Q4 2016 Real-Time Call Brief

Highlights

Total Company comps for both sales for the fourth quarter were down less than 1%.

We accelerated growth in Staples' Business Advantage, our North American contract business, with Q4 comparable sales up 4%.

We achieved non-GAAP earnings per share from continuing operations of $0.25.

We generated 2016 adjusted free cash flow of nearly $900 million well ahead of our guidance for $700 million.

Within Staples' Business Advantage our primary focus is on the $80 billion mid-market customer segment.

We continued to drive strong growth in paid membership during Q4 and ended the year with about 30,000 mid-market membership customers.

We're also leverage our success here with programs designed for smaller business customers, who shops on Staples.com and Quill.com, and we've an additional 30,000 customers signed up for these programs, bringing us to more than 60,000 total paid membership customers at the year-end.

Turning to sales beyond office supplies, these categories make up about 40% of our mid-market contract sales mix.

During Q4, we drove double-digit growth for the fourth consecutive quarter, with sales up 16% year-over-year, including a 4% tailwind from our acquisition of capital office product.

While same-store sales in North America were down 7% during Q4, our team did a great job managing the bottom line with operating income down about $7 million year-over-year.

During the fourth quarter, customer conversion in our U.S. stores increased 140 basis points and in Canada conversion was up more than 100 basis points.

We continue to drive positive same-store sales growth in our highly profitable print and marketing business, with sales up in the low single-digits in Q4.

We closed 13 stores during Q4, bringing our total store closures for the year to 48.

Over the next three years, we've more than 250 stores up for at least renewal per year in North America.

In 2017, we plan to close approximately 70 stores.

When we Staples 2020 last year, we initiated a plan to generate $300 million of annualized pretax savings by 2018.

We generated about $100 million of annualized cost savings in 2016, which was ahead of our goal of $70 million for the year.

As we move into 2017, we have a clear line of sight to about $100 million of additional savings.

Neil Ringel was promoted to President of our $10.6 billion North American delivery business.

Steve Matyas was appointed President of North American retail last year will continue to lead our $6.7 billion North American retail business.

This includes 1,255 U.S. stores and 304 Canadian stores.

Jeff was CFO at Express Scripts, where he helped transform that business, driving the growth of the company from $20 billion in revenues to $100 billion, leader in the pharmacy benefit management services.

With the sales of our European business, we have already achieved our goal to generate 95% of our sales in North America.

More than 80% of our sales will be delivered versus just over 60% today and more than 60% of our sales will come from categories beyond office supply versus less than 50% today.

Comparable sales were up 1% versus Q4 of last year.

In Staples' Business Advantage, our North American contract business fourth quarter comparable sales grew 4%.

Sales were up double-digit in facility supplies, technology product and break room supplies.

We drove high single-digit growth in furniture and mid-single digit sales growth in promotional products.

Staples' Business Advantage sales in four categories like ink and toner and tablets and office supply declined in the low single-digits.

During Q4, North American delivery operating income rate increased 10 basis points to 6.4%, and operating income rate increased $1 million year-over-year.

Turning to North America Retail, during Q4, comparable store sales declined by 7%, driven entirely by weaker traffic.

North American retail operating income rate increased 11 basis points to 6% and operating income declined $7 million versus Q4 of last year.

Total company comparable sales declined less than 1% versus Q4 of last year.

This excludes headwinds of about 150 basis points from acquisition and divestitures, over the past year; 80 basis points from store closures; and 30 basis points tailwind from the weaker U.S. dollar.

During Q4, gross profit dollars increased $7 million, versus Q4 of last year.

Gross profit rate increased 93 basis points year-over-year, to 27.1%.

Total Company SG&A increased $25 million year-over-year on a non-GAAP basis and SG&A rate increased 114 basis points year-over-year to 21.4%.

Excluding the impact of charges, total company operating income declined $18 million year-over-year to $243 million in Q4 and operating margin rate decreased 21 basis points year-over-year to 5.3%.

Our non-GAAP effective tax rate was 33.5%, which was below the non-GAAP effective tax rate of 35.5% that we've reported during the first three quarters of 2016.

In 2017, we expect our effective tax rate to remain at 33.5%.

During the fourth quarter, we achieved non-GAAP diluted earnings per share from continuing operations of $0.25, a decline of $0.01 versus Q4 of last year.

This reflects about $0.01 headwind as a result of reporting Europe, a discontinued operations and it exclude pretax charges of $791 million, primarily related to impairment of goodwill in North America region.

2016 capital expenditures came in at $255 million, a decrease of $126 million, or about 33% versus the prior year.

With operating cash flow of $934 million, our full year free cash flow was $679 million.

Keep in mind, that the $250 million breakup fee we pay to Office Depot, and cash payment of about $90 million related to Office Depot acquisition financing are included in the year to date operating cash outflows.

Excluding $210 million after tax impact to operating cash flow from the Office Depot related payments, full year adjusted free cash flow our 2017 came in at $889 million, which was well ahead of our guidance for $700 million.

We ended the year with an inventory ratio of $98 million versus Q4 at the year-end 2015.

Our liquidity remains very strong at $2.2 billion at the end of 2016.

This includes cash and cash equivalents of $1.1 billion as well as available lines of credit of $1.1 billion.

We returned $311 million to shareholders through our dividends in 2016, and we remain committed to returning excess cash to shareholders.

We expect first quarter fully diluted non-GAAP earnings per share from continuing operations in the range of $0.15 to $0.18. We expect to generate at least $500 million of free cash flow in 2017.