has completed a comprehensive risk assessment relative to vendor provided products, devices and/or services. Due diligence and monitoring with respect to vendors with the greatest impact on Staples RD is scheduled to be performed on a continuous basis throughout 1999. Staples RD estimated that the total cost of Year 2000 compliance will be between $25 and $30 million, $24 million of which had been spent as of July 31, 1999. Most of the costs to be incurred are related to remediation and testing of software using outside contracted services. The costs of compliance have been included in Staples RD's current 1999 IT budgets. The inclusion of Year 2000 compliance has not caused any critical IT projects to be delayed or eliminated. Staples RD is currently preparing a "what steps to follow" contingency plan in the event that an area of its operations is impacted by the Year 2000 issue. A formal plan will be adopted if it becomes more evident that there will be an area of non-compliance in Staples RD's systems or at a critical third party. Staples RD is developing these procedures for all of its sites and listing those to contact in the event a "Year 2000 suspected" issue is encountered. Although Staples RD expects to achieve Year 2000 compliance as scheduled, there are potential risks if it does not become, or is late in becoming, Year 2000 compliant. Such risks include impairing Staples RD's ability to process and deliver customer orders and payments, procure saleable merchandise, and perform other critical business functions which could have a material impact on financial performance. Staples RD has yet to analyze the effect that an instance of critical non-compliance by it or a third party would have on revenues and expenses since a worst case scenario has not been identified. Further, there is also the risk that claims may be made against Staples RD in the event of its non-compliance or the non-compliance of the products and services which it sells. The costs of defending and settling such claims could have a material impact on Staples RD's financial statements. As of July 31, 1999, each Staples RD point of customer contact (stores, call centers and customer service) has access to a "Year 2000 Preparedness Guide" for its customers so Staples RD can be proactive in assisting them with vendor contacts to answer their Year 2000 questions. The information presented above is based on management's estimates which were made using assumptions of future events. Uncontrollable factors such as the compliance of the systems of third parties and the availability of resources could materially increase the cost or delay the estimated date of Year 2000 compliance. All Year 2000 statements contained herein are designated as "Year 2000 Readiness Disclosures" pursuant to the Year 2000 Information and Readiness Disclosures Act (P.L. 105-271). Euro Currency On January 1, 1999, participating member countries of the European Union established fixed conversion rates between their existing currencies and the European Union's common currency (the "euro"). The former currencies of the participating countries are scheduled to remain legal tender as denominations of the euro until January 1, 2002 when the euro will be adopted as the sole legal currency. Staples RD has evaluated the potential impact on its business, including the ability of its information systems to handle euro-denominated transactions and the impact on exchange costs and currency exchange rate risks. Based on the results of this evaluation, Staples RD does not expect the conversion to the euro to have a material impact on its operations or financial position. VI-13 REPORT OF INDEPENDENT AUDITORS Board of Directors and Shareholders Staples, Inc. We have audited the accompanying combined balance sheets of Staples Retail and Delivery (as described in Notes A and C) as of January 30, 1999 and January 31, 1998, and the related combined statements of income, group equity, and cash flows for each of the three years in the period ended January 30, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the 1996 and 1997 financial statements of Quill Corporation, a wholly owned subsidiary, which statements reflect 6% of total assets as of January 31, 1998 and 22% and 27% of net income of Staples Retail and Delivery for the years ended January 31, 1998 and February 1, 1997, respectively. Those statements were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to data included in Staples Retail and Delivery as it relates to Quill Corporation is based solely on the report of the other auditors. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, based on our audits and, for 1996 and 1997, the reports of other auditors, the financial statements referred to above present fairly, in all material respects, the financial position of Staples Retail and Delivery at January 30, 1999 and January 31, 1998 and the results of its operations and its cash flows for each of the three years in the period ended January 30, 1999 in conformity with generally accepted accounting principles. As more fully described in Notes A and C to these financial statements, Staples Retail and Delivery is a business group of Staples, Inc., accordingly, the combined financial statements of Staples Retail and Delivery should be read in conjunction with the audited financial statements of Staples, Inc. /s/ Ernst & Young LLP Ernst & Young LLP Boston, Massachusetts September 21, 1999 VI-14 STAPLES RETAIL AND DELIVERY COMBINED BALANCE SHEETS (Dollar Amounts in Thousands)
January 30, January 31, 1999 1998 ----------- ----------- ASSETS Current Assets: Cash and cash equivalents............................. $ 357,993 $ 381,088 Short-term investments................................ 17,428 5,902 Merchandise inventories............................... 1,340,432 1,124,642 Receivables, net...................................... 221,836 203,143 Deferred income taxes................................. 75,261 33,108 Prepaid expenses and other current assets............. 50,117 38,257 ---------- ---------- Total current assets................................ 2,063,067 1,786,140 Property and Equipment: Land and buildings.................................... 231,378 150,947 Leasehold improvements................................ 372,451 292,128 Equipment............................................. 399,153 304,177 Furniture and fixtures................................ 239,755 173,711 ---------- ---------- Total property and equipment........................ 1,242,737 920,963 Less accumulated depreciation and amortization........ 403,462 310,701 ---------- ---------- Net property and equipment.......................... 839,275 610,262 Other Assets: Retained interest in Staples.com ..................... 1,962 -- Lease acquisition costs, net of amortization.......... 75,127 43,244 Investments........................................... -- 16,450 Goodwill, net of amortization......................... 148,201 139,753 Deferred income taxes................................. 28,735 15,451 Other................................................. 22,814 27,562 ---------- ---------- Total other assets.................................. 276,839 242,460 ---------- ---------- $3,179,181 $2,638,862 ========== ========== LIABILITIES AND GROUP EQUITY Current Liabilities: Accounts payable...................................... $ 794,427 $ 672,956 Accrued expenses and other current liabilities........ 438,226 266,023 Debt maturing within one year......................... 32,594 43,501 ---------- ---------- Total current liabilities........................... 1,265,247 982,480 Long-Term Debt.......................................... 205,015 218,959 Other Long-Term Obligations............................. 52,033 42,803 Convertible Debentures.................................. -- 300,000 Minority Interest....................................... -- 135 Group Equity............................................ 1,656,886 1,094,485 ---------- ---------- $3,179,181 $2,638,862 ========== ==========
See notes to combined financial statements. VI-15 STAPLES RETAIL AND DELIVERY COMBINED STATEMENTS OF INCOME (Dollar Amounts in Thousands)
Fiscal Year Ended ---------------------------------- January January February 30, 31, 1, 1999 1998 1997 ---------- ---------- ---------- Sales...................................... $7,106,303 $5,728,439 $4,493,554 Cost of goods sold and occupancy costs..... 5,384,202 4,374,915 3,433,318 ---------- ---------- ---------- Gross profit............................. 1,722,101 1,353,524 1,060,236 Operating and other expenses: Operating and selling.................... 990,239 807,880 628,423 Pre-opening.............................. 13,836 9,443 8,299 General and administrative............... 299,187 225,001 175,621 Amortization of goodwill................. 3,739 3,581 2,291 Merger-related and integration costs..... 41,000 29,665 -- Store closure charge..................... 49,706 -- -- Interest and other expense, net.......... 17,342 21,947 22,959 ---------- ---------- ---------- Total operating and other expenses..... 1,415,049 1,097,517 837,593 ---------- ---------- ---------- Income before equity in loss of affiliates, retained interest and income taxes........ 307,052 256,007 222,643 Equity in loss of affiliates............... -- (5,953) (11,073) Loss related to retained interest in Staples.com............................... (487) (300) (207) ---------- ---------- ---------- Income before income taxes............. 306,565 249,754 211,363 Income tax expense......................... 121,330 81,924 66,621 ---------- ---------- ---------- Net income before minority interest.... 185,235 167,830 144,742 Minority interest........................ 135 84 -- ---------- ---------- ---------- Net income............................. $ 185,370 $ 167,914 $ 144,742 ========== ========== ========== Pro forma: Historical net income.................... $ 185,370 $ 167,914 $ 144,742 Provision for income taxes on previously untaxed earnings of pooled S-Corporation income.................................. 1,814 14,786 15,329 ---------- ---------- ---------- Pro forma net income................... $ 183,556 $ 153,128 $ 129,413 ========== ========== ==========
See notes to combined financial statements. VI-16 STAPLES RETAIL AND DELIVERY COMBINED STATEMENTS OF GROUP EQUITY (Dollar Amounts in Thousands) For the Fiscal Years Ended January 30, 1999, January 31, 1998, and February 1, 1997
Group Comprehensive Equity Income ---------- ------------- Balances at February 3, 1996........................ $ 712,141 Net income for the year............................. 144,742 144,742 Other comprehensive income.......................... 1,914 1,914 Issuance of common stock for stock options exercised.......................................... 13,729 Tax benefit on exercise of options.................. 16,773 Dividends to shareholders of acquired S-Corp........ (24,908) Sale of common stock under Employee Stock Purchase Plan............................................... 8,980 Contribution of common stock to Employees' 401(k) Savings Plan....................................... 1,998 Other equity changes, net........................... 454 ---------- -------- Balances at February 1, 1997........................ $ 875,823 $146,656 ======== Net income for the year............................. 167,914 167,914 Other comprehensive income.......................... (9,132) (9,132) Issuance of common stock for stock options exercised.......................................... 32,183 Tax benefit on exercise of options.................. 32,873 Dividends to shareholders of acquired S-Corp........ (25,175) Sale of common stock under Employee Stock Purchase Plan............................................... 10,499 Issuance of Performance Accelerated Restricted Stock.............................................. 7,182 Contribution of common stock to Employees' 401(k) Savings Plan....................................... 2,318 ---------- -------- Balances at January 31, 1998........................ $1,094,485 $158,782 ======== Net income for the year............................. 185,370 185,370 Other comprehensive income.......................... (2,409) (2,409) Issuance of common stock for conversion of debentures, net of interest and deferred charges... 298,533 Issuance of common stock for stock options exercised.......................................... 50,123 Tax benefit on exercise of options.................. 74,157 Dividends to shareholders of acquired S-Corp........ (15,904) Purchase and retirement of S-Corp shares............ (48,102) Sale of common stock under Employee Stock Purchase Plan............................................... 13,210 Issuance of Performance Accelerated Restricted Stock.............................................. 10,654 Purchase of treasury shares......................... (7,892) Contribution of common stock to Employees' 401(k) Savings Plan....................................... 3,288 Other equity changes, net........................... 1,373 ---------- -------- Balances at January 30, 1999........................ $1,656,886 $182,961 ========== ========
See notes to combined financial statements. VI-17 STAPLES RETAIL AND DELIVERY COMBINED STATEMENTS OF CASH FLOWS (Dollar Amounts in Thousands)
Fiscal Year Ended ----------------------------------- January 30, January 31, February 1, 1999 1998 1997 ----------- ----------- ----------- Operating Activities: Net income.............................. $ 185,370 $ 167,914 $ 144,742 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Minority interest....................... (135) (84) -- Retained interest in loss of Staples.com ....................................... 487 300 207 Depreciation and amortization........... 99,149 90,714 61,497 Merger-related and integration costs.... 41,000 29,665 -- Store closure charge.................... 49,706 -- -- Expense from 401K and PARS stock contribution........................... 12,764 10,409 2,715 Equity in loss of affiliates............ -- 5,953 11,073 Deferred income taxes (benefit)/expense...................... (55,569) 3,877 3,137 Change in assets and liabilities, net of companies acquired using purchase accounting: Increase in merchandise inventories.... (211,052) (227,076) (171,593) Decrease (increase) in receivables..... (15,993) 17,569 (41,905) Increase in prepaid expenses and other assets................................ (8,806) (5,026) (7,026) Increase in accounts payable, accrued expenses and other current liabilities........................... 273,195 293,831 179,803 Increase in other long-term obligations........................... 9,597 5,074 6,303 --------- --------- ----------- 194,343 225,206 44,211 --------- --------- ----------- Net cash provided by operating activities............................. 379,713 393,120 188,953 Investing Activities: Acquisition of property and equipment... (321,236) (190,659) (212,007) Acquisition of businesses, net of cash acquired............................... (13,500) (79,325) -- Proceeds from sales and maturities of short-term investments................. 10,338 13,618 8,800 Purchase of short-term investments...... (22,913) (4,500) (9,595) Proceeds from sales and maturities of long-term investments.................. 18,995 265 -- Purchase of long-term investments....... (2,545) (5,714) (10,036) Capital contribution to Staples.com .... (2,449) -- -- Investment in affiliates................ -- (4,088) (18,836) Acquisition of lease rights............. (37,182) (2,717) (5,534) Other................................... 1,208 (11,998) 2,657 --------- --------- ----------- Net cash used in investing activities... (369,284) (285,118) (244,551) Financing Activities: Proceeds from sale of capital stock..... 63,996 48,043 21,773 Proceeds from borrowings................ 392,261 965,921 1,171,174 Payments on borrowings.................. (417,323) (830,018) (1,120,670) Purchase of dissenting shareholder S- Corporation stock...................... (48,102) -- -- Purchase of treasury stock.............. (7,892) -- -- Dividends to shareholders of acquired S- Corp................................... (15,904) (25,175) (24,908) --------- --------- ----------- Net cash (used in) provided by financing activities............................. (32,964) 158,771 47,369 Effect of exchange rate changes on cash................................... (560) (2,720) 643 --------- --------- ----------- Net (decrease) increase in cash and cash equivalents............................. (23,095) 264,053 (7,586) Cash and cash equivalents at beginning of period.................................. 381,088 117,035 124,621 --------- --------- ----------- Cash and cash equivalents at end of period.................................. $ 357,993 $ 381,088 $ 117,035 ========= ========= ===========
See notes to combined financial statements. VI-18 STAPLES RETAIL AND DELIVERY NOTES TO COMBINED FINANCIAL STATEMENTS NOTE A Basis of Presentation These combined financial statements and notes to combined financial statements of Staples Retail and Delivery ("Staples RD") should be read in conjunction with the audited consolidated financial statements and Annual Report on Form 10-K of Staples, Inc. ("Staples" or the "Company") for the year ended January 30, 1999 and the combined financial information of Staples.com contained in Annex VII of this Proxy Statement. The combined financial statements of Staples RD include the balance sheets, statements of income, cash flows and group equity of Staples' retail stores, catalog businesses and contract stationer businesses. The Staples RD combined financial statements also include its retained interest in Staples.com, currently 100%. The stockholders of Staples are scheduled to vote on a proposal (the "Tracking Stock Proposal") to amend the Company's certificate of incorporation to (i) authorize the issuance of a new series of common stock, to be designated as Staples.com common stock ("Staples.com Stock"), intended to reflect the performance of Staples.com, the Company's e-commerce business, (ii) increase the aggregate number of authorized shares of common stock that the Company may issue from 1,500,000,000 to 2,100,000,000, initially comprised of 1,500,000,000 shares of Staples Retail and Delivery common stock ("Staples Stock") and 600,000,000 shares of Staples.com Stock, and (iii) re-classify Staples existing common stock as Staples Stock, intended to reflect the performance of Staples RD, which consists of all of the Company's other businesses and a retained interest in Staples.com. Staples RD currently has a 100% retained interest in Staples.com. The Company expects to issue additional shares of Staples.com Stock in one or more private or public financings within twelve months of stockholder approval of the Tracking Stock Proposal. The specific terms of the financings, including whether they are private or public, the amount of Staples.com Stock issued, and the timing of the financings, will depend upon factors such as stock market conditions and the performance of Staples.com. The effect of the financings on the retained interest percentage and the outstanding interest percentage would depend upon the number of shares of Staples.com Stock sold and whether the Company elects to attribute the net proceeds of such financing to the equity of Staples.com or to Staples RD in respect of its retained interest. The book value associated with Staples RD's retained interest in Staples.com will be increased proportionately for net income (or decreased proportionately for net loss) of Staples.com. In order to prepare separate financial statements for Staples RD and Staples.com, the Company has allocated, for financial reporting purposes, all of its consolidated assets, liabilities, revenue, expenses and cash flow between Staples RD and Staples.com. Thus, the combined financial statements of Staples RD and Staples.com, taken together, comprise all of the accounts included in the corresponding consolidated financial statements of Staples. Staples RD's combined financial statements reflect the application of certain cash management and allocation policies adopted by the Board of Directors of Staples (the "Board"). These policies are summarized in Note C under "Corporate Activities." Staples RD's combined financial statements include the financial position, statements of income, cash flows of Staples RD and the effects of a 100 percent retained interest in Staples.com on the statements of income, balance sheets and statements of cash flows. These financial statements do not represent Staples primary financial statement presentation. Allocation and related party transaction policies adopted by the Board can be rescinded or amended at the sole discretion of the Board without approval by the stockholders, although no such changes are currently contemplated. Any such changes adopted by the Board would be made in its good faith business judgement of the Company's best interests, taking into consideration the interests of all stockholders. VI-19 STAPLES RETAIL AND DELIVERY NOTES TO COMBINED FINANCIAL STATEMENTS--(Continued) If the Tracking Stock Proposal is approved by the stockholders and implemented by the Board, the Company will provide to the holders of both Staples Stock and Staples.com Stock separate financial statements, management's discussion and analysis of the results of operations and financial condition, and other relevant information for Staples RD and Staples.com, as well as consolidated financial information of the Company. Even though Staples has allocated all of its consolidated assets, liabilities, revenue, expenses and cash flow between Staples RD and Staples.com, holders of Staples Stock will continue to be common stockholders of Staples and, as such, will be subject to the risks associated with an investment in Staples and all of its businesses, assets and liabilities. Assets attributed to one business are subject to the liabilities of the other business, whether such liabilities arise from lawsuits, contracts or indebtedness attributed to the other business. Holders of Staples Stock and Staples.com Stock will not have any legal rights related to specific assets of either business and in any liquidation will receive a fixed share of the net assets of the Company which may not reflect the actual trading prices, if any of the respective businesses at such time. Financial impacts which occur that affect Staples' consolidated results of operations or financial position could affect the results of operations or financial condition of Staples RD or the market price of Staples Stock. In addition, net losses of Staples.com, and any dividends or distributions on, or repurchases of, Staples.com Stock will reduce the assets of Staples legally available for dividends on Staples Stock. Accordingly, financial information for Staples RD should be read in conjunction with the financial information for Staples.com and financial information for Staples. NOTE B Summary of Significant Accounting Policies Nature of Operations: Staples RD operates a chain of office supply stores and contract stationer/delivery warehouses throughout North America and in the United Kingdom and Germany. Staples.com is the business of Staples that sells product through web-based superstores and portals. Staples RD represents the other businesses of Staples, including its retail stores, catalog businesses and contract stationer businesses. Fiscal Year: Staples RD's fiscal year is the 52 or 53 weeks ending the Saturday closest to January 31. Fiscal years 1998, 1997 and 1996, consisted of the 52 weeks ended January 30, 1999, January 31, 1998 and February 1, 1997 respectively. As more fully described in Note N, the statements of income combine Staples RD's historical operating results for the fiscal years with the corresponding Quill Corporation ("Quill") operating results for the calendar years ended December 31, 1997 and 1996. Accordingly, to conform fiscal years for 1998, an adjustment for Quill's operating results for January 1998 was made to group equity. Use of Estimates: The preparation of combined financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the combined financial statements and accompanying notes. Actual results could differ from those estimates. Cash Equivalents: Staples RD considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. Short-Term Investments: Staples RD's securities are classified as available for sale and consist principally of high-grade state and municipal securities having an original maturity of more than three months. The investments are carried at fair value, with the unrealized holding gains and losses reported as a component of Staples RD's equity. The cost of securities sold is based on the specific identification method. No individual issue in the portfolio constitutes greater than one percent of the total assets of Staples RD. VI-20 STAPLES RETAIL AND DELIVERY NOTES TO COMBINED FINANCIAL STATEMENTS--(Continued) Merchandise Inventories: Merchandise inventories are valued at the lower of weighted-average cost or market. Receivables: Receivables relate principally to amounts due from vendors under various incentive and promotional programs and trade receivables financed under regular commercial credit terms. Concentrations of credit risk with respect to trade receivables are limited due to Staples RD's large number of customers and their dispersion across many industries and geographic regions. Advertising: Staples RD expenses the production costs of advertising the first time the advertising takes place, except for the direct-response advertising, which is capitalized and amortized over its expected period of future benefits. Direct-response advertising consists primarily of the direct catalog production costs. The capitalized costs of the advertising are amortized over the six month period following the publication of the catalog in which it appears. Direct catalog production costs included in prepaid and other assets totaled $9,854,000 at January 30, 1999 and $7,667,000 at January 31, 1998. Total advertising and marketing expense was $355,333,000, $288,341,000, and $220,872,000 for the years ended January 30, 1999, January 31, 1998, and February 1, 1997, respectively. Property and Equipment: Property and equipment are recorded at cost. Depreciation and amortization, which includes the amortization of assets recorded under capital lease obligations, are provided using the straight-line method over the estimated useful lives of the assets or the terms of the respective leases. Depreciation and amortization periods are as follows: Buildings.......... 40 years Leasehold improvements...... 10 years or term of lease Furniture and fixtures.......... 5 to 10 years Equipment.......... 3 to 10 years
Lease Acquisition Costs: Lease acquisition costs are recorded at cost and amortized on the straight-line method over the respective lease terms, including option renewal periods if renewal of the lease is probable, which range from 5 to 40 years. Accumulated amortization at January 30, 1999 and January 31, 1998 totaled $24,674,000 and $19,483,000, respectively. Retained Interest in Staples.com: Staples RD currently has a 100% retained interest in Staples.com. The Company expects to issue additional shares of Staples.com Stock in one or more private or public financings within twelve months of stockholder approval of the Tracking Stock Proposal. The specific terms of the financings, including whether they are private or public, the amount of Staples.com Stock issued, and the timing of the financings, will depend upon factors such as stock market conditions and the performance of Staples.com. The effect of the financings on the retained interest percentage and the outstanding interest percentage would depend upon the number of shares of Staples.com Stock sold and whether we elect to attribute the net proceeds of such financing to the equity of Staples.com or to Staples RD in respect of its retained interest. Staples RD accounts for its investment in Staples.com in a manner similar to the method prescribed under APB No. 18, "The Equity Method of Accounting for Investments in Common Stock." For the purposes of these separate combined financial statements, Staples RD's interest in the equity and net income or loss of Staples.com has been included in Staples RD's balance sheets and statements of income as "retained interest in Staples.com." The amount included in the balance sheets and statements of income as retained interest in Staples.com represents Staples RD's proportional interest in the assets and liabilities and revenue and expenses of Staples.com. The carrying value of Staples RD's retained interest in Staples.com is increased or decreased by Staples RD's proportional interest in the net income or loss of Staples.com. Additionally, if dividends or other VI-21 STAPLES RETAIL AND DELIVERY NOTES TO COMBINED FINANCIAL STATEMENTS--(Continued) distributions are made on Staples.com Stock, including deemed dividends in respect of the Staples RD's retained interest in Staples.com, an amount representing Staples RD's proportional interest in such distributions would be transferred to Staples RD from Staples.com and would reduce the book value of Staples RD's retained interest in Staples.com. Goodwill: Goodwill arising from business acquisitions is amortized on a straight-line basis over 40 years. Accumulated amortization was $13,053,000 and $10,622,000 as of January 30, 1999 and January 31, 1998, respectively. Management periodically evaluates the recoverability of goodwill, which would be adjusted for a permanent decline in value, if any, as measured by the recoverability from projected future cash flows from the acquired businesses. Pre-opening Costs: Pre-opening costs, which consist primarily of salaries, supplies, marketing and occupancy costs, are charged to expense as incurred. Private Label Credit Card Receivables: Staples RD offers a private label credit card which is managed by a financial services company. Under the terms of the agreement, Staples RD is obligated to pay fees which approximate the financial institution's cost of processing and collecting the receivables, which are primarily non-recourse to Staples RD. Foreign Currency Translation: The assets and liabilities of Staples RD's foreign subsidiaries, The Business Depot Ltd. ("Business Depot"), Staples UK, and Staples Germany, are translated into U.S. dollars at current exchange rates as of the balance sheet date, and revenues and expenses are translated at average monthly exchange rates. The resulting translation adjustments, and the net exchange gains and losses resulting from the translation of investments in Staples RD's foreign subsidiaries during the years ended January 30, 1999, January 31, 1998 and February 1, 1997, are recorded in a separate section of group equity titled "Cumulative foreign currency translation adjustments." Stock Option Plans: Staples RD has adopted Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("FAS 123"). As permitted by FAS 123, Staples RD continues to account for Staples' stock-based plans under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and provides pro forma disclosures of the compensation expense determined under the fair value provisions of FAS 123. Earnings Per Share: Historical earnings per share is omitted from the statements of operations since the Staples Stock was not part of the capital structure of the Company for the periods presented. Following the implementation of the Tracking Stock Proposal, basic earnings per share for Staples RD would be computed by dividing the earnings or losses of Staples RD, including Staples RD's retained interest in the earnings or losses of Staples.com, by the weighted average number of shares of Staples Stock. Diluted earnings per share will include the effects of applying the treasury stock method to outstanding stock options, performance accelerated restricted stock ("PARS") and derivative instruments. Fair Value of Financial Instruments: Pursuant to Statement of Financial Accounting Standards No. 107, "Disclosure About Fair Value of Financial Instruments" ("FAS 107"), Staples RD has estimated the fair value of its financial instruments using the following methods and assumptions: --The carrying amount of cash and cash equivalents, receivables and accounts payable approximates fair value; -- The fair values of short-term investments and the 4 1/2% Convertible Subordinated Debentures are based on quoted market prices; VI-22 STAPLES RETAIL AND DELIVERY NOTES TO COMBINED FINANCIAL STATEMENTS--(Continued) -- The carrying amounts of Staples RD's debt approximates fair value, estimated by discounted cash flow analyses based on Staples RD's current incremental borrowing rates for similar types of borrowing arrangements. Long-Lived Assets: Staples RD adopted Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed Of" ("FAS 121"), which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flow estimated to be generated by those assets are less than the assets' carrying amount. Staples RD's policy is to evaluate long-lived assets for impairment at a store level. Comprehensive Income: Effective February 1, 1998, Staples RD adopted SFAS No. 130 "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130 establishes new rules for the reporting and display of comprehensive income and its components in a full set of general purpose financial statements. SFAS 130 requires Staples RD to report comprehensive income which includes net income, foreign currency translation adjustments and unrealized gains and losses on short-term investments, separately in group equity. Segment Reporting: Effective February 1, 1998, Staples RD adopted the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("Statement 131"). Statement 131 superseded FASB Statement No. 14, "Financial Reporting for Segments of a Business Enterprise." Statement 131 establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports. Statement 131 also establishes standards for related disclosures about products and services, geographic areas, and major customers. The adoption of Statement 131 did not affect the results of operations or financial position, but did affect the disclosure of segment information, see note P. NOTE C Corporate Activities Staples RD's combined financial statements reflect the application of the management and allocation policies adopted by the Board to various corporate activities, as described below: Finance Activities: Staples RD manages most finance activities on a centralized, consolidated basis. These activities include the investment of surplus cash, the issuance, repayment and repurchase of short-term and long- term debt, and the issuance and repurchase of common stock. Staples.com generally remits its cash receipts to Staples RD, and Staples RD generally funds Staples.com's disbursements on a regular basis. In the combined financial statements of Staples RD and the combined financial statements of Staples.com, (1) all equity transactions, and the proceeds thereof, were attributed to Staples RD, (2) whenever Staples.com held cash, that cash was transferred to Staples RD and accounted for as an inter- business revolving credit advance and (3) whenever Staples.com had a cash need, that cash need was funded by Staples RD and accounted for as an inter-business revolving credit advance. The inter-business revolving credit arrangement bears interest at a rate at which the Board, in its sole discretion, determines Staples could borrow such funds on a revolving credit basis, which was 6% for the fiscal years ended January 30, 1999, January 31, 1998 and February 1, 1997. As and when determined by the Board, this revolving credit arrangement will be settled between the businesses through a capital contribution or a return of capital, increasing or decreasing Staples RD's retained interest in Staples.com. After the date on which shares of Staples.com Stock, or options therefor are first issued, Staples RD intends to continue the above practice of transferring cash to Staples.com through an inter-business revolving credit arrangement. VI-23 STAPLES RETAIL AND DELIVERY NOTES TO COMBINED FINANCIAL STATEMENTS--(Continued) The Board, at its sole discretion, may elect an alternative financing mechanism between the businesses based upon the facts and circumstances. Shared Services and Support Activities: The cost of services shared by Staples RD and Staples.com, including general and administrative expenses, has been allocated between Staples RD and Staples.com based upon the use of such services and the good faith judgment of the Board or management. Where determinations based on use alone were not practical, other methods and criteria were used to provide a reasonable allocation of the cost of shared services, including support activities attributable to the businesses. Such allocated shared services represent, among other things, financial and accounting services, information system services, certain selling and marketing activities, certain merchandising and replenishment services, transportation and warehouse management services, certain customer service activities, executive management, human resources, legal and corporate planning activities. Taxes: Federal income taxes, which are determined on a consolidated basis, are allocated between the businesses, and reflected in their respective financial statements, in accordance with Staples' tax allocation policy. In general, this policy provides that the consolidated tax provision, deferred tax accounts and related tax payments or refunds, are allocated between the businesses based principally upon the financial income, taxable income, credits and other amounts directly related to the respective businesses. Tax benefits that cannot be used by the business generating such attributes, but can be utilized on a consolidated basis, are allocated to the business that generated such benefits. As a result, the allocated business amounts of taxes payable or refundable are not necessarily comparable to those that would have resulted if the businesses had filed separate tax returns. State income taxes generally are computed on a separate business basis. Employee Benefits: Staples RD participated in the following Company employee benefit plans: an Employee Stock Purchase Plan, an Employee 401(k) Savings Plan, a Supplemental Executive Retirement Plan and a contributory Medical and Dental Plan. The costs of these plans are allocated based on the benefits received under the plans by the employees comprising Staples RD or another basis as management believes to be an equitable and reasonable estimate of such costs. Carrying Charge: Staples RD maintains inventory to support Staples.com inventory needs and processes receivables for Staples.com. As such, Staples RD charges Staples.com a carrying charge for use of their capital as determined by the Board. The current charge is reflected in Staples.com's combined financial statements as part of operating and selling expenses and in Staples RD's combined financial statements as a reduction in operating and selling expenses. The charge is calculated based on the amount of receivables and inventory that Staples RD is required to carry for Staples.com. In addition, shrink, obsolescence and other inventory costs are allocated to Staples.com based on Staples.com's share of such costs. The Board may, in its sole discretion, change this charge as it deems appropriate in light of the circumstances from time to time. NOTE D Related Party Transactions Staples RD sells inventory to Staples.com based on Staples RD's product cost. Staples RD does not include these transactions in its reported sales. Inventory purchased by Staples.com totaled $10,796,000, $2,364,000, and $22,000 for the fiscal years ended January 30, 1999, January 31, 1998 and February 1, 1997, respectively. Had these sales been included in Staples RD's combined financial statements, Staples RD would have reported sales of $7,117,099,000, $5,730,803,000, and $4,493,576,000 and gross profit of 24.2%, 23.6% and 23.6% for the fiscal years ended January 30, 1999, January 31, 1998 and February 1, 1997, respectively. VI-24 STAPLES RETAIL AND DELIVERY NOTES TO COMBINED FINANCIAL STATEMENTS--(Continued) NOTE E Investments The following is a summary of available-for-sale investments as of January 30, 1999 and January 31, 1998 (in thousands):
Gross Gross Unrealized Unrealized Estimated Cost Gains Losses Fair Value ------- ---------- ---------- ---------- January 30, 1999 Short-term: Municipal obligations................ $10,515 $ 46 $-- $10,561 Agency Bonds......................... 6,902 7 (42) 6,867 ------- ------ ---- ------- Total short-term................... $17,417 $ 53 $(42) $17,428 ======= ====== ==== ======= Gross Gross Unrealized Unrealized Estimated Cost Gains Losses Fair Value ------- ---------- ---------- ---------- January 31, 1998 Short-term: Certificates of deposit.............. $ 3,236 $ -- $-- $ 3,236 Debt securities...................... 2,659 7 -- 2,666 ------- ------ ---- ------- Total short-term................... $ 5,895 $ 7 $-- $ 5,902 ======= ====== ==== ======= Long-term: Municipal obligations................ $ 9,986 $ 125 $ (7) $10,104 Equity securities.................... 4,061 950 (15) 4,996 Money market instruments............. 1,350 -- -- 1,350 ------- ------ ---- ------- Total long-term.................... $15,397 $1,075 $(22) $16,450 ======= ====== ==== =======
Proceeds from the sale of investment securities were $14,599,000 and $265,000 during the years ended January 30, 1999 and January 31, 1998, respectively. Other reductions in the cost balance resulted from maturities of securities. The net adjustment to unrealized holding gains and losses on available-for-sale investments included as a separate component of group equity totaled $(1,049,000) and $1,036,000 for the years ended January 30, 1999 and January 31, 1998, respectively. The amortized cost and estimated fair value of debt and marketable equity securities at January 30, 1999, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because the issuers of securities may have the right to prepay obligations without prepayment penalties.
Estimated Cost Fair Value ------- ---------- Due in one year or less................................... $17,417 $17,428
VI-25 STAPLES RETAIL AND DELIVERY NOTES TO COMBINED FINANCIAL STATEMENTS--(Continued) NOTE F Accrued Liabilities Accrued liabilities consist of the following (in thousands):
January 30, 1999 January 31, 1998 ---------------- ---------------- Taxes..................................... $114,179 $ 76,118 Acquisition and store closure reserves.... 91,484 16,596 Employee related.......................... 88,551 63,126 Advertising and direct marketing.......... 30,458 24,845 Other..................................... 113,554 85,338 -------- -------- Total................................. $438,226 $266,023 ======== ========
NOTE G Long-Term Debt and Credit Agreement Staples manages most financial activities on a centralized basis. Such financial activities include the issuance and repayment of short-term and long- term debt. Staples currently attributes each incurrence or issuance of external debt, and the proceeds thereof, to Staples RD and will continue to do so in the future unless the Board determines otherwise. The Board may, but is not required to, attribute an incurrence or issuance of debt, and the proceeds thereof, to Staples.com at a current incremental borrowing rate of 6%, to the extent that Staples incurs or issues the debt for the benefit of Staples.com. Long-term debt on the books of Staples RD consists of the following (in thousands):
January 30, 1999 January 31, 1998 ---------------- ---------------- Capital lease obligations and other notes payable in monthly installments with effective interest rates from 4% to 16%; collateralized by the related equipment.............................. $ 7,760 $ 14,909 Note payable with a fixed rate of 6.16%.................................. -- 25,000 Senior notes with a fixed rate of 7.125%................................. 200,000 200,000 Mortgage notes at various rates......... -- 13,805 Lines of credit......................... 29,849 8,746 -------- -------- $237,609 $262,460 Less current portion.................... 32,594 43,501 -------- -------- $205,015 $218,959 ======== ========
Aggregate annual maturities of long-term debt and capital lease obligations are as follows (in thousands):
Fiscal year: Total ------------ -------- 1999................................ $ 32,594 2000................................ 1,579 2001................................ 434 2002................................ 308 2003................................ 311 Thereafter.......................... 202,383 -------- $237,609 ========
VI-26 STAPLES RETAIL AND DELIVERY NOTES TO COMBINED FINANCIAL STATEMENTS--(Continued) Included in property and equipment are capital lease obligations for equipment recorded at the net present value of the minimum lease payments of $20,664,000. Future minimum lease payments of $3,001,000, excluding $201,000 of interest, are included in aggregate annual maturities shown above. Staples RD did not enter into any new capital lease agreements during the fiscal year ended January 30, 1999. New capital lease agreements totaling $2,770,000 were entered into during the fiscal year ended January 31, 1998. Senior Notes: Staples RD issued $200,000,000 of senior notes (the "Notes") on August 12, 1997 with an interest rate of 7.125% payable semi-annually on February 15 and August 15 of each year commencing on February 15, 1998. The Notes are due August 15, 2007. Net proceeds of approximately $198,000,000 from the sale of Staples RD's Notes were used for repayment of indebtedness under Staples RD's revolving credit facility and for general working capital purposes, including the financing of new store openings, distribution facilities and corporate offices. Credit Agreements: Effective November 13, 1997, Staples RD entered into a revolving credit facility, effective through November 2002, with a syndicate of banks, which provides up to $350,000,000 of borrowings. Borrowings made pursuant to this facility will bear interest at either the lead bank's prime rate, the federal funds rate plus 0.50%, the LIBOR rate plus a percentage spread based upon certain defined ratios, a competitive bid rate, or a swing line loan rate. This agreement, among other conditions, contains certain restrictive covenants, including net worth maintenance, minimum fixed charge interest coverage and limitations on indebtedness and sales of assets. As of January 30, 1999, no borrowings were outstanding under the revolving credit facility. Staples RD also has available $35,000,000 in uncommitted, short-term bank credit lines, of which no borrowings were outstanding as of January 30, 1999. Staples UK has a $50,000,000 line of credit which had an outstanding balance of $29,849,000 at January 30, 1999 and Business Depot has a $16,545,000 line of credit which had no outstanding balance at January 30, 1999. Interest paid by Staples RD totaled $29,600,000, $23,012,000 and $22,501,000 for the fiscal years ended January 30, 1999, January 31, 1998, and February 1, 1997, respectively. Capitalized interest totaled $2,254,000, $1,387,000 and $611,000 in the years ended January 30, 1999, January 31, 1998 and February 1, 1997, respectively. NOTE H Convertible Debentures On October 5, 1995, Staples RD issued $300,000,000 of 4 1/2% Convertible Subordinated Debentures due October 1, 2000 with interest payable semi-annually (the "4 1/2% Debentures"). During fiscal 1998, $299,995,000 of Staples RD's $300,000,000 of 4 1/2% Debentures were converted into an aggregate of 30,674,276 shares of common stock at a conversion price of $9.78 per share. The remaining $5,000 were called at par value plus a premium of 1.8% and accrued interest. The total principal amount converted was credited to common stock and additional paid-in capital, net of unamortized expenses of the original debt issue and accrued but unpaid interest. NOTE I Group Equity Staples stockholders will be reclassified as Staples Retail and Delivery common stock holders if the Tracking Stock Proposal is approved by Staples stockholders. Additional shares may be issued from time to time upon exercise of stock options or at the discretion of the Board. On November 12, 1998, December 30, 1997, March 5, 1996 and June 29, 1995, the Board of Directors approved three-for-two splits of Staples' common stock to be effected in the form of 50% stock dividends. The dividends were distributed on January 28, 1999 to shareholders of record as of January 18, 1999, January 30, 1998 to shareholders of record as of January 20, 1998, March 25, 1996 to shareholders of record as of March 15, 1996 and July 24, 1995 to shareholders of record as of July 14, 1995, respectively. VI-27 STAPLES RETAIL AND DELIVERY NOTES TO COMBINED FINANCIAL STATEMENTS--(Continued) During fiscal year 1998, Staples purchased treasury stock of $7,892,000 from employees and directors to fund the income taxes incurred by those employees and directors associated with the vesting of performance accelerated restricted stock (PARS). At January 30, 1999, 72,614,501 shares of common stock were reserved for issuance under Staples' stock option, 401(k), employee stock purchase and director stock option plans. NOTE J Employee Benefit Plans Staples RD elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under FASB Statement No. 123, "Accounting for Stock-Based Compensation" requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, since the exercise price of Staples' employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. Employee Stock Purchase Plan Staples' 1998 Employee Stock Purchase Plan authorizes a total of up to 6,000,000 shares of Staples' common stock to be sold to participating employees. Participating employees may purchase shares of common stock at 85% of its fair market value at the beginning or end of an offering period, whichever is lower, through payroll deductions in an amount not to exceed 10% of an employee's base compensation. Staples' 1994 Employee Stock Purchase Plan expired during 1998. Stock Option Plans Under Staples' 1992 Equity Incentive Plan ("1992 Plan"), Staples may grant to management and key employees incentive and nonqualified options to purchase up to 87,750,000 shares of Staples common stock and Performance Accelerated Restricted Stock ("PARS"). This amount was approved by the stockholders of Staples on June 18, 1997. As of February 27, 1997, Staples' 1987 Stock Option Plan (the "1987 Plan") expired; unexercised options under this plan however remain outstanding. The exercise price of options granted under the plans may not be less than 100% of the fair market value of Staples' common stock at the date of grant. Options generally have an exercise price equal to the fair market value of the common stock on the date of grant. Some options outstanding are exercisable at various percentages of the total shares subject to the option starting one year after the grant, while other options are exercisable in their entirety three to five years after the grant date. All options expire ten years after the grant date, subject to earlier termination in the event of employment termination. Staples' Amended and Restated 1990 Director Stock Option Plan ("Director's Plan") authorizes shares of Staples common stock to be issued to non-employee directors. The exercise price of options granted is equal to the fair market value of Staples' common stock at the date of grant. Options become exercisable in equal amounts over four years and expire ten years from the date of grant, subject to earlier termination, in certain circumstances, in the event the optionee ceases to serve as a director. Pro forma information regarding net income and earnings per share is required by FAS 123, which also requires that the information be determined as if Staples has accounted for its employee stock options granted subsequent to January 28, 1995 under the fair valued method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 1996, 1997, and 1998: risk-free interest rates ranging from 5.21% to 6.12%; volatility VI-28 STAPLES RETAIL AND DELIVERY NOTES TO COMBINED FINANCIAL STATEMENTS--(Continued) factor of the expected market price of Staples Stock of .30 for fiscal year 1996, .35 for fiscal year 1997, and .36 for fiscal year 1998; and a weighted- average expected life of the option of 4.0 years for the 1987 Plan and the 1992 Plan and 2.0 to 5.0 years for the Director's Plan. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. For purposes of FAS 123's disclosure requirements, the Employee Stock Purchase Plan is considered a compensatory plan. The expense was calculated based on the fair value of the employees' purchase rights. Staples' pro forma information, which includes the pro forma results of Quill, follows (in thousands except for earnings per share information):
January 30, January 31, February 1, 1999 1998 1997 ----------- ----------- ----------- Pro forma net income................... $156,265 $138,983 $122,116 Pro forma basic earnings per common share................................. $ 0.36 $ 0.34 $ 0.31 Pro forma diluted earnings per common share................................. $ 0.35 $ 0.33 $ 0.30
This pro forma impact only takes into account options granted since January 28, 1995 and is likely to increase in future years as additional options are granted and amortized ratably over the vesting period. Information with respect to options granted under the above plans is as follows:
Weighted-Average Number of Exercise Price Shares Per Share ----------- ---------------- Outstanding at February 3, 1996................ 47,220,579 $ 3.29 Granted...................................... 7,171,937 8.82 Exercised.................................... (6,140,543) 2.29 Canceled..................................... (2,357,118) 4.89 ----------- ------ Outstanding at February 1, 1997................ 45,894,855 $ 4.26 Granted...................................... 9,656,558 10.43 Exercised.................................... (10,147,409) 2.78 Canceled..................................... (2,807,883) 7.43 ----------- ------ Outstanding at January 31, 1998................ 42,596,121 $ 5.34 Granted...................................... 13,698,644 20.22 Exercised.................................... (13,965,713) 3.64 Canceled..................................... (1,938,669) 11.55 ----------- ------ Outstanding at January 30, 1999................ 40,390,383 $11.58 =========== ======
VI-29 STAPLES RETAIL AND DELIVERY NOTES TO COMBINED FINANCIAL STATEMENTS--(Continued) The following table summarizes information concerning currently outstanding and exercisable options:
Options Outstanding Options Exercisable -------------------- -------------------- Weighted Average Weighted Weighted Remaining Average Average Range of Exercise Number Contractual Exercise Number Exercise Prices Outstanding Life Price Exercisable Price - ----------------- ----------- ----------- -------- ----------- -------- $ 0.53-$ 3.56............. 5,083,310 4.14 $ 2.76 5,083,310 $ 2.76 $ 3.65-$ 5.56............. 4,542,693 5.67 $ 4.10 4,509,999 $ 4.09 $ 5.70-$ 8.30............. 4,800,123 6.45 $ 8.06 3,392,963 $ 8.12 $ 8.37-$ 9.17............. 4,623,599 7.56 $ 9.11 22,627 $ 8.57 $ 9.47-$ 9.83............. 229,980 8.10 $ 9.64 0 $ 0.00 $10.28-$10.28............. 5,734,482 8.57 $10.28 1,125 $10.28 $10.44-$19.42............. 3,004,779 8.72 $12.92 26,928 $10.82 $20.08-$20.08............. 10,699,422 9.42 $20.08 0 $ 0.00 $20.75-$27.71............. 1,511,123 9.83 $23.10 0 $ 0.00 $29.13-$29.13............. 160,872 10.01 $29.13 0 $ 0.00 ---------- ----- ------ ---------- ------ $ 0.53-$29.13............. 40,390,383 7.60 $11.58 13,036,952 $ 4.64
The weighted-average fair values of options granted during the years ended January 30, 1999, January 31, 1998 and February 1, 1997 were $7.18, $3.80 and $3.81, respectively. Exercise prices for the options outstanding as of January 30, 1999 ranged from $0.53 to $29.13. Performance Accelerated Restricted Stock ("PARS") PARS are shares of Staples common stock granted outright to employees and non-employee directors without cost to the employee or director. The shares, however, are restricted in that they are not transferable (e.g. they may not be sold) by the employee or director until they vest, generally after the end of five years. Such vesting date may accelerate if Staples achieves certain compound annual earnings per share growth over a certain number of interim years. If the employee leaves Staples, or the director ceases to serve as a director of Staples, prior to the vesting date for any reason, the PARS shares will be forfeited by the employee or director, as the case may be, and will be returned to Staples. Once the PARS have vested, they become unrestricted and may be transferred and sold like any other Staples common stock. PARS issued in the fiscal year ended January 30, 1999 totaling approximately 1,381,000 shares which have a weighted average fair value of $17.56, initially vest on February 1, 2003 or will accelerate on May 1, in 2000, 2001, or 2002 upon attainment of certain compound annual earnings per share targets in the prior fiscal year. PARS totaling approximately 798,000 shares which have a weighted average fair value of $12.47, issued in fiscal year 1997 will vest on May 1, 1999 as a result of Staples achieving its target earnings goal for the fiscal year ended January 30, 1999. In connection with the issuance of the PARS, Staples RD included $9,796,000, $7,496,000 and $532,000 in compensation expense for the fiscal years ended January 30, 1999, January 31, 1998 and February 1, 1997, respectively. Employees' 401(k) Savings Plan Under Staples' Employees' 401(k) Savings Plan (the "401(k) Plan"), and Supplemental Executive Retirement Plan (the "SERP Plan"), Staples may contribute up to a total of 2,503,125 shares of common stock to these plans. The 401(k) Plan is available to all employees of Staples who meet minimum age and length of VI-30 STAPLES RETAIL AND DELIVERY NOTES TO COMBINED FINANCIAL STATEMENTS--(Continued) service requirements. Company contributions are based upon a matching formula applied to employee contributions, with additional contributions made at the discretion of the Board. NOTE K Income Taxes Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components and the approximate tax effect of Staples RD's deferred tax assets and liabilities as of January 30, 1999 and January 31, 1998, are as follows (in thousands):
January 30, January 31, 1999 1998 ----------- ----------- Deferred Tax Assets: Inventory.......................................... $ 27,328 $ 20,116 Deferred rent...................................... 19,713 14,797 Acquired NOL's..................................... 8,743 7,132 Other net operating loss carryforwards............. 27,259 22,907 Insurance.......................................... 7,639 5,967 Employee benefits.................................. 9,746 5,569 Merger related charges............................. 10,823 -- Store closure charge............................... 20,274 -- Other--net......................................... 17,712 13,660 -------- -------- Total Deferred Tax Assets.......................... 149,237 90,148 -------- -------- Deferred Tax Liabilities: Depreciation....................................... (2,312) (6,687) Other--net......................................... (5,164) (4,835) -------- -------- Total Deferred Tax Liabilities..................... (7,476) (11,522) -------- -------- Total Valuation Allowance............................ (37,765) (30,067) -------- -------- Net Deferred Tax Assets.............................. $103,996 $ 48,559 ======== ========
Net deferred tax assets of approximately $4,500,000 attributable to businesses acquired during the fiscal year ended January 31, 1998 were allocated directly to reduce goodwill generated by these acquisitions. The deferred tax assets disclosed as acquired NOL's and other net operating loss carryforwards, totaling $36,002,000, have been fully reserved due to the uncertainty of the realization of the asset within the local country jurisdiction. Further, if this asset is utilitized when income is earned within the foreign jurisdiction, Staples RD will not have a consolidated tax benefit, as Staples RD will be required to pay U.S. income taxes on the income offset by the foreign NOL. For financial reporting purposes, income before taxes includes the following components (in thousands):
Fiscal Year Ended ----------------------------------- January 30, January 31, February 1, 1999 1998 1997 ----------- ----------- ----------- Pretax income: United States.......................... $262,371 $213,549 $187,644 Foreign................................ 44,194 36,205 23,719 -------- -------- -------- $306,565 $249,754 $211,363 ======== ======== ========
VI-31 STAPLES RETAIL AND DELIVERY NOTES TO COMBINED FINANCIAL STATEMENTS--(Continued) The provision for income taxes consists of the following (in thousands):
Fiscal Year Ended ----------------------------------- January 30, January 31, February 1, 1999 1998 1997 ----------- ----------- ----------- Current tax expense: Federal................................ $136,226 $53,248 $50,546 State.................................. 18,875 10,707 12,337 Foreign................................ 21,798 14,092 601 -------- ------- ------- 176,899 78,047 63,484 Deferred tax expense (benefit)........... (55,569) 3,877 3,137 -------- ------- ------- Total................................ $121,330 $81,924 $66,621 ======== ======= =======
A reconciliation of the federal statutory tax rate to Staples RD's effective tax rate on historical net income is as follows:
Fiscal Year Ended ----------------------------------- January 30, January 31, February 1, 1999 1998 1997 ----------- ----------- ----------- Federal statutory rate.................. 35.0% 35.0% 35.0% State taxes, net of federal benefit..... 6.0% 6.0% 6.3% Tax exempt interest..................... (0.5%) (0.5%) (0.4%) Tax benefit of loss carryforward........ (0.0%) (0.0%) (0.2%) Income of S-Corporation................. (0.6%) (5.7%) (7.0%) Other................................... (0.3%) (2.0%) (2.2%) ---- ---- ---- Effective tax rate...................... 39.6% 32.8% 31.5% ==== ==== ====
A reconciliation of the federal statutory tax rate to Staples RD's effective tax rate on pro forma net income is as follows:
Fiscal Year Ended ----------------------------------- January 30, January 31, February 1, 1999 1998 1997 ----------- ----------- ----------- Federal statutory rate.................. 35.0% 35.0% 35.0% State taxes, net of federal benefit..... 6.0% 6.0% 6.3% Tax exempt interest..................... (0.5%) (0.5%) (0.4%) Tax benefit of loss carryforward........ (0.0%) (0.0%) (0.2%) Other................................... (0.3%) (1.8%) (1.9%) ---- ---- ---- Effective tax rate...................... 40.2% 38.7% 38.8% ==== ==== ====
Income tax payments were $94,729,602, $23,487,877, and $45,925,276 during fiscal years ended January 30, 1999, January 31, 1998, and February 1, 1997, respectively. Staples RD has net operating losses of approximately $101,300,000 that can be carried forward indefinitely, $21,900,000 of which is attributable to Staples RD's increased ownership in Staples UK and Staples Germany. Undistributed earnings of Staples RD's foreign subsidiaries amounted to approximately $54,700,000 at January 30, 1999. Those earnings are considered to be indefinitely reinvested and, accordingly, no provision for U.S. federal and state income taxes has been provided thereon. Upon distribution of those earnings in the form VI-32 STAPLES RETAIL AND DELIVERY NOTES TO COMBINED FINANCIAL STATEMENTS--(Continued) of dividends or otherwise, Staples RD would be subject to both U.S. income taxes (subject to an adjustment for foreign tax credits) and withholding taxes payable to the various foreign countries. Determination of the amount of unrecognized deferred U.S. income tax liability is not practicable because of the complexities associated with its hypothetical calculation. Withholding taxes of approximately $1,800,000 would be payable upon remittance of all previously unremitted earnings at January 30, 1999. NOTE L Leases and other Off-Balance Sheet Commitments Staples RD leases certain retail and support facilities under long-term noncancellable lease agreements. Most lease agreements contain renewal options and rent escalation clauses and require Staples RD to pay real estate taxes in excess of specified amounts and, in some cases, allow termination within a certain number of years with notice and a fixed payment. Certain agreements provide for contingent rental payments based on sales. Other long-term obligations at January 30, 1999 include $49,000,000 relating to future rent escalation clauses and lease incentives under certain existing store operating lease arrangements. These rent expenses are recognized following the straight-line basis over the respective terms of the leases. Future minimum lease commitments for retail and support facilities (including lease commitments for 116 retail stores not yet opened at January 30, 1999) under noncancellable operating leases are due as follows (in thousands):
Fiscal year: ------------ 1999.............................. $ 271,741 2000.............................. 294,675 2001.............................. 290,547 2002.............................. 280,104 2003.............................. 276,425 Thereafter........................ 2,439,592 ---------- $3,853,084 ==========
Rent expense approximated $234,609,000, $193,990,000, and $142,508,000, for the fiscal years ended January 30, 1999, January 31, 1998, and February 1, 1997, respectively. Letters of credit are issued by Staples RD during the ordinary course of business through major financial institutions as required by certain vendor contracts. As of January 30, 1999, Staples RD had available open letters of credit totaling $7,923,000. NOTE M Quarterly Summary (Unaudited)
First Second Third Fourth Quarter Quarter Quarter Quarter ---------- ---------- ---------- ---------- (In thousands) Fiscal Year Ended January 30, 1999 Sales.................. $1,668,367 $1,472,890 $1,895,724 $2,069,322 Gross Profit........... 380,209 347,144 466,690 528,058 Net income............. 35,950 8,974(1) 69,186 71,260(4) Pro forma net income... 34,136(2) 8,974(1) 69,186 71,260(3)
VI-33 STAPLES RETAIL AND DELIVERY NOTES TO COMBINED FINANCIAL STATEMENTS--(Continued)
First Second Third Fourth Quarter Quarter Quarter Quarter ---------- ---------- ---------- ---------- (In thousands) Fiscal Year Ended January 31, 1998 Sales................. $1,292,477 $1,191,720 $1,551,222 $1,693,020 Gross Profit.......... 298,319 280,760 368,749 405,696 Net income............ 19,777(1) 22,759(1) 52,030 73,348(3) Pro forma net income.. 15,229(2) 19,577(2) 48,602(2) 69,720(2)
- -------- (1) Net income for the quarter ended August 1, 1998 includes a pre-tax charge of $41,000 resulting from costs incurred in connection with the merger with Quill Corporation. Net income for the quarters ended May 3, 1997 and August 2, 1997 include a pre-tax charge of $20,562 and $9,103, respectively, resulting from costs incurred in connection with the then proposed merger with Office Depot, Inc. (2) Pro forma net income includes the earnings of Quill with provision for income taxes on previously untaxed earnings of pooled S-Corporation income. (3) Net income for the quarter ended January 30, 1999 includes a pre-tax charge of $49,706 resulting from a store closure charge. NOTE N Business Acquisitions On May 21, 1998, Staples acquired Quill. The merger was structured as an exchange of shares in which the stockholders of Quill received approximately 26,000,000 shares of Staples' common stock, at an exchange ratio established at a combination of fixed and variable prices, and cash paid a dissenting stockholder of approximately $48,000,000, which equates to a purchase price of approximately $690,000,000. The merger was accounted for as a pooling of interests and, accordingly, Staples' consolidated financial statements have been restated to include the operations of Quill for all periods prior to the merger. The statements of income combine Staples' historical operating results for the fiscal years ended January 31, 1998 and February 1, 1997 with the corresponding Quill operating results for the years ended December 31, 1997 and 1996, respectively. Prior to the acquisition, Quill elected to be taxed as an S Corporation under the Internal Revenue Code. Accordingly, the current taxable income of Quill was taxable to its shareholders who were responsible for the payment of taxes thereon. Quill will be included in Staples' U.S. federal income tax return subsequent to the date of the acquisition. Pro forma adjustments have been made to the restated statements of operations to reflect the income taxes that would have been provided had Quill been subject to income taxes. In connection with the acquisition of Quill, Staples committed to a plan that results in the integration of the two businesses. As a result of the acquisition and integration plan, Staples RD recorded a charge to operating expense of $41,000,000 during the year ended January 30, 1999. These costs consist of direct merger-related and integration costs from the transaction. The merger transaction costs of approximately $10,500,000 consist primarily of fees for investment bankers, attorneys, accountants, and other related charges. The integration costs primarily include employee costs of approximately $7,000,000, contract and lease termination costs of approximately $14,100,000, the write-down of leasehold improvements of approximately $3,500,000 and other merger-related costs of approximately $5,900,000. Through January 30, 1999, Staples RD paid approximately $14,000,000, which consisted primarily of transaction and employee related costs. VI-34 STAPLES RETAIL AND DELIVERY NOTES TO COMBINED FINANCIAL STATEMENTS--(Continued) Separate net sales and net income of the merged entities prior to the merger are presented in the following table (in thousands):
January 31, 1998 February 1, 1997 ---------------- ---------------- Net sales: Staples.................................. $5,181,035 $3,967,665 Quill.................................... 551,110 525,924 ---------- ---------- Combined............................... $5,732,145 $4,493,589 ========== ========== Net income Staples.................................. $ 130,949 $ 106,420 Quill.................................... 36,965 38,322 ---------- ---------- Combined............................... $ 167,914 $ 144,742 ========== ========== Pro forma net income Staples.................................. $ 130,949 $ 106,420 Quill(1)................................. 22,179 22,993 ---------- ---------- Combined............................... $ 153,128 $ 129,413 ========== ==========
- -------- (1) Reflects adjustment for provision for income taxes on previously untaxed earnings. NOTE O Store Closure Charge In the fourth quarter of 1998, Staples RD committed to a plan to relocate certain stores which cannot be expanded and upgraded to Staples RD's current stores model and reported a pre-tax store closure charge of $49,706,000. The charge includes $29,620,000 for future rental payments under operating lease agreements that will be paid after the store is closed and will not be subsidized by subtenant income, $4,966,000 in fees, settlement costs and other expenses related to store closure, and $15,120,000 in asset impairment charges. Lease agreements for the relocation sites will be executed during fiscal year 1999 and the stores will be closed and relocated during fiscal years 1999 and 2000. As a result of Staples RD's commitment to exit these stores, Staples RD evaluated the long-lived assets at each location in accordance with FAS 121. The analysis indicated that the long-lived assets of the designated stores were impaired. Accordingly, Staples RD estimated the fair value of these assets based on discounted cash flows and recorded an impairment charge of $15,120,000, which is included in the store closure charge. Staples RD will continue to depreciate these assets based on their revised useful life. NOTE P Segment Reporting Staples RD has three reportable segments: North American Retail, North American Delivery Operations, and European Operations. Staples RD's North American Retail division consists of two operating units that operate stores throughout the US and Canada. Staples RD's North American Delivery Operations division consists of three operating units that sell office products and supplies directly to businesses. The European Operations segment consists of two operating units which operate office supply stores and sell directly to businesses throughout the United Kingdom and Germany. Measurement of Segment Profit or Loss and Segment Assets Staples RD evaluates performance and allocates resources based on profit or loss from operations before income taxes, not including gains and losses on Staples RD's investment portfolio. The accounting VI-35 STAPLES RETAIL AND DELIVERY NOTES TO COMBINED FINANCIAL STATEMENTS--(Continued) policies of the reportable segments are the same as those described in the summary of significant accounting policies. Intersegment sales and transfers are recorded at Staples RD's cost, therefore there is no intercompany profit or loss recognized on these transactions. Factors Management Used to Identify the Enterprise's Reportable Segments Staples RD's reportable segments are business units that distribute office products in different manners. The reportable segments are each managed separately because they distribute products to different classes of customer with different distribution methods. The European operations are considered a separate operating segment because of the significant difference in the operating environment from the North American operations. Information about segment profit/loss and segment assets (in thousands) Year ended January 30, 1999:
N. American N. American Delivery European Retail Operations Operations All Other(1) Totals ----------- -------------------- ---------- ------------ ---------- Revenues from external customers.............. $4,867,124 $1,898,089 $341,090 $ -- $7,106,303 Merger and store closure................ 49,706 41,000 -- -- 90,706 Depreciation expense.... 67,208 5,106 6,818 -- 79,132 Segment profit (loss)... 381,900 118,075 (17,077) (175,846) 307,052 Segment assets.......... 2,886,114 448,367 162,693 -- 3,497,174 Expenditures for long- lived assets........... 307,817 2,252 13,129 -- 323,198
- -------- (1) All other includes corporate general and administrative expenses. Year ended January 31, 1998:
N. American N. American Delivery European Retail Operations Operations All Other(1) Totals ----------- -------------------- ---------- ------------ ---------- Revenues from external customers.............. $3,854,745 $1,648,509 $225,185 $ -- $5,728,439 Merger expenses......... -- -- -- 29,665 29,665 Depreciation expense.... 52,479 3,908 4,358 -- 60,745 Segment profit (loss)... 319,939 112,011 (8,049) (173,847) 250,054 Segment assets.......... 2,432,696 386,053 130,088 -- 2,948,837 Expenditures for long- lived assets........... 173,767 7,527 43,932 -- 225,226
- -------- (1) All other includes corporate general and administrative expenses and merger related costs in connection with the then proposed merger with Office Depot, Inc.
January 30, January 31, Assets 1999 1998 - ------ ----------- ----------- Total assets for reportable segments.................. $3,497,174 $2,948,837 Elimination of intercompany receivables............... (89,664) (114,504) Elimination of intercompany investments............... (228,329) (195,471) ---------- ---------- Total consolidated assets........................... $3,179,181 $2,638,862 ========== ==========
VI-36 STAPLES RETAIL AND DELIVERY NOTES TO COMBINED FINANCIAL STATEMENTS--(Continued) Geographic Information Year ended January 30, 1999:
Long-Lived Revenues Assets ---------- ---------- North American........................................... $6,765,213 $1,028,652 Europe................................................... 341,090 35,913 ---------- ---------- Consolidated Total....................................... $7,106,303 $1,064,565 ========== ========== Year ended January 31, 1998: Long-Lived Revenues Assets ---------- ---------- North American........................................... $5,503,253 $ 762,371 Europe................................................... 225,186 30,888 ---------- ---------- Consolidated Total....................................... $5,728,439 $ 793,259 ========== ==========
NOTE Q Subsequent Events On February 26, 1999, Staples RD completed the acquisition of Claricom Holdings, Inc. and certain related entities ("Claricom") for a purchase price of approximately $140,000,000. The acquisition will be accounted for using the purchase method. Claricom is a full-service supplier of telecommunications services to small and medium sized businesses in the United States. On March 4, 1999, the Board approved a stock repurchase program intended to provide shares for employee stock programs. Staples expects to repurchase approximately 6,000,000 shares annually. Additionally, on September 15, 1999, Staples announced that its Board of Directors authorized the Company to purchase an additional $100,000,000 of its common stock bringing the total amount of the Company's stock repurchase program to approximately $300,000,000. On September 15, 1999, the Company announced the proposed restructuring of the existing common stock of the Company into two classes, intended to track the separate performances of the retail and delivery business of the Company (Staples RD) and the e-commerce business of the Company (Staples.com). The Company expects to issue shares of Staples.com Stock in one or more private or public financings within twelve months of stockholder approval of the Tracking Stock Proposal. The specific terms of the financings, including whether they are private or public, the amount of Staples.com Stock issued, and the timing of the financings, will depend upon factors such as stock market conditions and the performance of Staples.com. On October 6, 1999, Staples RD completed the acquisition of three European office supply companies for a total of approximately $120,000,000. The companies acquired were Sigma Burowelt in Germany, Office Centre in the Netherlands, and Office Centre in Portugal. All three companies operate office superstores focusing on every-day low pricing for a wide assortment of office supplies. Staples RD acquired a total of 41 stores, including 15 in Germany, 21 in the Netherlands, and 5 in Portugal. This acquisition will be accounted for using the purchase method of accounting. VI-37 STAPLES RETAIL AND DELIVERY The following interim financial information is unaudited but, in the opinion of the Company, includes all adjustments, consisting only of normal recurring accruals, necessary for a fair presentation. Operating results for the interim period are not necessarily indicative of the results that may be expected for the full year. The financial information should be read in conjunction with Staples RD's audited combined financial statements as of January 30, 1999 included herein, Staples, Inc.'s audited consolidated financial statements and Annual Report on Form 10-K as of January 30, 1999 and unaudited interim results on Form 10-Q. VI-38 STAPLES RETAIL AND DELIVERY COMBINED BALANCE SHEETS (Dollar Amounts in Thousands)
July 31, January 30, 1999 1999 ----------- ----------- (Unaudited) ASSETS Current Assets: Cash and cash equivalents............................. $ -- $ 357,993 Short-term investments................................ 1,252 17,428 Merchandise inventories............................... 1,518,768 1,340,432 Receivables, net...................................... 378,114 221,836 Inter-business receivable from Staples.com............ 1,697 -- Deferred income taxes................................. 79,397 75,261 Prepaid expenses and other current assets............. 51,367 50,117 ---------- ---------- Total current assets................................ 2,030,595 2,063,067 Property and Equipment: Land and buildings.................................... 246,948 231,378 Leasehold improvements................................ 407,722 372,451 Equipment............................................. 457,826 399,153 Furniture and fixtures................................ 260,868 239,755 ---------- ---------- Total property and equipment........................ 1,373,364 1,242,737 Less accumulated depreciation and amortization........ 449,538 403,462 ---------- ---------- Net property and equipment.......................... 923,826 839,275 Other Assets: Retained interest in Staples.com...................... 21,052 1,962 Lease acquisition costs, net of amortization.......... 70,098 75,127 Goodwill, net of amortization......................... 301,323 148,201 Deferred income taxes................................. 30,819 28,735 Other................................................. 26,306 22,814 ---------- ---------- Total other assets.................................. 449,598 276,839 ---------- ---------- $3,404,019 $3,179,181 ========== ========== LIABILITIES AND GROUP EQUITY Current Liabilities: Accounts payable...................................... $ 863,878 $ 794,427 Accrued expenses and other current liabilities........ 442,997 438,226 Debt maturing within one year......................... 43,997 32,594 ---------- ---------- Total current liabilities........................... 1,350,872 1,265,247 Long-Term Debt.......................................... 263,560 205,015 Other Long-Term Obligations............................. 55,909 52,033 Group Equity............................................ 1,733,678 1,656,886 ---------- ---------- $3,404,019 $3,179,181 ========== ==========
See notes to combined interim financial statements. VI-39 STAPLES RETAIL AND DELIVERY COMBINED STATEMENTS OF INCOME (Dollar Amounts in Thousands)
26 Weeks Ended ---------------------- July 31, August 1, 1999 1998 ---------- ---------- (Unaudited) Sales.................................................. $3,884,874 $3,141,258 Cost of goods sold and occupancy costs................. 2,941,867 2,413,905 ---------- ---------- Gross profit....................................... 943,007 727,353 Operating and other expenses: Operating and selling................................ 578,971 454,771 Pre-opening.......................................... 9,407 7,584 General and administrative........................... 169,007 137,283 Amortization of goodwill............................. 5,258 1,851 Merger-related and integration costs................. -- 41,000 Store closure charge................................. -- -- Interest and other expense, net...................... 5,341 10,613 ---------- ---------- Total operating and other expenses................. 767,984 653,102 ---------- ---------- Income before equity in loss of affiliates, retained interest and income taxes................ 175,023 74,251 Loss related to the retained interest in Staples.com......................................... (3,706) (104) ---------- ---------- Income before income taxes........................... 171,317 74,147 Income tax expense..................................... 68,259 29,383 ---------- ---------- Net income before minority interest................ 103,058 44,764 Minority interest.................................... -- 160 ---------- ---------- Net income......................................... $ 103,058 $ 44,924 ========== ========== Pro forma: Historical net income................................ $ 44,924 Provision for income taxes on previously untaxed earnings of pooled S-Corporation income............. 1,814 ---------- Pro forma net income............................... $ 43,110 ==========
See notes to combined interim financial statements. VI-40 STAPLES RETAIL AND DELIVERY COMBINED STATEMENTS OF CASH FLOWS (Dollar Amounts in Thousands)
26 Weeks Ended -------------------- July 31, August 1, 1999 1998 --------- --------- (Unaudited) Operating Activities: Net income............................................. $ 103,058 $ 44,924 Adjustments to reconcile net income to net cash used in operating activities: Minority interest.................................... -- (160) Retained interest in loss of Staples.com............. 3,706 104 Depreciation and amortization........................ 81,410 58,649 Merger-related and integration costs................. -- 41,000 Expense from 401K and PARS stock contribution........ 8,460 3,073 Deferred income tax benefit.......................... (6,208) (7,098) Change in assets and liabilities, net of companies acquired using purchase accounting: Increase in merchandise inventories................ (170,321) (169,012) Increase in receivables............................ (136,723) (56,419) (Increase)/Decrease in prepaid expenses and other assets............................................ (1,677) 8,616 Increase in accounts payable, accrued expenses and other current liabilities......................... 31,424 37,706 Increase in other long-term obligations............ 2,863 6,242 --------- --------- (187,066) (77,299) --------- --------- Net cash used in operating activities.................. (84,008) (32,375) Investing Activities: Acquisition of property and equipment.................. (145,897) (149,227) Acquisition of businesses, net of cash acquired........ (137,625) -- Proceeds from sales and maturities of short-term investments........................................... 32,765 11,313 Purchase of short-term investments..................... (16,651) (6,854) Proceeds from sales and maturities of long-term investments........................................... -- 18,995 Purchase of long-term investments...................... -- (2,545) Capital contributions to Staples.com................... (22,796) (410) Inter-business revolver advances to Staples.com........ (1,697) (104) Acquisition of lease rights............................ 1,946 (36,690) Other.................................................. 88 (1,619) --------- --------- Net cash used in investing activities.................. (289,867) (167,141) Financing Activities: Proceeds from sale of capital stock.................... 25,243 35,581 Proceeds from borrowings............................... 316,984 38 Payments on borrowings................................. (248,326) (52,082) Purchase of dissenting shareholder S-Corporation stock................................................. -- (48,102) Purchase of treasury stock............................. (78,246) (7,892) Dividends to shareholders of acquired S-Corp........... -- (15,601) --------- --------- Net cash provided by/(used in) financing activities.... 15,655 (88,058) Effect of exchange rate changes on cash................ 227 248 Net decrease in cash and cash equivalents.............. (357,993) (287,326) Cash and cash equivalents at beginning of period....... 357,993 381,088 --------- --------- Cash and cash equivalents at end of period............. $ -- $ 93,762 ========= =========
See notes to combined interim financial statements. VI-41 STAPLES RETAIL AND DELIVERY NOTES TO COMBINED INTERIM FINANCIAL STATEMENTS (Unaudited) NOTE A Basis of Presentation The accompanying interim unaudited combined financial statements include the accounts of Staples Retail and Delivery ("Staples RD"). All intercompany accounts and transactions are eliminated in consolidation. In order to prepare separate financial statements for Staples RD and Staples.com, the Company has allocated, for financial reporting purposes, all of its consolidated assets, liabilities, revenue, expenses and cash flow between Staples RD and Staples.com. These financial statements of Staples RD and Staples.com, taken together, comprise all of the accounts included in the corresponding consolidated financial statements of Staples. Staples RD's financial statements reflect the application of certain cash management and allocation policies adopted by the Board. Staples RD financial statements include the financial position, results of operations and cash flows of Staples RD and the effects of a 100 percent retained interest in Staples.com on the statements of income, balance sheets and cash flows. These financial statements should be read in conjunction with the audited consolidated financial statements and footnotes of Staples included in the Company's Annual Report on Form 10-K for the year ended January 30, 1999 and the combined financial statements and footnotes of Staples.com for the year ended January 30, 1999 included in Annex VII of this Proxy Statement. NOTE B Comprehensive Income Staples RD calculates comprehensive income in accordance with SFAS No. 130 "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130 establishes new rules for the reporting and display of comprehensive income and its components. The adoption of SFAS 130 had no impact on Staples RD's net income or group equity. SFAS 130 requires Staples RD to report comprehensive income which includes net income, foreign currency translation adjustments and unrealized gains and losses on short-term investments, which are reported separately in group equity, in the notes to the financial statements for interim periods. During the six months ended July 31, 1999, total comprehensive income amounted to approximately $101,920,000 compared to $41,393,000 for the corresponding period ended August 1, 1998. NOTE C Description of The Types of Products and Services from Which Each Reportable Segment Derives Its Revenues Staples RD has three reportable segments: North American Retail, North American Delivery Operations, and European Operations. Staples' North American Retail division consists of two operating units that operate stores throughout the US and Canada. Staples RD's North American Delivery Operations division consists of five operating units that sell office products and supplies directly to businesses. The European Operations segment consists of three operating units which operate office supply stores and sell directly to businesses throughout the United Kingdom and Germany. Measurement of Segment Profit or Loss and Segment Assets Staples RD evaluates performance and allocates resources based on profit or loss from operations before income taxes, not including gains and losses on Staples RD's investment portfolio. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies. Inter-segment sales and transfers are recorded at Staples RD's cost, therefore there is no intercompany profit or loss recognized on these transactions. Factors Management Used to Identify the Enterprise's Reportable Segments Staples RD's reportable segments are business units that distribute office products in different manners. The reportable segments are each managed separately because they distribute products to different classes of VI-42 customer with different distribution methods. The European operations are considered a separate operating segment because of the significant difference in the operating environment from the North American operations. The following is a summary of significant accounts and balances by reportable segment for the twenty-six weeks ended July 31, 1999 and August 1, 1998: Twenty-six weeks ended July 31, 1999:
N. American N. American European All Retail Delivery Operations Operations Other(1) Totals ----------- ------------------- ---------- --------- ---------- Revenues from external customers.............. $2,590,989 $1,126,995 $166,890 $ -- $3,884,874 Depreciation and amorti- zation expense......... 60,491 15,672 5,247 -- 81,410 Segment profit (loss)... 206,538 88,314 (19,354) (100,475) 175,023 Expenditures for long- lived assets........... $ 125,834 $ 169,929 $ 8,609 $ -- $ 304,372 Twenty-six weeks ended August 1, 1998: N. American N. American European All Retail Delivery Operations Operations Other(1) Totals ----------- ------------------- ---------- --------- ---------- Revenues from external customers.............. $2,088,478 $ 901,099 $151,681 $ -- $3,141,258 Merger and Integration Costs.................. -- 41,000 -- -- 41,000 Depreciation and amorti- zation expense......... 44,856 10,006 3,787 -- 58,649 Segment profit (loss)... 145,780 20,623 (10,631) (81,521) 74,251 Expenditures for long- lived assets........... $ 169,965 9,325 7,037 -- 186,327
- -------- (1) All other is composed of corporate general and administrative expenses.
Total Assets ($ in 000's) ------------------------------ July 31, 1999 January 30, 1999 ------------- ---------------- N. American Retail............................... $2,981,101 $2,886,114 N. American Delivery............................. 589,338 448,367 European Operations.............................. 185,025 162,693 ---------- ---------- Totals........................................... 3,755,464 3,497,174 Elimination of Intercompany Receivables.......... (94,696) (89,664) Elimination of Intercompany Investments.......... (256,749) (228,329) ---------- ---------- Total Consolidated Assets........................ $3,404,019 $3,179,181 ========== ========== Geographic Information: Revenues from External Customers ($ in 000's) 26 Weeks Ended ------------------------------ July 31, 1999 August 1, 1998 ------------- ---------------- N. American...................................... $3,717,984 $2,989,577 European......................................... 166,890 151,681 ---------- ---------- Totals........................................... $3,884,874 $3,141,258 ========== ========== Long-lived Assets ($ in 000's) ------------------------------ July 31, 1999 January 30, 1999 ------------- ---------------- N. American...................................... $1,274,545 $1,028,652 European......................................... 41,754 35,913 ---------- ---------- Totals........................................... $1,316,299 $1,064,565 ========== ==========
VI-43 NOTE D Acquisitions On February 26, 1999, Staples RD completed the acquisition of Claricom Holdings, Inc. and certain related entities, now referred to as Staples Communications, for a purchase price of approximately $137,900,000. The acquisition has been accounted for using the purchase method of accounting, and accordingly, Staples RD has recognized goodwill of approximately $158,400,000, including a provision for merger related and integration costs of approximately $7,000,000. Staples Communications is a full-service supplier of telecommunications services to small and medium sized businesses in the United States. NOTE E Equity Forward Purchase Agreement During the quarter ended July 31, 1999, Staples entered into an equity forward purchase to hedge against stock price fluctuations for the repurchase of Staples common stock in connection with the annual stock option grant to employees and directors. Under the agreement, Staples must purchase 2,600,000 shares of Staples stock at an average price of $30.263. The Company may elect to settle the contract on a net share basis in lieu of physical settlement. NOTE F Subsequent Events On September 15, 1999, Staples announced that its Board authorized the Company to purchase an additional $100,000,000 of its common stock bringing the total amount of the Company's stock repurchase program to approximately $300,000,000. On September 15, 1999, the Company announced the proposed restructuring of the existing common stock of the Company into two classes, intended to track the separate performances of the retail and delivery business of the Company (Staples RD) and the e-commerce business of the Company (Staples.com). The Company expects to issue shares of Staples.com Stock in one or more private or public financings within twelve months of stockholder approval of the Tracking Stock Proposal. The specific terms of the financings, including whether they are private or public, the amount of Staples.com Stock issued, and the timing of the financings, will depend upon factors such as stock market conditions and the performance of Staples.com. On October 6, 1999, Staples RD completed the acquisition of three European office supply companies for a total of approximately $120,000,000. The companies acquired were Sigma Burowelt in Germany, Office Centre in the Netherlands, and Office Centre in Portugal. All three companies operate office superstores focusing on every-day low pricing for a wide assortment of office supplies. Staples RD acquired a total of 41 stores, including 15 in Germany, 21 in the Netherlands, and 5 in Portugal. This acquisition will be accounted for using the purchase method of accounting. VI-44 ANNEX VII STAPLES.COM COMBINED FINANCIAL INFORMATION VII-1 ANNEX VII STAPLES.COM INDEX TO COMBINED FINANCIAL INFORMATION Management's Discussion and Analysis of Financial Condition and Results of Operations.......................................................... VII-3 Audited Financial Statements Report of Independent Auditors........................................ VII-10 Combined Balance Sheets -- January 30, 1999 and January 31, 1998...... VII-11 Combined Statements of Operations -- Fiscal years ended January 30, 1999, January 31, 1998 and February 1, 1997.......................... VII-12 Combined Statements of Group Equity -- Fiscal years ended January 30, 1999, January 31, 1998 and February 1, 1997.......................... VII-13 Combined Statements of Cash Flows -- Fiscal years ended January 30, 1999, January 31, 1998 and February 1, 1997.......................... VII-14 Notes to Staples.com Combined Financial Statements.................... VII-15 Interim Financial Statements (unaudited) Combined Balance Sheets -- July 31, 1999 and January 30, 1999......... VII-23 Combined Statements of Operations -- 26 weeks ended July 31, 1999 and August 1, 1998....................................................... VII-24 Combined Statements of Cash Flows -- 26 weeks ended July 31, 1999 and August 1, 1998....................................................... VII-25 Notes to Staples.com Interim Combined Financial Information........... VII-26
VII-2 STAPLES.COM MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS You should read this discussion along with the Staples Retail and Delivery ("Staples RD") Combined Financial Statements contained in this Proxy Statement. Historical results and percentage relationships may not necessarily be indicative of operating results for any future periods. The combined financial statements of Staples.com include the balance sheets, statements of operations, cash flows and group equity of Staples' e-commerce businesses, including principally Staples.com, Quillcorp.com and StaplesLink.com. The stockholders of Staples, Inc. ("Staples" or the "Company") are scheduled to vote on a proposal (the "Tracking Stock Proposal") to amend the Company's certificate of incorporation to (i) create a new class of common stock called Staples.com common stock ("Staples.com Stock"), intended to reflect the performance of Staples.com, the Company's e-commerce business, (ii) increase the aggregate number of shares of common stock that the company may issue from 1,500,000,000 to 2,100,000,000, initially comprised of 1,500,000,000 shares of Staples Retail and Delivery common stock ("Staples Stock") and 600,000,000 shares of Staples.com Stock, and (iii) reclassify Staples existing common stock as Staples Stock, intended to reflect the performance of Staples RD, which consists of all of the Company's other businesses and a retained interest in Staples.com. If the Tracking Stock Proposal is approved by the Company's stockholders, the filing of the amendment to the Company's certificate of incorporation implementing the proposal will automatically reclassify each share of existing common stock into Staples Stock. Subject to stockholder approval of the Tracking Stock Proposal, the Company expects to issue additional shares of Staples.com Stock in one or more private or public financings within twelve months of such approval. The specific terms of the financings, including whether they are private or public, the amount of Staples.com Stock issued, and the timing of the financings, will depend upon factors such as stock market conditions and the performance of Staples.com. The effect of any financings on the retained interest percentage and the outstanding interest percentage will depend upon the number of shares of Staples.com Stock sold and whether the Company elects to attribute the net proceeds of such financings to the equity of Staples.com or to Staples RD in respect of its retained interest. The combined financial statements of Staples.com and the combined financial statements of Staples RD comprise all of the accounts included in the consolidated financial statements of Staples. The separate financial statements give effect to all allocation and related party transaction policies adopted by the Board of Directors of Staples (the "Board"). These policies are described in Note C to the Staples.com combined financial statements. The Staples.com combined financial statements have been prepared in a manner which management believes is reasonable and appropriate. Such financial statements include the financial position, results of operations and cash flows of Staples.com presented to give effect to the accounting policies that will be applicable upon implementation of the Tracking Stock Proposal. If the Tracking Stock Proposal is approved by the Company's stockholders, the Company will provide to the holders of Staples.com Stock separate financial statements, financial reviews, descriptions of the business, and other relevant financial information for Staples RD and Staples.com as well as consolidated financial information for the Company. Notwithstanding the allocation of assets and liabilities, including contingent liabilities, between Staples.com and Staples RD for the purposes of preparing their respective combined financial statements, this allocation and the change in the capital structure of the Company as a result of the approval of the Tracking Stock Proposal will not result in the distribution or spin-off to stockholders of any of the Company's assets or liabilities and will not affect ownership of its assets or responsibility for its liabilities or those of its subsidiaries. Holders of Staples.com Stock will be common stockholders of the Company. The assets the Company attributes to one business will be subject to the liabilities of the other business, even if such liabilities arise from lawsuits, contracts or indebtedness that are attributed to the other business. If the Company is unable to satisfy one business's liabilities out of the assets attributed to it, the Company may be required to satisfy those liabilities with assets the Company has attributed to the other business. Further, VII-3 holders of Staples.com Stock and Staples Stock will not have any legal rights related to specific assets of either business and in any liquidation will receive a fixed share of the net assets of the Company which may not reflect the actual trading prices, if any, of the respective businesses at such time. Financial effects from one business that affect the Company's consolidated results of operations or financial condition could, if significant, affect the results of operations or financial condition of the other business and the market price of the common stock relating to the other business. In addition, net losses of either business and dividends and distributions on, or repurchases of, either class of common stock or repurchases of preferred stock at a price per share greater than par value will reduce the funds we can pay on each class of common stock under Delaware law. Accordingly, the Staples.com combined financial statements should be read in conjunction with the Company's audited consolidated financial information and Annual Report on Form 10-K and the combined financial information of Staples RD contained in Annex VI of this Proxy Statement. Results of Operations Comparison of Fiscal Years ended January 30, 1999, January 31, 1998, and February 1, 1997 General. Staples' electronic commerce business, or e-business, sells office products and services over the Internet to Staples' entire spectrum of business customers, including small, medium and large businesses, as well as consumers. Our e-commerce business operates under the name Staples.com and is comprised of three principal business units, Staples.com, Quillcorp.com and StaplesLink.com (formerly Staples Network Advantage Plus, or SNAP), each of which has its own web site and is specifically designed to serve a target customer base. Staples launched the Staples.com website, the e-commerce business portal of its traditional retail superstore, in November 1998. Staples.com markets over 6,000 products to primarily home office and small business customers through its web- based superstore. Quill sold its first products through Quillcorp.com, the e-commerce business portal of our Quill catalog business, in November 1996. Quillcorp.com markets products from its direct mail catalog to small to medium sized business customers such as legal and medical offices. Quill's private label products are among the products Staples.com sells on the Quillcorp.com web site. Staples established the StaplesLink.com website, the e-commerce business portal of its Staples Network Advantage contract stationer business, in August 1998. The StaplesLink.com website focuses on meeting the needs of medium to large sized business customers by offering simple order entry and contract pricing. During the fiscal year ended January 30, 1999, Staples acquired, in a pooling of interests transaction, Quill Corporation and certain related entities, including the operations of Quillcorp.com, which had 1997 net sales of approximately $3,700,000. The financial information set forth below includes adjustments to give effect to the acquisition of the operations of Quillcorp.com for all periods presented. Prior to its acquisition by Staples, Quill elected to be treated as an S Corporation under the Internal Revenue Code, and accordingly, its earnings and the earnings of Quillcorp.com were not subject to taxation at the corporate level. Pro forma adjustments have been made to reflect an income tax benefit on such previously untaxed earnings for each period presented at an assumed rate of 40%. The statements of operations combine Staples.com's historical operating results for the fiscal years ended January 31, 1998 and February 1, 1997 with corresponding Quill operating results for the years ended December 31, 1997 and 1996. Sales. Sales increased to $16,886,000 in the fiscal year ended January 30, 1999 as compared to $3,706,000 and $35,000 in the fiscal years ended January 31, 1998 and February 1, 1997, respectively, as the roll out of Staples' e-commerce businesses grew. The fiscal year ended January 30, 1999 includes sales from all three e-commerce businesses, Staples.com, Quillcorp.com, and StaplesLink.com, while the previous years included only Quillcorp.com which launched in November 1996. Gross Profit. Gross profit as a percentage of sales was 24.7%, 25.1%, and 25.7% for the fiscal years ended January 30, 1999, January 31, 1998, and February 1, 1997, respectively. The decrease in the fiscal year ended January 30, 1999 is attributable to product and customer mix during the continued rollout of e-commerce VII-4 activities. This decrease was partially offset by the benefit provided by the inter-business allocation agreement which passed on the benefit of lower product costs from vendors. Operating and Selling Expenses. Operating and selling expenses, which consist of payroll, advertising and other operating expenses, were 14.7%, 17.2%, and 371% of sales for the fiscal years ended January 30, 1999, January 31, 1998, and February 1, 1997, respectively. These expenses have decreased as a percentage of sales as sales volume has increased, leveraging fixed and start up expenses over time. General and Administrative Expenses. General and administrative expenses as a percentage of sales were 14.4%, 15.8%, and 237% in the fiscal years ended January 30, 1999, January 31, 1998, and February 1, 1997, respectively. The primary drivers of these expenses are investments in staffing and infrastructure. Included in general and administrative expenses was an allocation of certain Staples RD services provided on a centralized basis amounting to $1,264,000, $320,000, and $3,000 for the fiscal years ended January 30, 1999, January 31, 1998, and February 1, 1997, respectively. These costs decreased as a percentage of sales primarily due to economies of scale. Interest and Other Expense, Net. Net interest and other expense totaled $28,000, $8,000, and $3,000 in the fiscal years ended January 30, 1999, January 31, 1998, and February 1, 1997, respectively. The interest expense is calculated based upon the inter-business credit advance and an incremental borrowing rate of 6% for the fiscal years ended January 30, 1999, January 31, 1998 and February 1, 1997. These credit advances from Staples RD fund the operating needs of Staples.com as most finance activities are managed on a centralized basis and attributed to Staples RD. These advances were funded as a capital contribution by Staples RD at the end of each fiscal year. Income Taxes. The income tax benefit as a percentage of pre-tax income was 38.4%, for the year ended January 30, 1999 and 0% for the fiscal years ended January 31, 1998 and February 1, 1997. On a pro forma basis, to reflect a provision for income taxes on previously untaxed earnings of Quill, Staples.com's effective tax rate would have been 41% for the years ended January 30, 1999, January 31, 1998 and February 1, 1997. Comparison of the 26 Weeks ended July 31, 1999 and August 1, 1998 Sales. Sales increased to $27,302,000 for the six months ended July 31, 1999 as compared to $5,058,000 for the six months ended August 1, 1998. This growth is attributable to the continued rollout of the e-commerce business as the results for the six months ended July 31, 1999 include all three of Staples' internet channels, Staples.com, Quillcorp.com and StaplesLink.com, while the results for the same period in the prior year only include the operations of Quillcorp.com. Staples.com and StaplesLink.com were launched in the quarters ended January 31, 1999 and October 31, 1998, respectively. Gross Profit. Gross profit as a percentage of sales was 23.1% and 26.7% for the six months ended July 31, 1999 and August 1, 1998, respectively. The decrease is attributable to product and customer mix during the continued rollout of e-commerce activities. This decrease was offset by the benefit provided by the inter-business allocation principles which passed on the benefit of lower product costs from vendors. Operating and Selling Expenses. Operating and selling expenses, which consist of payroll, advertising and other operating expenses, increased as a percentage of sales in the six months ended July 31, 1999 to 26.0% compared to 12.1% for the six months ended August 1, 1998. The increase was primarily due to increased marketing expenses which represented 19.2% of sales for the six months ended July 31, 1999 as compared to 7.6% of sales for the same period ended August 1, 1998. General and Administrative Expenses. General and administrative expenses as a percentage of sales were 19.2% and 17.7% for the six months ended July 31, 1999 and August 1, 1998, respectively. Included in general and administrative expenses was an allocation of the costs of certain Staples RD services provided on a VII-5 centralized basis amounting to $1,373,000 and $488,000 for the six months ended July 31, 1999 and August 1, 1998, respectively. The increase in general and administrative costs as a percentage of sales reflects the building of the infrastructure for the continued rollout of e-commerce activities. Interest and Other Expense, Net. Net interest and other expense totaled $51,000 and $1,000 for the six months ended July 31, 1999 and August 1, 1998, respectively. The interest expense relates to the inter-business revolving credit advances from Staples RD to fund the operating needs of Staples.com as most treasury activities are managed on a centralized basis and attributed to Staples RD unless the Board determines otherwise. These advances were funded as a capital contribution by Staples RD at the end of each fiscal year. Income Taxes. Income tax benefit as a percentage of pre-tax income was 39.0% for the six months ended July 31, 1999 as compared to 33.8% for the six months ended August 1, 1998. On a pro forma basis, to reflect a provision for income taxes on previously untaxed earnings of Quill, Staples.com's effective tax rate would have been 41.4% for the six months ended August 1, 1998. Liquidity and Capital Resources Staples manages most finance activities on a centralized, consolidated basis. These activities include the investment of surplus cash, the issuance, repayment and repurchase of short-term and long-term debt, and the issuance and repurchase of common stock. Staples currently attributes each incurrence or issuance of external debt, and the proceeds thereof, to Staples RD and will continue to do so in the future unless the Board determines otherwise. Whenever Staples.com holds cash, Staples.com will normally, but will not be obligated to, transfer that cash to Staples RD. Conversely, whenever Staples.com has a cash need, Staples RD will normally, but will not be obligated to, fund that cash need. The Board will determine, in its sole discretion, whether either business will provide any particular funds on any particular occasion to the other business, but will not be obligated to cause such cash transfers. All cash transfers from one business to or for the account of the other business (other than transfers in return of assets or services rendered or transfers in respect of Staples RD's retained interest that correspond to dividends paid on Staples.com Stock), will be accounted for as inter-business revolving credit advances unless: . the Board determines that a given transfer, or type of transfer, should be accounted for as a long-term loan, . the Board determines that a given transfer, or type of transfer, should be accounted for as a capital contribution increasing Staples RD's retained interest in Staples.com. . the Board determines that a given transfer, or type of transfer, should be accounted for as a return of capital reducing Staples RD's retained interest in Staples.com. There are no specific criteria to determine when Staples RD will account for a cash transfer as a long-term loan, a capital contribution or a return of capital rather than an inter-business revolving credit advance. The Board would make such a determination based on its judgement at the time of such transfer, or at the time of the first of such type of transfer, based upon all relevant circumstances. Factors the Board would consider include: . the current and projected capital structure of each business, . the relative levels of internally generated funds of each business, . the financing needs and objectives of the recipient business, . the investment objectives of the transferring business, the availability, cost and time associated with the alternative financing sources and prevailing interest rates and general economic conditions. Any cash transfer accounted for as an inter-business revolving credit advance will bear interest at a rate at which the Board, in its sole discretion, determines Staples could borrow such funds on a revolving credit basis. VII-6 Any cash transfer accounted for as a long-term loan will have interest rate, amortization, maturity, redemption and other terms that generally reflect the then prevailing terms on which the Board, in its sole discretion, determines Staples could borrow such funds. Any cash transfer from Staples RD to Staples.com, or for Staples.com's account, accounted for as a capital contribution will correspondingly increase Staples.com's group equity and Staples RD's retained interest in Staples.com. As a result, the number of shares issuable with respect to Staples RD's retained interest in Staples.com will increase by the amount of such capital contribution divided by the market value of Staples.com Stock on the date of transfer. Any cash transfer from Staples.com to Staples RD, or for Staples RD's account, accounted for as a return of capital will correspondingly reduce Staples.com's group equity and Staples RD's retained interest in Staples.com. As a result, the number of shares issuable with respect to Staples RD's retained interest in Staples.com will decrease by the amount of such return of capital divided by the market value of Staples.com Stock on the date of transfer. As a result of the cash management policies in place between Staples RD and Staples.com, Staples.com is heavily dependent on Staples RD for its continued funding. Accordingly, Staples.com's liquidity could be adversely affected by the liquidity needs of Staples RD. During the years ended January 30, 1999, January 31, 1998 and February 1, 1997, Staples RD also utilized its revolving credit facility to support its various growth initiatives. Staples.com is dependent on continued funding from Staples RD. Any deterioration in the financial condition of the Company or Staples RD could have an adverse impact on Staples.com's ability to fund operations. During the year ended January 30, 1999, cash used in operations was $1,377,000, primarily due to an increase in prepaid and other current assets and the net loss from operations. Cash used in investing activities was $1,072,000 due to the acquisition of equipment. Cash provided by financing activities was $2,449,000, representing capital contributions from Staples RD. During the six months ended July 31, 1999, cash used in operations was $1,697,000, primarily due to the net loss from operations of $3,706,000 offset by an increase in accounts payable, accrued expenses and other liabilities of $1,142,000 and a decrease in prepaid and other current assets of $700,000. Cash used in investing activities of $22,796,000 represents investments made in internet related companies of $20,906,000 and acquisitions of property and equipment of $1,890,000. Cash provided by financing activities of $24,493,000 represents capital contributions from Staples RD of $22,796,000 and proceeds from borrowings under the inter-business revolver of $1,697,000. Inflation and Seasonality While inflation or deflation has not had, and Staples.com does not expect it to have, a material impact upon operating results, there can be no assurance that Staples.com's business will not be affected by inflation or deflation in the future. Staples.com believes that its business is somewhat seasonal, with sales and profitability slightly lower during the first and second quarters of its fiscal year. Future Operating Results This document includes or incorporates forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. You can identify these forward-looking statements by our use of the words "believes", "anticipates", "plans", "expects", "may", "will", "would", "intends", "estimates" and other similar expressions, whether in the negative or affirmative. Staples.com cannot guarantee that it actually will achieve these plans, intentions or expectations disclosed in the forward looking statements it makes. Staples.com has included important factors in the cautionary statements below that it believes could cause its actual results to differ materially from the forward-looking statements that it makes. The forward-looking statements do not reflect the potential impact of any future acquisitions, mergers or dispositions. Staples.com does not assume any obligation to update any forward-looking statement it makes. VII-7 Staples.com has a limited operating history on which to assess its future prospects. Staples.com has a limited history upon which to base an evaluation of its prospects. Staples.com's prospects must be considered in light of the risks, expenses and difficulties frequently encountered by start-up companies in the new and rapidly evolving e-commerce market. Staples.com's sales and cost of operations have grown substantially and Staples.com has incurred cumulative net losses since inception. These losses reflect expenditures necessary to develop, launch and acquire Staples.com's site and services. Staples.com believes that newly launched sites and services require a certain period of growth before they begin to achieve adequate sales to support their operations. There can be no assurance that Staples.com's sales will increase or even continue at its current level, or that Staples.com will achieve or maintain profitability or generate cash from operations in future periods. Staples.com's market is highly competitive and it may not continue to compete successfully. Staples.com competes in a highly competitive marketplace with a variety of retailers, dealers, distributors and other e-commerce operations. These include other high-volume office supply chains, such as Office Depot, OfficeMax and Office World, that have pricing strategies and product selections that are similar to Staples.com. Staples.com also competes with online and other mass merchants, such as Wal-Mart, warehouse clubs, computer and electronic superstores, and other discount retailers. In addition, Staples.com competes with numerous mail order firms, contract stationer businesses and direct manufacturers. Some of Staples.com's current and potential competitors are larger and have substantially greater financial resources than Staples.com. It is possible that increased competition or improved performance by competitors may reduce Staples.com's market share, may force Staples.com to charge lower prices than it otherwise would, and may adversely affect its business and financial performance in other ways. Sales and profitability are also influenced by product mix and additional investments Staples.com makes in its business. Staples.com's quarterly operating results are subject to significant fluctuation. Staples.com's operating results have fluctuated from quarter to quarter in the past, and it expects that they will continue to do so in the future. Staples.com's earnings may fall short of either a prior fiscal period or investors' expectations. Factors that could cause these quarterly fluctuations include the following: . the mix of products sold; . pricing actions of competitors; . the level of advertising and promotional expenses; . seasonality, primarily because sales and profitability is typically slightly lower in the first and second quarter of our fiscal year than in other quarters; and . charges associated with acquisitions. Most of Staples.com's operating expenses, such as rent expense, advertising expense and employee salaries, do not vary directly with the amount of sales and are difficult to adjust in the short term. As a result, if sales in a particular quarter are below expectations for that quarter, Staples.com may not proportionately reduce operating expenses for that quarter, and therefore this sales shortfall would have a disproportionate effect on Staples.com's net income for the quarter. Staples.com's rapid growth may continue to strain its operations, which could adversely affect its business and financial results. Staples.com's business, including sales, and number of employees, has grown dramatically since its inception. This growth has placed significant demands on its management and operational systems. If Staples.com is not successful in upgrading its operational and financial systems, expanding its management team and increasing and effectively managing its employee base, this growth is likely to result in operational inefficiencies and ineffective management of Staples.com's business and employees, which will in turn adversely affect its business and financial performance. VII-8 Staples.com as a new business enterprise may not be able to manage many general business risks faced by other more mature e-commerce businesses. Staples.com must, among other things, effectively develop new relationships and maintain existing relationships with its customers, advertisers, and other on-line partners; provide a wide variety of products, services, and content; develop and upgrade its technology; respond to competitive developments; and attract, retain and motivate qualified personnel. There can be no assurance that Staples.com will succeed in addressing such risks and the failure to do so could have a material adverse effect on Staples.com's business, financial condition or results of operations. Year 2000 Readiness Disclosure Staples RD has completed an assessment of the internal computer systems and applications of Staples.com. Because these systems were developed recently, Staples RD does not believe that these systems will be directly impacted by the "Year 2000 issue" as described below. The operations of Staples.com as a whole, however, are directly reliant upon the compliance of the systems and applications of Staples RD. Staples.com's operations could also be affected by the compliance of various third parties including internet hosting and routing services, vendors, telephone providers and the systems of their customers who must use their systems to place orders on Staples.com's various e-commerce platforms. For a discussion of Year 2000 compliance activities of Staples RD, which are being managed on a corporate wide basis, see the "Year 2000 Readiness Disclosure" for Staples RD contained in Annex VI of this Proxy Statement. VII-9 REPORT OF INDEPENDENT AUDITORS Board of Directors and Shareholders Staples, Inc. We have audited the accompanying combined balance sheets of Staples.com (as described in Notes A and C) as of January 30, 1999 and January 31, 1998, and the related combined statements of operations, group equity and cash flows for each of the three years in the period ended January 30, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Staples.com at January 30, 1999 and January 31, 1998 and the results of its operations and its cash flows for each of the three years in the period ended January 30, 1999 in conformity with generally accepted accounting principles. As more fully described in Notes A and C to these financial statements, Staples.com is a business group of Staples, Inc., accordingly, the combined financial statements of Staples.com should be read in conjunction with the audited financial statements of Staples, Inc. /s/ Ernst & Young LLP ERNST & YOUNG LLP Boston, Massachusetts September 21, 1999 VII-10 STAPLES.COM COMBINED BALANCE SHEETS (Dollar Amounts in Thousands)
January 30, January 31, 1999 1998 ----------- ----------- ASSETS Current Assets: Cash and cash equivalents............................. $ -- $ -- Prepaid expenses and other current assets............. 1,033 -- ------- ------ Total current assets................................ 1,033 -- Equipment: Equipment............................................. 1,072 -- Less accumulated depreciation......................... 58 -- ------- ------ Net equipment....................................... 1,014 -- ------- ------ $ 2,047 $ -- ======= ====== LIABILITIES AND GROUP EQUITY Current Liabilities: Accrued expenses and other current liabilities........ $ 85 $ -- ------- ------ Total current liabilities........................... 85 -- Group equity............................................ 1,962 -- ------- ------ $ 2,047 $ -- ======= ======
See notes to combined financial statements. VII-11 STAPLES.COM COMBINED STATEMENTS OF OPERATIONS (Dollar Amounts in Thousands)
Fiscal Year Ended ----------------------------------- January 30, January 31, February 1, 1999 1998 1997 ----------- ----------- ----------- Sales...................................... $16,886 $3,706 $ 35 Cost of goods sold and occupancy costs..... 12,721 2,775 26 ------- ------ ----- Gross profit............................. 4,165 931 9 Operating and other expenses: Operating and selling.................... 2,488 637 130 General and administrative............... 2,440 586 83 Interest and other expense, net.......... 28 8 3 ------- ------ ----- Total operating and other expenses..... 4,956 1,231 216 ------- ------ ----- Loss before income taxes................... (791) (300) (207) Income tax benefit......................... (304) -- -- ------- ------ ----- Net loss................................. $ (487) $ (300) $(207) ======= ====== ===== Pro forma: Historical net loss...................... $ (487) $ (300) $(207) Provision for income tax benefit on previously untaxed earnings of pooled S- Corporation income...................... (12) (120) (83) ------- ------ ----- Pro forma net loss....................... $ (475) $ (180) $(124) ======= ====== =====
See notes to combined financial statements. VII-12 STAPLES.COM COMBINED STATEMENTS OF GROUP EQUITY (Dollar Amounts in Thousands) For the Fiscal Years Ended January 30, 1999, January 31, 1998, and February 1, 1997
Group Equity ------ Balances at February 3, 1996............................................ $ -- Capital contribution by Staples RD...................................... $ 207 Net loss for the year................................................... (207) ------ Balances at February 1, 1997............................................ $ -- Capital contribution by Staples RD...................................... $ 300 Net loss for the year................................................... (300) ------ Balances at January 31, 1998............................................ $ -- Capital contribution by Staples RD...................................... 2,449 Net loss for the year................................................... (487) ------ Balances at January 30, 1999............................................ $1,962 ======
See notes to combined financial statements. VII-13 STAPLES.COM COMBINED STATEMENTS OF CASH FLOWS (Dollar Amounts in Thousands)
Fiscal Year Ended ----------------------------------- January 30, January 31, February 1, 1999 1998 1997 ----------- ----------- ----------- Operating Activities: Net loss.................................. $ (487) $(300) $(207) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation and amortization............. 58 -- -- Change in assets and liabilities Increase in prepaid expenses and other assets................................. (1,033) -- -- Increase in accounts payable, accrued expenses and other current liabilities............................ 85 -- -- ------- ----- ----- (890) -- -- ------- ----- ----- Net cash used in operating activities....... (1,377) (300) (207) Investing Activities: Acquisition of property and equipment..... (1,072) -- -- ------- ----- ----- Net cash used in investing activities..... (1,072) -- -- Financing Activities: Proceeds from borrowings.................. 1,377 300 207 Repayment of borrowings................... (1,377) (300) (207) Capital contributions from Staples RD..... 2,449 300 207 ------- ----- ----- Net cash provided by financing activities............................... 2,449 300 207 Net (decrease) increase in cash and cash equivalents................................ -- -- -- Cash and cash equivalents at beginning of period..................................... -- -- -- ------- ----- ----- Cash and cash equivalents at end of period.. $ -- $ -- $ -- ======= ===== =====
See notes to combined financial statements. VII-14 STAPLES.COM NOTES TO COMBINED FINANCIAL STATEMENTS NOTE A Basis of Presentation These combined financial statements and notes to combined financial statements of Staples RD should be read in conjunction with the audited consolidated financial statements and Annual Report on Form 10-K of Staples, Inc. ("Staples" or "the Company") for the year ended January 30, 1999 and the combined financial information of Staples Retail and Delivery ("Staples RD") contained in Annex VI of this Proxy Statement. Staples.com is comprised of the e-commerce operations of Staples. These operations consist of three principal business units, Staples.com, Quillcorp.com and StaplesLink.com (formerly Staples Network Advantage Plus, or SNAP), each of which operates its own web site and serves a separate target customer base. The stockholders of Staples are scheduled to vote on a proposal (the "Tracking Stock Proposal") to amend the Company's certificate of incorporation to (i) create a new class of common stock, to be designated as Staples.com common stock ("Staples.com Stock"), intended to reflect the performance of Staples.com, (ii) increase the aggregate number of shares of common stock that the Company may issue from 1,500,000,000 to 2,100,000,000, initially comprised of 1,500,000,000 shares of Staples Retail and Delivery common stock ("Staples Stock") and 600,000,000 shares of Staples.com Stock, and (iii) reclassify Staples existing common stock as Staples Stock, intended to reflect the performance of Staples RD, which consists of all of the Company's other businesses and a retained interest in Staples.com. Staples RD currently has a 100% retained interest in Staples.com. The Company expects to issue additional shares of Staples.com Stock in one or more private or public financings within twelve months of stockholder approval of the Tracking Stock Proposal. The specific terms of the financings, including whether they are private or public, the amount of Staples.com Stock issued, and the timing of the financing, will depend upon factors such as stock market conditions and the performance of Staples.com. The effect of the financing on the Staples.com financial statements will depend upon the number of shares of Staples.com sold and whether the Company elects to attribute the net proceeds of such financing to the equity of Staples.com or to Staples RD in respect of its retained interest. In order to prepare separate financial statements for Staples.com and Staples RD, the Company has allocated, for financial reporting purposes, all of its consolidated assets, liabilities, revenue, expenses and cash flow between Staples.com and Staples RD. Thus, the combined financial statements of Staples.com and Staples RD, taken together, comprise all of the accounts included in the corresponding consolidated financial statements of Staples. Staples.com's combined financial statements reflect the application of certain cash management and allocation policies adopted by the Board of Directors of Staples (the "Board"). These policies are summarized in Note C under "Corporate Activities." Allocation and related party transaction policies adopted by the Board can be rescinded or amended at the sole discretion of the Board without approval by the stockholders, although no such changes are currently contemplated. Any such changes adopted by the Board would be made in its good faith business judgement of the Company's best interests, taking into consideration the interests of all stockholders. If the Tracking Stock Proposal is approved by the stockholders and implemented by the Board, the Company will provide to the holders of both Staples Stock and Staples.com Stock separate financial statements, management's discussion and analysis of the results of operations and financial condition, and other relevant information of the Company. Even though Staples has allocated all of its consolidated assets, liabilities, revenue, expenses and cash flow between Staples RD and Staples.com, holders of Staples.com Stock will be common stockholders of Staples and, as such, will be subject to the risks associated with an investment in Staples and all of its businesses, assets and liabilities. Assets attributed to one business are subject to the liabilities of the other businesses, whether such liabilities arise from lawsuits, contracts or indebtedness attributed to the other business. Holders of Staples Stock and Staples.com Stock will not have any legal rights related to specific assets of either group and in any liquidation will receive a fixed share of the net assets of the Company which may not reflect the actual trading prices, if any, of the respective businesses at such time. VII-15 STAPLES.COM NOTES TO COMBINED FINANCIAL STATEMENTS--(Continued) Financial impacts which occur that affect Staples consolidated results of operations or financial position could affect the results of operations or financial condition of Staples.com. In addition, any dividends or distributions on, or repurchases of, Staples Stock will reduce the assets of Staples legally available for dividends on Staples.com Stock. Accordingly, financial information for Staples.com should be read in conjunction with the financial information for Staples RD and financial information for Staples. NOTE B Summary of Significant Accounting Policies Nature of Operations: Staples RD operates a chain of office supply stores and contract stationer/delivery warehouses throughout North America and in the United Kingdom and Germany. Staples.com represents the e-commerce business of Staples and is comprised of three principal business units, including Staples.com, Quillcorp.com and StaplesLink.com, each of which has its own website. Staples RD represents the other business of Staples, including its retail stores, catalog businesses and contract stationer businesses. Fiscal Year: Staples.com's fiscal year is the 52 or 53 weeks ending the Saturday closest to January 31. Fiscal years 1998, 1997 and 1996, consisted of the 52 weeks ended January 30, 1999, January 31, 1998 and February 1, 1997, respectively. As more fully described in Note J, the statements of income combine Staples' historical operating results for the fiscal years with the corresponding Quill Corporation ("Quill") operating results for the calendar years ended December 31, 1997 and 1996. Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management of Staples.com to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Concentration of Credit Risk: Staples.com does not carry any inventory or receivables and is solely reliant upon Staples RD and its ability to fullfill Staples.com's sales. Staples.com is also dependent on Staples RD to provide funding for its operations, and the Board will determine, in its sole discretion, whether to provide any particular funds on any particular occasion to either group, but will not be obligated to do so. Advertising: Advertising production costs are expensed the first time the advertising takes place. Total advertising and promotion expenses were $1,595,000, $497,000 and $128,000 for the years ended January 30, 1999, January 31, 1998, and February 1, 1997, respectively. Included in prepaid and other assets was $1,033,000 and $0 at January 30, 1999 and January 31, 1998, respectively, relating to prepaid advertising and promotion expenses. Equipment: Equipment is recorded at cost. Depreciation is provided using the straight-line method over the estimated useful lives of the assets. Depreciation periods for equipment are three to five years. Stock Option Plans: Staples.com has adopted Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("FAS 123"). As permitted by FAS 123, Staples.com continues to account for Staples' stock-based plans under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", and provides pro forma disclosures of the compensation expense determined under the fair value provisions of FAS 123. Earnings Per Share: Historical Earnings per Share for Staples.com has been omitted from the statements of operations since Staples.com Stock was not part of the capital structure of the Company for the periods presented. Following the implementation of the Tracking Stock Proposal, earnings per share for Staples.com will be computed by dividing (i) the product of the earnings of Staples.com multiplied by the "Outstanding VII-16 STAPLES.COM NOTES TO COMBINED FINANCIAL STATEMENTS--(Continued) Staples.com Fraction" by (ii) the weighted average number of shares of Staples.com Stock and dilutive Staples.com Stock equivalents outstanding during the applicable period. The "Outstanding Staples.com Fraction" is a fraction, the numerator of which is such number of shares of Staples.com Stock outstanding and the denominator of which is the number of shares of Staples.com Stock that, if issued, would represent 100 percent of the equity of Staples.com. Long-Lived Assets: Staples.com adopted Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed Of" ("FAS 121"), which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flow estimated to be generated by those assets are less than the assets' carrying amount. Segment Reporting: Staples.com reports segment information under Financial Accounting Standards Board issued Statement No. 131, "Disclosures about Segments of an Enterprise and Related Information" (FAS 131). This statement, which is based on the management approach to segment reporting, establishes requirements to report selected segment information quarterly and to report entity-wide disclosures about products and services, major customers, and the major countries in which Staples.com holds assets and reports revenues. Staples.com holds assets and reports revenues in one operating segment. NOTE C Corporate Activities Staples.com's financial statements reflect the application of the management and allocation policies adopted by the Board to various corporate activities, as described below: Finance Activities: Staples manages most finance activities on a centralized, consolidated basis. These activities include the investment of surplus cash, the issuance, repayment and repurchase of short-term and long- term debt, and the issuance and repurchase of common stock. Staples.com generally remits its cash receipts to Staples RD, and Staples RD generally funds Staples.com's disbursements on a regular basis. In the combined financial statements of Staples.com and Staples RD, (1) all equity transactions, and the proceeds thereof, were attributed to Staples RD, (2) whenever Staples.com held cash, that cash was transferred to Staples RD and accounted for as an inter-business revolving credit advance and (3) whenever Staples.com had a cash need, that cash need was funded by Staples RD and accounted for as an inter-business revolving credit advance. Staples intends to continue these practices until shares of Staples.com Stock, or options therefor, are issued or the Board determines an alternative method appropriate. The inter-business revolving credit arrangement bears interest at a rate at which the Board, in its sole discretion, determines Staples could borrow such funds on a revolving credit basis which was 6% for the fiscal years ended January 30, 1999, January 31, 1998 and February 1, 1997. At the date on which the shares of Staples.com Stock, or options therefor are first issued, the Company intends to continue the above practice of transferring cash between businesses through an inter-business revolving credit arrangement. As and when determined by the Board, this revolving credit arrangement will be settled between the businesses through a capital contribution or a return of capital, increasing or decreasing Staples RD's retained interest in Staples.com. The Board, at its sole discretion, may elect an alternative financing mechanism between the businesses based upon the facts and circumstances. VII-17 STAPLES.COM NOTES TO COMBINED FINANCIAL STATEMENTS--(Continued) Shared Services and Support Activities: The cost of services shared by Staples RD and Staples.com, including general and administrative expenses, has been allocated between Staples.com and Staples RD based upon the use of such services and the good faith judgement of the Board or management. Where determinations based on use alone were not practical, other methods and criteria were used to provide a reasonable allocation of the cost of shared services, including support activities attributable to the business. Such allocated shared services represent, among other things, financial and accounting services, information system services, certain selling and marketing activities, certain merchandising and replenishment services, transportation and warehouse management services, certain customer service activities, executive management, human resources, legal and corporate planning activities. Carrying Charge: Staples RD maintains inventory and receivables to support Staples.com inventory needs and the processing of receivables for Staples.com. As such, Staples RD charges Staples.com a carrying charge for use of its capital as determined by the Board. The current charge is reflected in Staples.com's financial statements as part of operating and selling expenses and is calculated based on the amount of receivables and inventory that Staples RD is required to carry for Staples.com. The Board may, in its sole discretion, change this charge as it deems appropriate in light of the circumstances from time to time. In addition, shrink, obsolescence and other inventory costs are allocated to Staples.com's based on Staples.com share of such costs. Taxes: Federal income taxes, which are determined on a consolidated basis, are allocated between the businesses, and reflected in their respective financial statements, in accordance with Staples' tax allocation policy. In general, this policy provides that the consolidated tax provision, and related tax payments or refunds, are allocated between the businesses based principally upon the financial income, taxable income, credits and other amounts directly related to the respective businesses. Tax benefits that cannot be used by the businesses generating such attributes, but can be utilized on a consolidated basis, are allocated to the businesses that generated such benefits. As a result, the allocated amounts of taxes payable or refundable are not necessarily comparable to those that would have resulted if the businesses had filed separate tax returns. State income taxes generally are computed on a separate business basis. Employee Benefits: Staples.com participated in the following Company employee benefit plans: an Employee Stock Purchase Plan, an Employee 401(k) Savings Plan, a Supplemental Executive Retirement Plan and a contributory Medical and Dental Plan. The costs of these plans are allocated based on the benefits received under the plans by the employees comprising the Staples.com or another basis as management believes to be an equitable and reasonable estimate of such costs. NOTE D Related Party Transactions Staples RD sells inventory to Staples.com for resale. Under this arrangement, Staples.com purchases inventory from Staples RD for resale. The cost per inventory unit purchased by Staples.com is based on Staples RD's product cost. Inventory purchased by Staples.com totaled $10,796,000, $2,364,000, and $22,000 for the fiscal years ended January 30, 1999, January 31, 1998 and February 1, 1997, respectively. NOTE E Long-Term Debt and Credit Agreement Staples manages most financial activities on a centralized basis. Such financial activities include the issuance and repayment of short-term and long- term debt. Staples currently attributes each incurrence or issuance of external debt, and the proceeds thereof, to Staples RD and will continue to do so in the future unless the Board determines otherwise. The Board may, but is not required to, attribute an incurrence or issuance of debt, and the proceeds thereof, to Staples.com, at a current incremental borrowing rate of 6%, to the extent that Staples incurs or issues the debt for the benefit of Staples.com. VII-18 STAPLES.COM NOTES TO COMBINED FINANCIAL STATEMENTS--(Continued) NOTE F Group Equity Staples.com Stock will represent a separate class of Staples's stock if the Tracking Stock Proposal is approved by Staples' stockholders. Shares of Staples.com Stock may be issued from time to time at the discretion of the Board. NOTE G Employee Benefit Plans Staples.com elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under FASB Statement No. 123, "Accounting for Stock-Based Compensation" requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, since the exercise price of Staples' employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. Employee Stock Purchase Plan Staples' 1998 Employee Stock Purchase Plan authorizes a total of up to 6,000,000 shares of Staples' common stock to be sold to participating employees. Participating employees may purchase shares of common stock at 85% of its fair market value at the beginning or end of an offering period, whichever is lower, through payroll deductions in an amount not to exceed 10% of an employee's base compensation. Staples' 1994 Employee Stock Purchase Plan expired during 1998. Stock Option Plans Under Staples' 1992 Equity Incentive Plan ("1992 Plan"), Staples may grant to management and key employees incentive and nonqualified options to purchase up to 87,750,000 shares of Staples common stock and Performance Accelerated Restricted Stock ("PARS"). This amount was approved by the stockholders of Staples on June 18, 1997. As of February 27, 1997, Staples' 1987 Stock Option Plan (the "1987 Plan") expired; unexercised options under this plan however remain outstanding. The exercise price of options granted under the plans may not be less than 100% of the fair market value of Staples' common stock at the date of grant. Options generally have an exercise price equal to the fair market value of the common stock on the date of grant. Some options outstanding are exercisable at various percentages of the total shares subject to the option starting one year after the grant, while other options are exercisable in their entirety three to five years after the grant date. All options expire ten years after the grant date, subject to earlier termination in the event of employment termination. Staples' Amended and Restated 1990 Director Stock Option Plan ("Director's Plan") authorizes shares of common stock to be issued to non-employee directors. The exercise price of options granted is equal to the fair market value of Staples' common stock at the date of grant. Options become exercisable in equal amounts over four years and expire ten years from the date of grant, subject to earlier termination, in certain circumstances, in the event the optionee ceases to serve as a director. Performance Accelerated Restricted Stock ("PARS") PARS are shares of Staples' common stock granted outright to employees and non-employee directors without cost to the employee or director. The shares, however, are restricted in that they are not transferable (e.g. they may not be sold) by the employee or director until they vest, generally after the end of five years. Such vesting date may accelerate if Staples achieves certain compound annual earnings per share growth over a VII-19 STAPLES.COM NOTES TO COMBINED FINANCIAL STATEMENTS--(Continued) certain number of interim years. If the employee leaves Staples, or the director ceases to serve as a director of Staples, prior to the vesting date for any reason, the PARS shares will be forfeited by the employee or director, as the case may be, and will be returned to Staples. Once the PARS have vested, they become unrestricted and may be transferred and sold like any other Staples common stock. Employees' 401(k) Savings Plan Under Staples' Employees' 401(k) Savings Plan (the "401(k) Plan"), and Supplemental Executive Retirement Plan (the "SERP Plan"), Staples may contribute up to a total of 2,503,125 shares of common stock to these plans. The 401(k) Plan is available to all employees of Staples who meet minimum age and length of service requirements. Company contributions are based upon a matching formula applied to employee contributions, with additional contributions made at the discretion of the Board. NOTE H Income Taxes The provision (benefit) for income taxes and related assets and liabilities attributed to Staples.com are determined in accordance with Staples' tax allocation policy. In general, this policy provides that the consolidated tax provision, and related tax payments or refunds, are allocated between the businesses based principally upon the financial income, taxable income, credits and other amounts directly related to the respective businesses. Tax benefits that cannot be used by the business generating such attributes, but can be utilized on a consolidated basis, are allocated to the business that generated such benefits. As a result, the allocated amounts of taxes payable or refundable are not necessarily comparable to those that would have resulted if the businesses had filed separate tax returns. Deferred income taxes reflect the tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Staples.com's temporary differences primarily consist of a net operating loss of $761,000 and basis differences related to equipment. Because Staples.com has been fully reimbursed for the benefit of the net operating loss under Staples' tax allocation policy, no valuation allowance has been provided on the net operating loss and the balance is included in the inter-business revolver balance. The provision for income tax for the fiscal year ended January 30, 1999 is comprised solely of an income tax benefit of $304,000. VII-20 STAPLES.COM NOTES TO COMBINED FINANCIAL STATEMENTS--(Continued) NOTE I Quarterly Summary (Unaudited)
First Second Third Fourth Quarter Quarter Quarter Quarter ------- ------- ------- ------- (In thousands) Fiscal Year Ended January 30, 1999 Sales........................ $2,244 $2,815 $4,046 $7,781 Gross Profit................. 569 783 1,077 1,736 Net loss..................... (53) (50) (99) (285) Pro forma net loss........... (41)(1) (50) (99) (285) First Second Third Fourth Quarter Quarter Quarter Quarter ------- ------- ------- ------- (In thousands) Fiscal Year Ended January 31, 1998 Sales........................ $ 244 $ 619 $1,171 $1,672 Gross Profit................. 61 158 290 422 Net loss..................... (22) (95) (122) (61) Pro forma net loss........... (13)(1) (57)(1) (73)(1) (37)(1)
- -------- (1) Pro forma net income includes the earnings of Quill with provision for income taxes on previously untaxed earnings of pooled S-Corporation income. NOTE J Business Acquisitions On May 21, 1998, Staples acquired Quill Corporation and certain related entities, including the operations of QuillCorp.com. The merger was structured as an exchange of shares in which the stockholders of Quill received approximately 26,000,000 shares of Staples' common stock, at an exchange ratio established at a combination of fixed and variable prices, and cash paid to a dissenting stockholder of approximately $48,000,000, which equates to a purchase price of approximately $690,000,000. The merger was accounted for as a pooling of interests and, accordingly, Staples.com's consolidated financial statements have been restated to include the operations of Quillcorp.com for all periods prior to the merger. The statements of income combine Staples.com's historical operating results for the fiscal years ended January 31, 1998 and February 1, 1997 with the corresponding Quillcorp.com operating results for the years ended December 31, 1997 and 1996 respectively. Prior to the acquisition, Quill elected to be taxed as an S Corporation under the Internal Revenue Code. Accordingly, the current taxable income of Quillcorp.com was taxable to its shareholders who were responsible for the payment of taxes thereon. Quill will be included in Staples' U.S. federal income tax return subsequent to the date of the acquisition. Pro forma adjustments have been made to the restated statements of operations to reflect the income taxes that would have been provided had Quillcorp.com's income been subject to income taxes. VII-21 STAPLES.COM INTERIM FINANCIAL STATEMENTS The following interim financial information is unaudited but, in the opinion of the Company, includes all adjustments, consisting only of normal recurring accruals, necessary for a fair presentation. Operating results for the interim period are not necessarily indicative of the results that may be expected for the full year. The financial information should be read in conjunction with Staples.com's audited combined financial statements as of January 30, 1999 included herein, the Staples, Inc. audited consolidated financial statements and Annual Report on Form 10-K as of January 30, 1999 and unaudited interim results on Form 10-Q. VII-22 STAPLES.COM COMBINED BALANCE SHEETS (Dollar Amounts in Thousands)
July 31, 1999 January 30, (Unaudited) 1999 ----------- ----------- ASSETS Current Assets: Cash and cash equivalents............................. $ -- $ -- Prepaid expenses and other current assets............. 333 1,033 ------- ------ Total current assets................................ 333 1,033 Equipment: Equipment............................................. 2,962 1,072 Less accumulated depreciation......................... 225 58 ------- ------ Net equipment....................................... 2,737 1,014 Other Assets: Investments........................................... 20,906 -- ------- ------ Total other assets.................................. 20,906 -- ------- ------ $23,976 $2,047 ======= ====== LIABILITIES AND GROUP EQUITY Current Liabilities: Inter-business payable to Staples RD.................. $ 1,697 $ -- Accrued expenses and other current liabilities........ 1,227 85 ------- ------ Total current liabilities........................... 2,924 85 Group equity.......................................... 21,052 1,962 ------- ------ $23,976 $2,047 ======= ======
See notes to combined interim financial statements. VII-23 STAPLES.COM COMBINED STATEMENTS OF OPERATIONS (Dollar Amounts in Thousands)
26 Weeks Ended ------------------- July 31, August 1, 1999 1998 -------- --------- (Unaudited) Sales....................................................... $27,302 $5,058 Cost of goods sold and occupancy costs...................... 20,997 3,706 ------- ------ Gross profit............................................ 6,305 1,352 Operating and other expenses: Operating and selling..................................... 7,086 611 General and administrative................................ 5,243 897 Interest and other expense, net........................... 51 1 ------- ------ Total operating and other expenses...................... 12,380 1,509 ------- ------ Loss before income taxes.................................. (6,075) (157) Income tax benefit.......................................... (2,369) (53) ------- ------ Net loss.................................................. $(3,706) $ (104) ======= ====== Pro forma: Historical net loss....................................... $ (104) Provision for income taxes on previously untaxed earnings of pooled S-Corporation income........................... (12) ------ Pro forma net loss...................................... $ (92) ======
See notes to combined interim financial statements. VII-24 STAPLES.COM COMBINED STATEMENTS OF CASH FLOWS (Dollar Amounts in Thousands)
26 Weeks Ended ------------------- July 31, August 1, 1999 1998 -------- --------- (Unaudited) Operating Activities: Net income................................................. $(3,706) $(104) Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization............................ 167 -- Change in assets and liabilities: (Increase)/Decrease in prepaid expenses and other assets................................................ 700 -- Increase in accounts payable, accrued expenses and other current liabilities............................. 1,142 -- ------- ----- 2,009 -- ------- ----- Net cash used in operating activities...................... (1,697) (104) Investing Activities: Acquisition of property and equipment...................... (1,890) (410) Purchase of long-term investments.......................... (20,906) -- ------- ----- Net cash used in investing activities...................... (22,796) (410) Financing Activities: Proceeds from borrowings................................... 1,697 104 Capital contributions from Staples RD...................... 22,796 410 ------- ----- Net cash provided by financing activities.................. 24,493 514 Net decrease in cash and cash equivalents.................. -- -- Cash and cash equivalents at beginning of period........... -- -- ------- ----- Cash and cash equivalents at end of period................. $ -- $ -- ======= =====
See notes to combined interim financial statements. VII-25 STAPLES.COM NOTES TO COMBINED INTERIM FINANCIAL STATEMENTS (Unaudited) NOTE A Basis of Presentation The accompanying interim unaudited combined financial statements include the accounts of Staples.com. All intercompany accounts and transactions are eliminated in consolidation. In order to prepare separate financial statements for Staples RD and Staples.com, the Company has allocated, for financial reporting purposes, all of its consolidated assets, liabilities, revenue, expenses and cash flow between Staples RD and Staples.com. The financial statements of Staples RD and Staples.com, taken together, comprise all of the accounts included in the corresponding consolidated financial statements of Staples. Staples.com financial statements reflect the application of certain cash management and allocation policies adopted by the Board, Staples.com financial statements include the historical financial position, results of operations, and cash flows of Staples.com. These combined financial statements should be read in conjunction with the audited consolidated financial statements and footnotes of Staples included in the Company's Annual Report on Form 10-K for the year ended January 30, 1999 and the combined financial statements and footnotes of Staples RD for the year ended January 30, 1999 included in Annex VI of this Proxy Statement. NOTE B Computation of Earnings Per Common Share Historical Earnings per Share for Staples.com has been omitted from the statements of operations since Staples.com Stock was not part of the capital structure of the Company for the periods presented. Following the implementation of the Tracking Stock Proposal, earnings per share for Staples.com will be computed by dividing (i) the product of the earnings of Staples.com multiplied by the "Outstanding Staples.com Fraction" by (ii) the weighted average number of shares of Staples.com Stock and dilutive Staples.com Stock equivalents outstanding during the applicable period. The "Outstanding Staples.com Fraction" is a fraction, the numerator of which is such number of shares of Staples.com Stock outstanding and the denominator of which is the number of shares of Staples.com Stock that, if issued, would represent 100 percent of the equity of Staples.com. NOTE C Investments Investments consist of stock purchased in internet related companies whose stock is not publicly traded on an exchange. These investments have been accounted for on a cost basis as each investment represents an interest of no greater than fifteen percent. VII-26 [Staples logo appears here] PROXY STAPLES, INC. Proxy for the Special Meeting of Stockholders to be held on november 9, 1999 THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS OF THE COMPANY The undersigned, revoking all prior proxies, hereby appoint(s) John J. Mahoney, Jack A. VanWoerkom and Mark G. Borden, and each of them, with full power of substitution, as proxies to represent and vote, as designated herein, all shares of Common Stock of Staples, Inc. (the "Company") which the undersigned would be entitled to vote if personally present at the Special Meeting of Stockholders of the Company to be held at the offices of Hale and Dorr LLP, 60 State Street, Boston, Massachusetts, on Tuesday, November 9, 1999, at 2:00 p.m., local time, and at any adjournment thereof. In their discretion, the proxies are authorized to vote upon such other matters as may properly come before the meeting or any adjournment thereof. This proxy, when properly executed, will be voted in the manner directed by the undersigned stockholder(s). If no direction is given, this proxy will be voted FOR Proposals 1, 2, 3 and 4. Attendance of the undersigned at the meeting or any adjournments thereof will not be deemed to revoke this proxy unless the undersigned shall revoke this proxy in writing or affirmatively indicate the intent to vote in person. CONTINUED AND TO BE SIGNED ON THE REVERSE SIDE SEE REVERSE SIDE SEE REVERSE SIDE MANAGEMENT RECOMMENDS A VOTE "FOR" PROPOSALS 1,2,3, AND 4. Please mark your votes as [X] indicated in this example 1. To approve an amendment to the Company's Restated FOR AGAINST ABSTAIN Certificate of Incorporation (i) to authorize a [ ] [ ] [ ] new series of common stock called Staples.com Stock, (ii) to increase the number of authorized shares of common stock from 1,500,000,000 to 2,100,000,000, initially comprised of 1,500,000,000 shares of Staples Stock and 600,000,000 shares of Staples.com Stock, and (iii) to reclassify each outstanding share of existing common stock into a share of Staples Stock. 2. To approve the amendments to the Company's 1992 FOR AGAINST ABSTAIN Equity Incentive Plan. [ ] [ ] [ ] 3. To approve the amendments to the Company's Amended FOR AGAINST ABSTAIN and Restated 1990 Director Stock Option Plan. [ ] [ ] [ ] 4. To approve the amendments to the Company's 1998 FOR AGAINST ABSTAIN Employee Stock Purchase Plan. [ ] [ ] [ ] MARK HERE IF YOU PLAN TO [ ] MARK HERE FOR ADDRESS [ ] ATTEND THE MEETING CHANGE AND NOTE AT LEFT Signature Signature Date ------------------------------ -------------------- -------- Please sign exactly as name appears hereon. When shares are held by joint owners, both should sign. When signing as attorney, executor, administrator, trustee or guardian, please give title as such. If a corporation or a partnership, please sign by authorized person. - -------------------------------------------------------------------------------- FOLD AND DETACH HERE -----END PRIVACY-ENHANCED MESSAGE-----